9.1 Introduction

Due diligence is the duty of care. It can be broadly defined as a collection of procedures employed by an entity that are used to obtain sufficiently reliable information about another entity with which the primary entity intends to enter into a business transaction.

Carrying out a due diligence requires a significant investment of time, and resources. India does not have a law which deals strictly with how the due diligence process must be carried out, but rather, due diligence is tied into the concept of notice. Under Section 3 of the Transfer of Property Act 1882:

While due diligence is not spoken of explicitly in Indian law, it does find mention under the Securities and Exchange Board of India (Mutual Funds) Regulations 1996. Further, Section 24 of the Securities Contract Regulation Act 1956, Section 27 of the Securities and Exchange Board Act 1992, and Section 278B of the Income Tax Act 1961, contain a standard proviso to the sub-section relating to offences committed by companies which states:

The inference that may be drawn from the above is based on the principle of caveat emptor or buyer beware. In the context of due diligence, the principle puts the onus on the person entering a business transaction to take adequate precautions before entering such transaction or venture. If a person proves that he has exercised due diligence in the conduct of his business, then he will be held harmless from any legal action or liability.

9.2 Sources utilised prior to due diligence

Looking into a number of sources prior to the commencement of any transaction or the process of due diligence will give the foreign entity a preliminary insight into the affairs of the service provider/contract manufacturing organisation (CMO). These sources include:

9.3 Areas of due diligence

The main purpose of a due diligence is to obtain information or any fact which may affect key business decisions in a proposed transaction.

There are certain basic objectives which should be borne in mind while collecting and sorting data, to ensure the quality of such data. These include the following:

The importance of due diligence in the biopharma industry cannot be underestimated. The industry is a highly regulated one and the spectrum of approvals and certifications required, as discussed in previous chapters, before the commencement of production of drugs or the conducting of clinical trials is a wide one. When carrying out a due diligence, it must be ensured that the service provider/CMO has all these requisite approvals and certifications. Furthermore, it should be noted which of these is near expiry and identify the process of renewal.

The compliance record of the service provider/CMO should be closely scrutinised. This would entail looking into whether there is any outstanding litigation³ faced by the service provider/CMO or whether sanctions or penalties have been levied against the service provider/CMO by any governmental authority.

In assessing the capacity of a service provider/CMO in successfully carrying out its obligations, a detailed review of the infrastructure available to it and contracts with other companies will provide the foreign entity with an understanding of the service provider/CMO’s competence and experience in the relevant field. The contracts and fulfilment thereof will provide information on whether the products were delivered on time, the reasons for any delay and what steps were taken to resolve any issues.

The service provider/CMO may be a listed company. If this is the case, due diligence should look into the service provider/CMO’s compliance with the various regulations promulgated by the Securities and Exchange Board of India (SEBI) which include the takeover code, insider trading regulations, the listing agreement and circulars issued by SEBI from time to time.

While assessing the service provider/CMO, a key aspect is the profile of the employees on its rolls. Quality employees will translate into quality work. It is, therefore, imperative that the service provider/CMO has experienced employees with the requisite qualifications. Experience in large companies not only means a suitable depth of knowledge but also a greater understanding of the regulatory environment and what is required to take drugs through the approval process. On the other hand, experience in smaller companies may give an employee an edge in understanding what it takes to work within a tight budget and on short time lines because of these budget constraints.⁴ It is also essential that the employees execute appropriate confidentiality and non-compete agreements, and IP rights deeds in favour of the service provider/CMO.

In recent times, off-shore units of pharmaceutical companies have come under closer scrutiny because of violations of the US FDA’s regulations relating to manufacturing malpractices and drug adulteration. For example, British pharmaceutical major, GlaxoSmithKline, was the subject of civil and criminal charges in relation to the manufacturing and distribution of certain adulterated drugs at a plant of its subsidiary, SB Pharmco Puerto Rico. These charges led to a payout of US$750 million in fines by the company and closure of the plant in question.

In light of such stringent punishment, it would be prudent on the part of a foreign biopharma entity to exercise abundant caution in carrying out extensive due diligence before establishing partnerships with Indian service providers/CMOs. Such an undertaking would pre-empt adverse consequences which may arise in the future.

9.4 Due diligence process

The due diligence process should have defined objectives and strategies. A core team should be formed along with other groups, each with a clearly defined role and responsibility. Consultants with technical expertise should be consulted in each relevant area and technology utilised in situations which require it. Any data and information should be stored securely, but at the same time should be accessible whenever required. The foreign entity should organise site visits to get a clear idea of the style of functioning of the service provider/CMO. Site visits can provide essential information where documents may not.

The due diligence process is a complex one and may be conducted in several ways depending on the requirement in that particular case. Generally, a combination of methods will be implemented. The questionnaire method contemplates the sending of a questionnaire to the service provider/CMO which will act as a guide to the service provider/CMO’s financial stability and will identify potential risks which the foreign entity should be aware of. When drawing up a commercial contract, the service provider/CMO can be called upon to make certain representations and warranties to address concerns which the foreign entity may have. The process will involve reviewing the financial and legal risks associated with the proposed transaction.

It is important to engage qualified and experienced professionals for every part of a due diligence. The process will involve management representatives of the foreign entity, legal counsels, chartered accountants and technical consultants.

Management representatives will identify the key areas of focus for the due diligence. These could include suppliers, existing customers and personnel of the service provider/CMO. A coordination plan will be drawn up, and responsibility will be delegated. Confidentiality agreements may be signed by those involved on the due diligence process.

In the first stage of investigation, the main objective should be to identify critical issues or so-called red flags which could potentially be deal breakers. These include:

The foreign entity should examine the service provider/CMO’s local reputation and its capacity for taking on new business. The service provider/CMO’s supply chain and external linkages are also significant, the supply chain should be strong enough to withstand breakages along the way, and offer alternate solutions to deal with unforeseen issues which may arise.

It is essential that the service provider/CMO make full disclosure at the beginning of proceedings. To confirm full disclosure, the foreign entity may ask for a signed declaration that the information provided is complete and no material disclosure has been withheld. The same may be secured via adjusted representations and warranties backed by indemnity provisions.

However, it is frequently seen that existing non-disclosure/confidentiality agreements may bar the sharing of material information. In addition to this, the information disclosed may not be sufficient. Professional management of a due diligence can overcome these problems.

9.5 Contents of the due diligence report⁶

The due diligence report ordinarily contains information pertaining to:

9.6 Conclusion

A thorough due diligence will ensure that the contract signed between the parties will contain representations and warranties which accurately reflect the ground realities, and ensure that local service providers/CMOs take adequate precautions in discharging their duties as well as indemnifying the foreign entity, under the terms of the agreement. A due diligence exercise will give the foreign entity a clear analysis of the service provider/CMO’s capabilities and will be a guide in the conduct of business with the service provider/CMO.

After the completion of the due diligence process, there is every possibility that certain issues have been overlooked or have not been analysed in enough detail. For this reason, it is important that the lines of communication between the companies are kept open. Communication will be facilitated by each company designating a person who will be in charge of maintaining communications. It is generally advised that too many people from either company should not get involved in this sphere, as this may lead to information falling through the cracks. However, an argument can be made for counterparts from either organisation maintaining communication to facilitate speedier dissemination of critical information. No matter what stance is adopted, the protocol for communication should be agreed upon at the beginning of any negotiations to avoid confusion at a later stage.⁷

The biopharma industry is characterised by the use of high end technology, trained employees and modern infrastructure. It is possible that more than one service provider/CMO will have similar capabilities simply from a technical stand point. The question then arises, what criteria will separate these competing service providers/CMOs? The answer to this is that the foreign entity should find a service provider/CMO which not only fulfils its technical requirements, but one which provides a fit with the corporate culture and values of the foreign entity.