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Doing Your Homework – Due Diligence

  • Commercial and Business Law, Corporate Advisory
  • Christian Tager
  • No Comments
  • December 1, 2010

Doing Your Homework – Due Diligence

It may be surprising to learn that few people are aware of the vast array of tools and sources of information that are available to learn more about their suppliers, potential business partners and customers.  In an online world, this can easily flow both ways though and there may be more information available about your business than you realise.

“Due diligence” is a term with two meanings:

  • It refers to investigations which take place before making a voluntary decision (such as a signing a contract); and
  • It is a standard of care that may be legally imposed on a person or entity in measuring their compliance with an obligation (here the term is closer to “reasonable efforts”).

This article is concerned with the first sense, as it is how most people will employ the term.

Example – An Exclusive Distribution Arrangement

As an example, consider that your business is considering signing up to an exclusive distribution arrangement with an exporting manufacturer in the United States.  There are a number of questions you would consider:

  • What is the legal status of the manufacturer?  If they are incorporated, in which jurisdiction are they registered and what is their history of corporate regulatory compliance?
  • Where does the manufacturer do business?  What jurisdictions require them to hold licences or approvals and do they possess all of these?
  • What is the financial status of the manufacturer?  Have they shown any willingness to disclose recent financial reports or offer any form of further assurance?  What about their major assets?
  • What is their market reputation?  What have other customers said about them?  Do they have a good environmental and employment-related record?  Is the company involved in any litigation at the moment?
  • Does the manufacturer have the experience or do they appear to be capable of fulfiling their end of the contract?  What is their supply chain and is it exposed to market fluctuations?  If it is not apparent how the business works or sources its products, then take steps to find out.
  • As manufacturer, what is their safety reputation like?  Have there been any product recalls or major defective product claims?  Consider that the Trade Practices Act 1974 (Cth) can deem an importer to be the manufacturer (meaning that you could be stuck dealing with complaints and claims for a poorly made or defective product).
  • How has the manufacturer defined and protected its intellectual property?  Does the manufacturer rely on any patent, design or copyright licensing and are there any outstanding legal threats in this regard?  Would your business require any similar licences?

Where to Look

The internet has greatly helped to quickly reveal more information on these sorts of questions than was possible before.  Many jurisdictions now have licence, company and intellectual property registers online for conducting searches, while news reports and forum discussions can help build a picture of the businesses’ reputation and history. 

Naturally, it is important to consider the selection bias that can occur in online feedback mediums (disgruntled customers may have a higher incentive to complain compared to people who have merely had their expectations fulfilled).  A smart reader will note that information could easily be available about a business that does not have an official online presence.

However, processing the really difficult due diligence questions is a task made much easier with a good business lawyer.  While it is ultimately your decision on what to do, half the trick is knowing where to start looking.