Authored By: MADHAV MALHOTRA
SYMBIOSIS LAW SCHOOL, NOIDA
Introduction
Due diligence on mergers and acquisitions is a critical safety step in commercial deals, working as a tool for analysing risks and conserving assets. The cornerstone of good deal-making in India is a careful analysis of financial obligations and regulatory compliance, where sophisticated restrictions meet changing market situations.[1] Potential deal-breakers that might be lurking beneath the surface of corporate papers or financial statements are meticulously uncovered throughout the due diligence process.[2]
Inadequate due diligence failed to detect false accounts of ₹7,136 crore before takeover negotiations, which led to the devastating collapse of Satyam Computer Services in 2009.[3] This tragedy acts as a lasting warning story.[4] By showing how financial and regulatory monitoring may influence transaction feasibility, this episode profoundly transformed the corporate governance landscape in India.[5] As SEBI tightens disclosure criteria and the Insolvency and Bankruptcy Code modifies asset valuation methodology, current M&A practice increasingly needs forensic-level review of balance sheets and compliance records.[6]
Financial Liabilities: Identifying Hidden Risks
Types of Financial Liabilities
Three basic forms of financial liabilities that demand careful attention are prevalent in current M&A negotiations. First, contingent liabilities are prospective obligations brought forth by unforeseeable future situations. These include continuing legal actions (commercial disputes, IP infringement litigation), product warranties, the expenditure of environmental cleaning, and regulatory enquiries. Second, operational lease commitments (with implications for Ind-AS 116),[7] financial guarantees for third-party debts, special purpose vehicle (SPV) obligations, and derivative contract exposures are examples of off-balance-sheet arrangements that are typically disguised from financial statements.[8] Third, tax uncertainties, such as GST input credit reversals, unresolved income tax assessments, transfer pricing disputes (especially for multinational targets), and withholding tax compliance gaps, offer specific obstacles in cross-border transactions.[9] Such liabilities must be declared under the Companies Act 2013 (Section 129) and Ind-AS 37, but practitioners frequently confront inadequate documentation, which makes due diligence more difficult.[10]
Forensic accounting procedures are essential in high-value transactions because of the Satyam scandal, which illustrated how even approved financial statements may mask large liabilities.[11] SEBI has enhanced disclosure criteria in response to previous abuses, and it now enforces better reporting of contingent liabilities in merger applications. Significant value erosion, regulatory penalties, and post-acquisition litigation may occur from erroneously appraising these duties.
Due Diligence Tools
Sophisticated due diligence tools are vital for discovering hidden financial risks in current M&A agreements. The utilisation of data analytics for anomaly detection, Benford’s Law for finding accounting abnormalities, bank statement analysis for transaction tracing, and extensive mapping of related-party transactions are all key components of forensic accounting operations. In financial document reviews, working capital trends are evaluated, debt covenant compliance is validated, cash flows are assessed for operational reality checks, and three-year audited statements with auditor comments are extensively studied.[12] Special-purpose audits, Quality of Earnings (QoE) reports, Net Working Capital (NWC) analysis, and going concern reviews under Ind-AS 1 are some of the ways that independent auditors help. These approaches evaluate asset valuation processes, revenue recognition procedures, provision sufficiency, and the identification of unrecorded liabilities. Standardised verification is required by the Institute of Chartered Accountants of India (ICAI) under SA 700 (Revised), while current practice increasingly uses AI-driven financial analysis to examine massive datasets fast and effectively, enhancing risk assessment accuracy.[13]
Case Study: Satyam Scandal
The 2009 Satyam scandal highlighted evident failures in due diligence when Tech Mahindra purchased the firm without knowing about the $1.47 billion accounting fraud conducted by Ramalinga Raju.[14] False interest income, $253 million in concealed obligations, and 5,000% inflated cash holdings were all part of the scheme. The effects were dire: Tech Mahindra’s stock plunged 35%, demanding years of reputational repair and an emergency $225 million investment. Regulators responded with vigour: ICAI tightened audit standards, the Companies Act of 2013 reinforced disclosures, and SEBI compelled auditor rotation.[15] This catastrophe gives long-lasting lessons for M&A: always utilise bank confirmations to authenticate cash balances, reconcile revenues with customer contracts, extensively analyse management histories, and require independent financial verification. The case serves as a strong reminder that high-stakes transactions demand forensic analysis even in audited financials.
Regulatory Non-Compliance In M&A: Legal Pitfalls And Mitigation Strategies
Common Compliance Risks
Significant regulatory problems are linked with mergers and acquisitions (M&A) in India, notably with relation to securities, competition, and corporate compliance. SEBI breaches are among the most crucial areas, as noncompliance with insider trading standards (PIT Regulations)[16] or inadequate disclosures under the Takeover Code (SAST Regulations) may lead to serious repercussions, such as fines and director disqualification.[17] Pending litigation is another big risk, as unresolved labour lawsuits or undisclosed intellectual property (IP) problems may lead mergers to fall through or result in unforeseen liabilities following an acquisition. The Competition Commission of India (CCI)[18] may also invalidate a merger for breaches of the Competition Act, such as unreported combinations (passing asset/turnover standards) or anti-competitive agreements.[19]
Case Study: SEBI’s Enforcement in M&A – Subhkam Ventures v. SEBI
The repercussions of regulatory non-compliance in M&A are demonstrated by the Subhkam Ventures v. SEBI case.[20] Penalties for breaching disclosure rules stemmed from the company’s failure to report creeping acquisitions that exceeded the restrictions authorised by SEBI’s Takeover Code. The necessity of timely filings under Regulation 29(2) of the SAST Regulations, which mandates disclosure of changes in ownership, was confirmed by this conclusion. The case also highlights the importance of pre-transaction legal due diligence to assure compliance and the need for continued monitoring of ownership patterns to prevent unintended infringement. This verdict serves as a reminder to acquirers to rigorously watch regulatory thresholds and ensure transparency in commercial transactions as SEBI tightens enforcement.[21]
Best Practices for Risk Mitigation in M&A
In order to avoid legal and regulatory risks in M&A negotiations, organisations need to employ a methodical, three-phase procedure. To notice such red signals early, complete due diligence checklists should cover all critical regulatory elements throughout the pre-deal process, such as SEBI compliance, CCI thresholds, FEMA guidelines, tax requirements, and labour law adherence.[22] To discover hidden liabilities like ongoing litigation or unreported transactions, objective third-party audits of financial and legal data are needed. Last-minute transaction derailments may also be prevented by acquiring the requisite pre-clearances from authorities (SEBI for securities compliance, CCI for competition approvals, and RBI for foreign investment regulations).
Financial safeguards are given throughout the deal structuring process by protective measures such as robust indemnification agreements that cover pre-existing compliance infractions and escrow accounts that retain 10-15% of consideration for indemnity claims.[23] An extra degree of protection is offered by making closure subject to regulatory permissions. Integration audits undertaken after closure make sure that new regulatory frameworks are being followed, and staff are being taught about their upgraded compliance duties via specialist training programs.[24]
Conclusion
India has a convoluted regulatory framework for mergers and acquisitions (M&A), and noncompliance may have major ramifications, such as financial penalties and deal failure. Potential SEBI violations (including insider trading or inadequate disclosures under the Takeover Code), the Competition Commission of India’s (CCI) investigation of anti-competitive activity, and unreported litigation that might surface after a deal are the primary regulatory issues. In order to limit these risks, acquirers need to put in place a robust risk management strategy that includes extensive due diligence to discover hidden liabilities, well-written contractual safeguards including escrow agreements and indemnification provisions, and frequent post-closing compliance checks. Navigating India’s shifting regulatory environment demands a proactive approach that involves legal compliance at every stage, from early due diligence to final integration.
Reference(S):
[1] DENNIS J. BLOCK ET AL., THE BUSINESS JUDGMENT RULE: FIDUCIARY DUTIES OF CORPORATE DIRECTORS 327-30 (6th ed. 2009).
[2] Ronald J. Gilson, The Value of M&A Due Diligence in a Global Market, 28 YALE J. REG. 163, 168-71 (2011).
[3] Securities and Exchange Board of India v. Satyam Computer Services Ltd., [2015] 124 SCL 216 (SAT).
[4] Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011, reg. 12.
[5] Companies Act, 2013, §232, No. 18, Acts of Parliament, 2013.
[6] Insolvency and Bankruptcy Code, 2016, §29A, No. 31, Acts of Parliament, 2016.
[7] Ind AS 37, Provisions, Contingent Liabilities and Contingent Assets (2016).
[8] PRICEWATERHOUSECOOPERS, INDIA ACCOUNTING STANDARDS: A COMPREHENSIVE GUIDE 187-90 (2021 ed.).
[9] Central Goods and Services Tax Act, 2017, §16, No. 12, Acts of Parliament, 2017.
[10] .S. DATEY, INDIRECT TAXES LAW AND PRACTICE 345-48 (2023 ed.).
[11] S. Burks, The Satyam Scandal: A Case Study of India’s Enron, 12 J. FORENSIC ACCT. 45, 50-53 (2011).
[12] MARTIN D. GINSBURG & JACK S. LEVIN, MERGERS, ACQUISITIONS, AND BUYOUTS ¶9.03[2] (2023 ed.).
[13] ICAI, SA 700 (Revised), Forming an Opinion and Reporting on Financial Statements (2021).
[14] Securities and Exchange Board of India v. Ramalinga Raju, [2014] 121 SCL 1 (SAT).
[15] ICAI Disciplinary Committee Report on Satyam (2009).
[16] SEBI (Prohibition of Insider Trading) Regulations, 2015, reg. 3.
[17] SEKHAR GHOSH, SEBI LAWS & REGULATIONS MANUAL 145-48 (2023 ed.).
[18] Competition Act, 2002, §6, No. 12, Acts of Parliament, 2003.
[19] CCI v. Thomas Cook (India) Ltd., Case No. 50 of 2013 (CCI Order 2013).
[20] Subhkam Ventures (I) Pvt. Ltd. v. SEBI, [2010] 102 SCL 247 (SAT)
[21] Sandeep Parekh, Creeping Acquisitions and Disclosure Norms, 7 NUJS L. REV. 421, 428-30 (2014).
[22] ICAI, DUE DILIGENCE STANDARDS FOR M&A TRANSACTIONS 34-37 (2022).
[23] Companies (Meetings of Board and its Powers) Rules, 2014, rule 18.
[24] Priya Lele, Post-Merger Integration Challenges in India, 15 CORP. GOVERNANCE INT’L 89, 94-96 (2021).
