Due Diligence on a Distressed Claim: A Buyer's Checklist

A buyer of a distressed debt takes the claim as it finds it. If the documents are defective, the security is unregistered or the limitation period has run, the buyer owns the problem. Due diligence is the work of finding these defects before the price is agreed. This note lists what a careful buyer, or a lender preparing to sell, should examine. It is general information, not advice on a particular transaction.

The claim

1. The origin. The loan or supply agreement, any amendment, the sanction letter and the board or credit approvals. Check that the lender or supplier had the authority to enter into it and that the borrower had the authority to borrow.
2. The amount. The statement of account from the start, with every drawing, repayment, charge and interest entry. For a bank, a certified copy under the Bankers' Books Evidence Act, 1891. Recompute the balance.
3. The default. The date of the first default, the date the account became non-performing and the notices of recall.
4. Limitation. The date from which time runs, any acknowledgments or part-payments in writing that restart it, and the remaining period.

The security and the guarantees

• The mortgage deeds, hypothecation agreements and pledges, and evidence that each was properly executed, stamped and, where required, registered.
• A search of the Registrar of Companies records for the charges registered by the borrower, and of the Central Registry of Securitisation Asset Reconstruction and Security Interest (CERSAI) for security interests registered by lenders.
• The title to the secured property, with a search at the sub-registrar's office for the title history and encumbrances, and the land or municipal records.
• The guarantees, whether they are current, whether the guarantors consented to changes made since and whether the invocation requirements have been met.

Proceedings

A list of every proceeding connected with the debt: suits, applications before the Debts Recovery Tribunal, the National Company Law Tribunal, arbitration, cheque complaints and appeals, with the stage reached and any orders of stay. The buyer should know of any order that affects enforcement, and of any counterclaim or defence that has been pleaded.

The borrower

• The corporate records from the Ministry of Corporate Affairs: directors, filings, charges, and the latest financial statements.
• The existence of other creditors and proceedings against the borrower, including any insolvency application.
• The condition of the business, the assets it holds and whether they are being preserved.
• The results of the search for other assets, as described in the note on asset searches.

The chain of title

If the debt has been assigned before, each assignment must be examined for a signed written instrument under Section 130 of the Transfer of Property Act, payment of stamp duty and, for a bank sale, compliance with the applicable Reserve Bank guidelines. A gap in the chain is a gap in the buyer's title.

The sale terms

• Representations and warranties from the seller that the debt is valid, the amount is correct, the security is enforceable and there are no undisclosed defences or payments.
• A remedy if a representation is wrong, such as repurchase or a price adjustment.
• An obligation on the seller to deliver the original documents and to cooperate in the pending cases, including the substitution of the buyer as a party.
• An agreed allocation of recoveries in the period between the cut-off date and completion.

Reporting the findings

The result of the review should be a written report that lists the defects, rates their effect on value and recommends how to deal with them. Some can be cured before completion, by registering a charge or obtaining a signed acknowledgment. Others are reasons to reduce the price or to decline the purchase. A buyer who has seen the defects at the start can price them. A buyer who finds them afterwards can only bear them.