Transaction Due Diligence
One of the parameters of good corporate governance is successful business risk management.
Conducting a thorough due diligence exercise before engaging in a domestic or international transaction is one of the most effective ways to manage and mitigate risks in trade and commerce. This form of due diligence is referred to as a Transaction Due Diligence and includes evaluating the authenticity of the parties involved and the terms of a business deal.
During the process of conducting transaction due diligence, coming across data that appears incongruent or unusual given the specific situation is commonly termed a "Red Flag." Essentially, Red Flags encompass any factors that make you hesitate or provoke doubts regarding the authenticity of the individual or organization you are contemplating to transact with.
The identification of Red Flags, like all aspects of transaction due diligence assessments, should occur BEFORE entering into a business deal, and this process should be repeated when transacting with a new party (especially so when the party is based in a foreign jurisdiction). Red Flags can potentially surface at any stage of a transaction. When Red Flags are raised, it is crucial that you examine the situation thoroughly and decide whether the transaction can proceed, needs further scrutiny, or should be halted to avoid getting involved in a prohibited transaction or with a restricted party. In the event you decide to proceed with the transaction, it may be prudent to have in place security measures such as (amongst others):
- Obtaining a comprehensive list of representations and warranties from the other party;
- Insisting on a performance bank guarantee (as the case may be);
- Collecting upfront payments in excess of the typical amount collected in the industry applicable to the transaction;
- Insisting for applicable insurances to be maintained by the other party and for certified copies of such insurances to be appended to the contract
- Strong risk-shifting provisions (indemnity clauses)
The following non-exhaustive list outlines several typical scenarios that should raise concerns during a transaction. These instances may or may not serve as clear Red Flags for a specific transaction. It boils down to the party contemplating the transaction to thoroughly examine any elements unique to that particular deal to ascertain the authenticity of the terms and the parties involved. This becomes especially crucial when dealing with an entity that is unfamiliar to you or your company.
Where the party is a Malaysian incorporated corporate entity, a search on it at the Companies Commission of Malaysia (SSM) bears no result; or there is inconsistency between the name of the company reflected in the search and the name it trades as; principal activity(ies) of the entity as per the search result is different from what it represents to carry out;
SSM search shows that the entity is a dormant entity;
Where the company is a foreign entity, such entity's address is unverifiable/incomplete/untrue;
Use of personal webmail email accounts instead of a corporate email address;
The industry category of the entity appears inconsistent with the nature of the transaction (e.g., a chemical manufacturer buying aircraft components or a fruit juice manufacturer acquiring industrial lasers)
The representative of the entity shows an inability or reluctance to furnish straightforward responses to standard commercial or technical inquiries typical in the anticipated business deal;
The entity requests for shipment of goods to be made via a country categorised as a diversion risk or is geographically totally unrelated to the entity’s home country;
Unusual payment terms, such as demands for cash payments, wire transfers to a foreign bank, or funding from multiple unconventional sources;
The final shipment destination is indicated as the address of a freight forwarder or broker;
Requests by the entity to engage individuals in transactions that typically involve government entities;
A request for uncommon or excessive secrecy regarding the transaction's details or the entities involved;
Sudden or unexplained urgency, along with last-minute requests for changes to the transaction
Where a trust or private investment firm participating in the transaction cannot or is unwilling to furnish details about those who control it or its beneficiaries;
Inquiries by the entity are typically made outside of normal business channels;
Demands for unusual labelling or packaging of goods without showing proof of regulatory requirements;
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