View source for Due diligence

{{Short description|Standard of care before entering into a contract with another party}}
{{Other uses|Diligence (disambiguation)}}
{{Use mdy dates|date=April 2013}}
{{Globalize|article|USA|2name=the United States|date=October 2016}}
{{Companies law}}

'''Due diligence''' is the investigation or exercise of care that a reasonable business or person is normally expected to take before entering into an agreement or [[contract]] with another party or an act with a certain [[standard of care]].

Due diligence can be a [[legal obligation]], but the term more commonly applies to voluntary investigations. It may also offer a [[defense (legal)|defence]] against legal action. A common example of due diligence is the process through which a potential acquirer evaluates a target company or its assets in advance of a [[Mergers and acquisitions|merger or acquisition]].<ref>{{cite book |last1=Hoskisson |first1=Robert E. |last2=Hitt |first2=Michael A. |last3=Ireland |first3=R. Duane |year=2004 |title=Competing for Advantage |location=Mason, OH |publisher=South-Western/Thomson Learning |page=251 |isbn=0-324-27158-1 }}</ref> The theory behind due diligence holds that performing this type of investigation contributes significantly to informed decision making by enhancing the amount and quality of information available to decision makers and by ensuring that this information is systematically used to deliberate on the decision at hand and all its costs, benefits, and risks.<ref>{{cite book |last=Chapman |first=C. E. |year=2006 |title=Conducting Due Diligence |publisher=[[Practicing Law Institute]], New York, NY }}</ref>

==Development of the term==
The term "due diligence" can be read as "required carefulness" or "reasonable care" in general usage, and has been used in the literal sense of "requisite effort" since at least the mid-[[fifteenth century]].<ref>{{citation |title='Due Diligence' Merriam-Webster entry |url=https://www.merriam-webster.com/dictionary/due%20diligence}}</ref> It became a specialized [[legal term]] and later a common business term due to the United States' [[Securities Act of 1933]], where the process is called "reasonable investigation". Under Section 11b3, a person could avoid liability for an untrue statement of a material fact if they had, "after reasonable investigation, reasonable ground to believe and did believe, at the time", the truth of the statement.<ref>[https://www.govinfo.gov/content/pkg/COMPS-1884/pdf/COMPS-1884.pdf Securities Act of 1933] Section 11(b)(3), accessed 11 July 2023</ref> The defense at Section 11, referred to later in legal usage as the "due diligence" defense, could be used by [[broker-dealer]]s when accused of inadequate disclosure to investors of material information with respect to the purchase of [[securities]]. In legal and business use, the term was soon used for the process itself instead of how it was to be performed, so that the original expressions such as "exercise due diligence in investigating" and "investigation carried out with due diligence" were soon shortened to "due diligence investigation" and finally "due diligence".

As long as broker-dealers exercised "due diligence" (required carefulness) in their investigation into the company whose [[capital stock|equity]] they were selling, and as long as they disclosed to the investor what they found, they would not be found liable for non-disclosure of information that was not discovered in the process of that investigation.

The broker-dealer community quickly institutionalized,{{when|date=July 2023}} as a standard practice, the conducting of due diligence investigations of any stock offerings in which they involved themselves. Originally the term was limited to public offerings of equity investments, but over time it has become associated with investigations of private [[mergers and acquisitions]] (M&A) as well.

== Examples ==
=== Business transactions and corporate finance ===
Due diligence takes different forms depending on its purpose:
# The examination of a potential target for merger, acquisition, [[privatization]], or similar [[corporate finance|corporate]] [[finance transaction]] normally by a buyer. (This can include self due diligence or "reverse due diligence", i.e. an assessment of a company, usually by a third party on behalf of the company, prior to taking the company to market.)
# A reasonable investigation focusing on material future matters.
# An examination being achieved by asking certain key questions, including, how do we buy, how do we structure an acquisition, and [[Business valuation|how much do we pay]]?
# An investigation of current practices of process and policies.
# An examination aiming to make an acquisition decision via the [[investment theory|principles of valuation]] and shareholder value analysis.<ref name="Gillman">{{cite book | last=Gillman | first=Luis | year=2010 | title= Due Diligence, a Strategic and Financial Approach | edition=2nd |publisher=LexisNexis |location=Durban |isbn=978-0-409-04699-1 }}</ref>

A due diligence process can be divided into nine distinct areas:<ref name="Gillman"/>

{{Div col}}
# Compatibility audit.
# [[Financial audit]].<ref name="Harvey">{{cite journal |last1=Harvey |first1=M. G. |last2=Lusch |first2=R. F. |year=1995 |title=Expanding the Nature and Scope of Due Diligence |journal=Journal of Business Venturing |volume=10 |issue=1 |pages=5–21 |doi=10.1016/0883-9026(94)00020-U }}</ref><ref name="Kroener">{{cite journal |last1=Kroener |first1=P. H. |last2=Kroener |first2=M. H. |year=1991 |title=Towards more successful Mergers and Acquisitions |journal=International Journal of Technology Management |volume=6 |issue=1/2 |pages=33–40 |doi=10.1504/IJTM.1991.025872 |doi-broken-date=July 12, 2025 }}</ref>
# Macro-environment audit.<ref name="Harvey"/><ref name="Kroener"/>
# Legal/environmental audit.<ref name="Harvey"/><ref name="Kroener"/><ref>{{cite journal |last1=Scott Feeley |first1=Michael |last2=Potash |first2=Aron |title=The Oft-Overlooked Importance of Air Emission Credits in M&A |url=https://www.transactionadvisors.com/insights/oft-overlooked-importance-air-emission-credits-ma |journal=Transaction Advisors |issn=2329-9134 |access-date=July 21, 2015 |archive-date=January 5, 2019 |archive-url=https://web.archive.org/web/20190105201349/https://www.transactionadvisors.com/insights/oft-overlooked-importance-air-emission-credits-ma |url-status=dead }}</ref>
# Marketing audit.<ref name="Harvey"/><ref name="Kroener"/>
# Production audit.<ref name="Harvey"/><ref name="Kroener"/>
# Management audit.<ref name="Harvey"/><ref name="Kroener"/>
# Information systems audit.<ref name="Harvey"/><ref name="Kroener"/>
# Reconciliation audit.
 {{Div col end}}

It is essential that the concepts of valuations (shareholder value analysis) be considered in a due diligence process. This is in order to reduce the number of failed mergers and acquisitions.<ref name="Gillman"/>

In this regard, two new audit areas have been incorporated into the Due Diligence framework:<ref name="Gillman"/>
* the Compatibility Audit which deals with the strategic components of the transaction and in particular the need to add shareholder value and
* the Reconciliation audit, which links/consolidates other audit areas together via a [[Valuation (finance)|formal valuation]] in order to test whether shareholder value will be added.<ref name="Gillman"/>

The relevant areas of concern may include the financial, legal, labor, tax, IT, environment and market/commercial situation of the company. Other areas include intellectual property, real and personal property, insurance and liability coverage, debt instrument review, employee benefits (including the [[Affordable Care Act]]) and labor matters, immigration, and international transactions.<ref>{{cite journal |last1=Truax |first1=Margret |title=M&A Transactions: Affordable Care Act Due Diligence Considerations |url=https://www.transactionadvisors.com/insights/ma-transactions-affordable-care-act-due-diligence-considerations |journal=Transaction Advisors |issn=2329-9134 |access-date=May 23, 2016 |archive-date=December 23, 2017 |archive-url=https://web.archive.org/web/20171223042533/https://www.transactionadvisors.com/insights/ma-transactions-affordable-care-act-due-diligence-considerations |url-status=dead }}</ref><ref>Gary M. Lawrence, Due Diligence in Business Transactions, ([[American Lawyer Media|Law Journal Press]] 1994, updated as needed). {{ISBN|978-1-58852-066-1}}.</ref><ref>{{cite journal |last1=Tanenbaum |first1=William |title=Avoiding IP Business Risks in Corporate Transactions |url=https://www.transactionadvisors.com/insights/avoiding-ip-business-risks-corporate-transactions |journal=Transaction Advisors |issn=2329-9134 |access-date=July 23, 2015 |archive-date=December 22, 2017 |archive-url=https://web.archive.org/web/20171222105249/https://www.transactionadvisors.com/insights/avoiding-ip-business-risks-corporate-transactions |url-status=dead }}</ref> Areas of focus in due diligence continue to develop with [[cybersecurity]] emerging as an area of concern for business acquirers.<ref>{{cite journal |last1=Cunard |first1=Jeffrey |last2=Pastore |first2=James |last3=Ford |first3=Christopher |title=Cybersecurity: Evaluating Transactional Risk |url=https://www.transactionadvisors.com/insights/cybersecurity-evaluating-transactional-risk |journal=Transaction Advisors |issn=2329-9134 |access-date=July 21, 2015 |archive-date=December 23, 2017 |archive-url=https://web.archive.org/web/20171223042503/https://www.transactionadvisors.com/insights/cybersecurity-evaluating-transactional-risk |url-status=dead }}</ref> Risk is a key factor in determining 'duty of care'.<ref>{{Cite web |date=2022 |title=Duty of Care Risk Analysis Standard |url=https://www.docra.org/standard |website=DoCRA}}</ref> Regulations require 'reasonable security' in cybersecurity programs, and litigators examine whether 'due care' was practiced. Due diligence findings impact a number of aspects of the transaction including the purchase price, the [[Contract#Representations versus warranties|representations and warranties]] negotiated in the transaction agreement, and the [[indemnification]] provided by the sellers.

Due Diligence has emerged as a separate profession for accounting and auditing experts and is typically referred to as Transaction Services.{{explain|date=July 2023}}

===Legislation===
{{main|Foreign Corrupt Practices Act|Bribery Act 2010}}
With the number and size of penalties increasing, the United States' [[Foreign Corrupt Practices Act]] (FCPA) has caused many U.S. institutions to look into how they evaluate all of their relationships overseas. The lack of a due diligence of a company's agents, vendors, and suppliers, as well as merger and acquisition partners in foreign countries could lead to doing business with an organization linked to a [[foreign official]] or state owned enterprises and their executives. This link could be perceived as leading to the bribing of the foreign officials and as a result lead to noncompliance with the FCPA. Due diligence in regard to FCPA compliance is required in two aspects:

# Initial due diligence – this step is necessary in evaluating what risk is involved in doing business with an entity prior to establishing a relationship and assesses risk at that point in time.
# Ongoing due diligence – this is the process of periodically evaluating each relationship overseas to find links between current business relationships overseas and ties to a [[foreign official]] or illicit activities linked to corruption. This process will be performed indefinitely as long as a relationship exists, and usually involves comparing the companies and executives to a database of foreign officials. This process should be performed on all relationships regardless of location<ref>{{cite web |url=http://www.worldcompliance.com/fcpa-definition.html |title=FCPA Definition - Foreign Corrupt Practices Act |access-date=2010-01-07 |url-status=dead |archive-url=https://web.archive.org/web/20100830160102/http://worldcompliance.com/fcpa-definition.html |archive-date=August 30, 2010 |df=mdy }} WorldCompliance.com</ref> and is often part of a wider [[Integrity Management]] initiative.{{failed verification|date=November 2011}}

In the M&A context, buyers can use the due diligence phase to integrate a target into their internal FCPA controls, focusing initial efforts on necessary revisions to the target's business activities with a high-risk of corruption.<ref>{{cite journal |last1=Brooks |first1=Robin |last2=Stacey |first2=Oliver |last3=Jarman |first3=Daniel |title=Tackling Corruption and Regulatory Risk in M&A Transactions |url=https://www.transactionadvisors.com/insights/tackling-corruption-and-regulatory-risk-ma-transactions |journal=Transaction Advisors |issn=2329-9134 |access-date=July 21, 2015 |archive-date=October 18, 2015 |archive-url=https://web.archive.org/web/20151018015812/https://www.transactionadvisors.com/insights/tackling-corruption-and-regulatory-risk-ma-transactions |url-status=dead }}</ref>

While financial institutions are among the most aggressive in defining FCPA best practices, manufacturing, retailing and energy industries are highly active in managing FCPA compliance programs.

In the United Kingdom, the [[Bribery Act 2010]] requires companies using an "adequate procedures" defence to a charge of bribery to have undertaken due diligence on their business partners. Due diligence is described as "knowing exactly who you are dealing with". Official guidance suggests that "ask[ing] a few questions and do[ing] a few checks" can help to protect an organisation from taking on untrustworthy partners.<ref>[[Ministry of Justice (United Kingdom)|Ministry of Justice]], [https://assets.publishing.service.gov.uk/media/5d80cfd5ed915d5257b5b693/bribery-act-2010-quick-start-guide.pdf The Bribery Act 2010: Quick Start Guide], accessed 24 December 2023</ref>

===Human rights===
Passed on May 25, 2011, the [[OECD]] member countries agreed to revise their guidelines promoting tougher standards of corporate behavior, including human rights. As part of this new definition, they utilized a new aspect of due diligence that requires a corporation to investigate third party partners for potential abuse of human rights.

The [[OECD Guidelines for Multinational Enterprises]] (a government-backed international agreement that provides guidance on responsible business conduct) state that multinational enterprises will "Seek ways to prevent or mitigate adverse human rights impacts that are directly linked to their business operations, products or services by a business relationship, even if they do not contribute to those impacts".<ref>[http://www.oecd.org/dataoecd/43/29/48004323.pdf] {{webarchive|url=https://web.archive.org/web/20110904230329/http://www.oecd.org/dataoecd/43/29/48004323.pdf|date=September 4, 2011}}</ref>

The term 'due diligence' was originally put forward in this context by UN Special Representative for Human Rights and Business [[John Ruggie]], who used it as an umbrella to cover the steps and processes by which a company understands, monitors and mitigates its human rights impacts. [[Human Rights Impact Assessment]] is a component of this.

The UN formalized guidelines for Human Rights Due Diligence on June 16, 2011, with the endorsement of Ruggie's Guiding Principles for Business and Human Rights.<ref>{{cite web|url=https://digitallibrary.un.org/record/705860/files/A_HRC_17_31-EN.pdf |title= Report of the Special Representative of the Secretary-General on the issue of human rights and transnational corporations and other business enterprises, John Ruggie|publisher=Human Rights Council|access-date=May 21, 2021}}</ref>

=== Civil litigation ===
{{norefs|section|date=July 2023}}
Due diligence in civil procedure is the idea that reasonable investigation is necessary before certain kinds of [[judicial relief|relief]] are requested. For example, duly diligent efforts to locate and/or serve a party with civil process is frequently a requirement for a party seeking to use means other than [[service of process|personal service]] to obtain jurisdiction over a party. Similarly, in areas of the law such as [[bankruptcy]], an attorney representing someone filing a bankruptcy petition must engage in due diligence to determine that the representations made in the bankruptcy petition are factually accurate. Due diligence is also generally prerequisite to a request for relief in states where civil litigants are permitted to conduct pre-litigation discovery of facts necessary to determine whether or not a party has a factual basis for a cause of action.

In civil actions seeking a foreclosure or seizure of property, a party requesting this relief is frequently required to engage in due diligence to determine who may claim an interest in the property by reviewing public records concerning the property and sometimes by a physical inspection of the property that would reveal a possible interest in the property of a tenant or other person.

Due diligence is also a concept found in the civil litigation concept of a [[statute of limitations]]. Frequently, a statute of limitations begins to run against a plaintiff when that plaintiff knew or should have known had that plaintiff investigated the matter with due diligence that the plaintiff had a claim against a defendant. In this context, the term "due diligence" determines the scope of a party's [[constructive knowledge]], upon receiving notice of facts sufficient to constitute "inquiry notice" that alerts a would-be plaintiff that further investigation might reveal a cause of action.

=== Criminal law ===
In [[criminal law]], due diligence is the only available defense to a crime that is one of [[strict liability]] (i.e., a crime that only requires an [[actus reus]] and no [[mens rea]]). Once a criminal offence is proven, the defendant must prove on balance that they did everything possible to prevent the act from happening. It is not enough that they met the normal [[standard of care]] in their industry – they must show that they took every reasonable precaution.

The term "due diligence" is also used in criminal law to describe the scope of the duty of a prosecutor to make efforts to turn over potentially [[exculpatory evidence]] to (accused) criminal defendants.{{cn|date=December 2024}}

In criminal law, "due diligence" also identifies the standard a prosecuting entity must satisfy in pursuing an action against a defendant, especially with regard to the provision of the Federal and State Constitutional and statutory right to a speedy trial or to have a warrant or detainer served in an action. In cases where a defendant is in any type of custodial situation where their freedom is constrained, it is solely the prosecuting entity's duty to ensure the provision of such rights and present the citizen before the court with jurisdiction. This also applies where the respective judicial system and/or prosecuting entity has current address or contact information on the named party and said party has made no attempt to evade notice of the prosecution of the action.<ref>Hawaii Revised Statues 353-66.5 and 604-7.2</ref>

==Due diligence defence==
In the United Kingdom, "proper use of a due diligence system" may be used as a defence against a charge of breach of regulations: for example, under the Timber and Timber Products (Placing on the Market) Regulations 2013<ref name=timber>[http://www.legislation.gov.uk/uksi/2013/233/pdfs/uksi_20130233_en.pdf Timber and Timber Products (Placing on the Market) Regulations 2013, SI 233/2013]</ref> and the Environmental Protection (Microbeads) (England) Regulations 2017,<ref>[http://www.legislation.gov.uk/uksi/2017/1312/pdfs/uksi_20171312_en.pdf Environmental Protection (Microbeads) (England) Regulations 2017, SI 1312/2017]</ref> businesses may be able to defend a charge of non-compliance with regulations if they can show that they have undertaken supplier due diligence to a necessary standard. References to "due diligence" and the maintenance of a "due diligence system" in the regulation concerning timber are drawn from the [[European Union]]'s Regulation 995/2010, which covers the legal obligations of "operators who place timber and timber products on the market".<ref name=timber />

==See also==
{{Div col}}  
* [[Bias ratio (finance)]]
* [[Data room]], [[Virtual data room]]
* [[Duty of care]]
* [[Hydropower Sustainability Assessment Protocol]]
* [[Integrity management]]
* [[Management due diligence]]
* [[Model audit]]
* [[Non-disclosure agreement]]
* [[Operational due diligence]] (ODD)
* [[Standard of care]]
* [[Vetting]] 
{{Div col end}}

==References==
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{{law}}
{{Authority control}}

{{DEFAULTSORT:Due Diligence}}
[[Category:Corporate finance]]
[[Category:American legal terminology]]
[[Category:Criminal law]]
[[Category:Contract law]]
[[Category:Business terms]]
[[Category:Mergers and acquisitions]]