Law DUE DILIGENCE

The phrase “due diligence” is familiar to most people in the business world, but how many people really know what it means? To the average business person, the phrase indicates an extensive, comprehensive and all exposing investigation into the affairs of his own or another person’s business which arises in the process of doing a securities underwriting or with respect to a proposed takeover purchase of an interest in another business. At law, these meanings are just two of several that apply to the phrase. As a generality, “due diligence” involves or relates a procedure carried out by a person to protect his backside. As indicated above, in a takeover or substantial investment situation, “due diligence” means taking as close a look as possible at the target corporation. It does not, however, mean that the acquiring corporation can or should be expected to obtain non- public or “inside” information, as to do so the acquiring corporation has to contact the target and obtain its co-operation and consent. Obviously, such contact results in the intent of the acquiring corporation being revealed to the target (and quite possibly, through rumor or “leak,” to the public) and, also, it means that the acquiring corporation will be acquiring confidential or “insider” information under securities legislation. In a takeover situation, the offering materials are substantially different between the situations where the acquiring corporation has chosen to rely solely upon the publicly available information and where it has acquired non-public information. The latter is far more extensive and must be prepared so that the shareholders of the target corporation to whom the offer is being made are fully informed and not misled. On the other hand, if only publicly available information is used by the acquiring corporation to inform itself of the target, then an offer may be made quickly, without concern that any “inside” information acquired has been properly dealt with or that a leak to the public will cause a price rise in the shares of the target before the offer is made. The obvious danger is that the public files may not be up to date or accurate. In these two cases, the “due diligence” phrase certainly means a thorough investigation of the target corporation, but the investigations are of an entirely different nature in each case. It is a corporate decision of the acquiring corporation which route it wishes to take, and both are common.

In a case where an underwriting is concerned, “due diligence” is the process whereby the underwriter and the professional advisers to both the corporation issuing securities and the underwriter carry out a thorough investigation of the issuer’s affairs to make certain that full, true and plain disclosure has been made in the prospectus, and that there are no misrepresentations or incorrect statements in the prospectus. In this case, “due diligence” is carried out to protect the parties involved and particularly those that have to sign the prospectus.

There is also a legal defence of “due diligence.” In general, this defence is pleaded in a situation where a party under investigation is claiming that it did everything reasonable in the circumstances to avoid the matter under investigation arising. The defence is a common one where it is claimed that a party did not fulfil its obligations under the law.

The various obligations under the Environmental Protection Act (EPA) offer a good example of the legal defence of “due diligence.” Under the EPA, directors and senior officers of a corporation have a statutory duty to see that their corporation has an “environmental plan” in carrying out its operations so as to avoid contaminating the environment and, in addition, if an incident occurs, a plan for dealing with that incident. If the directors or senior officers do not fulfil this obligation, they may be held to be guilty of an offence under the EPA. If a director of a corporation was charged under this part of the EPA, he or she could well plead the defence of “due diligence” on the basis that his or her actions as a director were reasonable in the circumstances and satisfied the statutory obligation. If, as part of this defence, he or she could show involvement in the formulation and implementation of an “environmental plan” at the board-of-directors level, then even if the corporation was held not to have adopted such a plan the director could well be acquitted on the basis of “due diligence.” Obviously, in a defence such as this, the more a director could show that he or she had done, the better. In addition, if the director knew that the plan was not being implemented and did nothing about it, the defence could be lost. Although the courts could hardly expect a director to “roll up his sleeves” and take over direct operations of the corporation, he or she must take reasonable steps in the circumstances and in his or her capacity as a director or officer to satisfy the court that the defence of “due diligence” is appropriate and that acquital is called for.

Many other examples of “due diligence” can be given, but from the foregoing it can be seen that it is not a phrase that can be bantered around indiscriminately. Some thought should be given to the circumstances of its use, and its meaning very definitely depends upon such circumstances. Karl J. C. Harries is a graduate mining engineer and partner with the Toronto law firm of Fasken & Calvin. The information in this article is summary and general in nature and is not intended to be taken or acted upon as legal advice.