REAL ESTATE PART IN A DUE DILIGENCE

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    INTRODUCTION

In this fast changing business world, due to globalization and cut throat competition, companies have to strive hard to achieve quality and excellence in their fields of operation. Every company has the prime objective to grow profitably. The profitable growth for the companies can be possible both internally as well as externally also called as Organic growth and Inorganic growth.

 

Organic growth is through internal strategies, which may relate to business or financial restructuring within the organization that results in enhanced customer base, higher sales, increased revenue, without resulting in change of the corporate entity.

 

Inorganic growth is through external strategies. It provides an organization with an avenue for attaining accelerated growth enabling it to skip few steps on the growth ladder. Corporate Restructuring constitutes one of the most important methods for securing inorganic growth.


In today’s globalised economy corporate restructuring schemes are being increasingly used world over as a strategy for achieving a larger asset base, for entering new markets, generating greater market share and gaining complementary strengths and competencies, to become more competitive in the marketplace and ultimately to maximize the shareholders value.

    WHAT IS CORPORATE RESTRUCTURING?

As per Oxford dictionary Restructuring means “to give a new structure to, rebuild or rearrange".

According to Prasanna Chandra “Corporate restructuring refers to a broad array of activities that expand or contract a firm’s operations or substantially modify its financial structure or bring about a significant change in its organizational structure and internal functioning.”

 

Corporate restructuring can involve making dramatic changes to a business by cutting out or merging departments. It implies rearranging the business for increased efficiency and profitability. In other words, it is a comprehensive process, by which a company can consolidate its business operations and strengthen its position for achieving corporate objectives-synergies, continuing as a competitive & successful entity and increasing shareholder value.

  




    DUE DILIGENCE

Due diligence is opposite to negligence and a generally accepted method in undertaking any Corporate Restructuring strategy. Diligence is where each party tries to learn all it can about the other party to eliminate misunderstanding and ensure that the valuation is appropriate. A positive due diligence report is a major prerequisite to any restructuring strategy. An effective due diligence should be a comprehensive analysis of the target company's entire business, not just an analysis of their cash flow and financial stability.


Good due diligence is well structured and very pro-active; trying to anticipate how customers, employees, suppliers, owners, and others will react once the restructuring is announced. Failure to perform due diligence can be disastrous. The reputation of the company can be severely damaged if an announced restructuring is called-off.

 

There are various types of due diligence:


A legal due diligence can be described as a process where a detailed investigation and analysis is performed to assess the possible legal issues facing a target company. A typical Legal Diligence answers the following two questions - What legal issues can we expect due to restructuring? What liabilities, lawsuits, and other claims are outstanding against the Target Company?

Since the focus of this article is on the Real Estate part in a Due Diligence Report, we have discussed the same below.


REAL ESTATE PART IN A DUE DILIGENCE REPORT

 

Every target company has some free hold properties, some leased out properties and some factories & warehouses, from where they conduct their business or manufacture their product. Having a complete picture of the properties of a target company is an integral exercise before entering into any transaction, from a commercial standpoint & also for determining the purchase price for the proposed target company.

 

A Legal Due Diligence is conducted mainly to verify the ownership of title over the property and to any encumbrances over the property, so as to protect one against pre-existing claims over the property, before he makes the final decision whether to consummate an acquisition, merger, or a loan transaction.

 

A proper diligence of a free hold property is done to:-

  •  Ensure whether the current owner of the property or any of the predecessor title holders of such owner is a minor or a person of unsound mind,

[If the current owner of the property is a minor, then the property cannot be purchased without the prior permission of competent authorities. Only a person appointed as a manager, by a district court under the Mental Health Act, 1987, can sell the property on behalf a person of unsound mind]

 

  • Identify the nature of current owner's right over the property,

[The types of rights that an owner can have over the property can be classified as follows:

  a. free hold or absolute ownership;

b. right of perpetual lease;

c. tenancy right; and

d. land allotted by State Government/ Central Government under various enactments]

  •   Identify the source of right or title of the current owner:

In India, a person can acquire right or title over the property in following ways:

a. By Purchase

[Verify the registered sale deeds and the title documents of the preceding title ownership holders]

b. By Inheritance

[Examine the will documents and the order of a competent court authorizing legality of the will]

c. By gift

[Scrutinize the registered gift deed or any other relevant document to give effect to the transferability of the real estate property]

d. By perceptual lease

[Examine the lease deed, parties’ rights and compliance of all the obligations in regard to transferability of such

property]

  • Identify the Encumbrances over the property:

[It is necessary to verify whether there are any encumbrances, charges, or mortgages on the properties of the target company. The records of the concerned Sub-Registrar of Properties should be examined to ensure that the properties are free from all sorts of registered encumbrances or charges or mortgages]


[If an encumbrance is created over any property which belongs to a company then such encumbrance needs to be registered with the Registrar of Companies]

 

[Further in case of an equitable mortgage or mortgage by deposit of title deeds, the acquirer requires delivery (actual or constructive) of sale deed or conveyance deed. This is to verify the authenticity of the original title deeds and to safeguard his interest by assuring non-existence of such unregistered mortgage]

  • Ensure that adequate Stamp duty is paid on purchase of property

[When the required stamp duty on a document is not paid or inadequately paid, it cannot be accepted or received in evidence. Therefore, a transaction is invalid if it is done on the basis of a document not duly stamped. Further, documents presented to any public officer will be impounded and the stamp duty will be levied with a penalty]


  • Ensure that all ROC compliances are been adhered to

[Compliances for change in Registered office as per section 12 of the Companies Act, 2013, compliances for creation, modification & satisfaction of a charge as per section 77 of the Companies Act,2013 etc]


  •  Ensure that all government approvals and authorizations are taken

[Verify that all the approvals and authorization in relation to the transaction have been procured by the competent government authorities for building & industrial approvals, insurance policies, taxes, environment compliance etc]

  • Identify any pending litigations on the properties

[There might be some pending litigation on the properties of the target company which might have adverse effect on the valuations and commercial decisions done by the acquirer]


  • A proper diligence of a leasehold property is done to:-

 

Get an overall view on different leasehold properties with the target company, for     what purpose are they used for, the period of lease, extracts of termination clauses etc

  • Ensure that adequate Stamp duty is paid on lease/license agreement of the property

[When the required stamp duty on a document is not paid or inadequately paid, it cannot be accepted or received in evidence. Therefore, a transaction is invalid if it is done on the basis of a document not duly stamped. Further, documents presented to any public officer will be impounded and the stamp duty will be levied with a penalty]


  • Ensure that any prior approval of the licensor/lessee is required due to change incontrol


[If the prior approval is not taken, it could cause a breach of agreement]

  • Ensure that any prior approval of the licensor/lessee is required due to change in management

[If the prior approval is not taken, it could cause a breach of agreement]

  •  Ensure whether the premises is used only for activities approved under the agreement

[If the property is used for any other purpose, then it could cause a breach of agreement]

  •  Ensure that prior approval of licensee/lessee is taken before subletting of the property

[If the prior approval is not taken, it could cause a breach of agreement] 

Any specific clause in the agreement affecting the proposed investors

 

SOME INSIGHTS FROM THE INDUSTRY EXPERTS

“Real Estate Due Diligence happens by bringing together all possible data relating to the property and by crossing them amongst themselves. The process of legal due diligence involves preparing a checklist in accordance with various state jurisdictions and legislations, scrutinizing litigations pending against the immovable property, encumbrances/ charges, easements and registrations/ authorizations with the competent government authorities. It brings together all the knowledge and information that is useful for the buyer to know before proceeding with the purchase.” – Utkarsha Nikam

“Legal Due Diligence in a real estate transaction is an investigation of real estate property records and anything else deemed relevant to the sale, purchase, lease or mortgage of the property. It contributes to speeding up the purchase time, gathering all the information useful for the transaction in advance.Due diligence in real estate transactions refers to reasonable measures which every individual should adapt before executing an agreement in relation to the real estate and immovable property.” – Khushwant Pawar

 

CONCLUSION

 

In view of the above, Real Estate part in a Legal Due Diligence plays a significant role for an acquirer. It is obligatory to probe and evaluate every such record or information about the real estate property which affects the transaction. The Due Diligence process must be structured and co-ordinated in such a way that the information gathered enables the buyer to make an informed decision on whether to go through with the acquisition and whether to manage any post-acquisition issues that have been identified.

"This article is written by Mr. Rohan Parikh, you can reach out to him at parikh95@gmail.com"

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