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How to carry out due diligence in corporate simplification projects

Conducting corporate simplification or legal entity reduction projects can remove unnecessary legal entities and therefore reduce costs such as audit fees and company secretarial costs and improve transparency. 

Due diligence is an important part of this process. This guide outlines what this involves and includes a free template due diligence questionnaire.

The need for due diligence

The legal mechanics of removing a company are often straightforward but it is important to follow a structured process for due diligence before removing a company.

The purpose of due diligence in corporate simplification projects is to identify:

  • any assets held by the company which have a material value and which need to be moved to another entity in the group;
  • any liabilities or potential liabilities of the company which need to be dealt with;
  • any other issues or arrangements affecting the company which need to be addressed or dealt with prior to liquidation or strike off.

Adopting an appropriate due diligence process should reduce the risk of assets or issues being discovered after the event, in which case time and money would need to be spent on restoring the company to the register.

Managing liability issues for directors

A clear due diligence process is important not just for the commercial reasons set out above. It is also important in order to manage personal liability issues for the directors who will be asked to approve the actions required to remove the relevant companies.

The following table summarises the liability risks for directors associated with the most common procedures from the perspective of English law.

Procedure

Director involvement

 

Personal duty on the part of directors

Potential sanction for breach

Strike off

Form DS01 to be signed by a majority of directors. Notification to be made, inter alia, to all creditors of the company

Ongoing duty to notify all creditors, employees, pensions trustees etc. – defence if director proves he “took all reasonable steps to perform the duty”

Unlimited fine, disqualification from being a director. Up to seven years' imprisonment for aggravated offence.

Reduction of share capital using the ‘solvency statement’ procedure

Statement of solvency to be signed by all directors

Statement of solvency – potential personal liability if made “without reasonable grounds”

Fine of up to £5,000; up to 12 months' imprisonment; disqualification

Commencement of Members’ Voluntary Liquidation

Statement of solvency to be made by a majority of directors

Statement of solvency – potential personal liability if made “without reasonable grounds”

Fine of up to £5,000; up to 24 months' imprisonment; disqualification

 

By adopting and following a standard approach for due diligence, directors are put in the best position to show that they have taken appropriate steps to satisfy their legal obligations. This means that directors can demonstrate that they have ensured that all reasonable steps have been taken to identify material assets and material liabilities.

How to structure the due diligence process

A typical due diligence process often follows the following steps:

  1. identifying the likely companies to be removed, and sorting them into manageable batches of five to 15 companies;
  2. setting deadlines for each batch, and allocating responsibility to specific people to achieve those deadlines. Typical milestones may include obtaining responses to due diligence questionnaires; resolving outstanding due diligence issues; obtaining any third party consents needed; obtaining the necessary internal approvals, and commencement of liquidation / application for strike off;
  3. carrying out standard checks. Those checks may include searches at Companies House or the relevant authority; a review of the relevant companies’ own company secretarial records, and searches for registered intellectual property rights and registered land;
  4. completing due diligence questions by the relevant functions within the organisation. Those functions may include the relevant business unit; finance; tax; treasury; company secretary; legal; human resources; pensions; health and safety; insurance, and real estate;
  5. resolving outstanding due diligence issues;
  6. carrying out the necessary actions to complete the removal of the relevant company.

Hidden assets and hidden liabilities and how to identify them

One of the challenges of corporate simplification projects is that some assets and liabilities may not appear on any given company’s balance sheet, and may also not appear on any public register. Such assets may include:

  • assets held on trust or as nominee (for example, shares held in other group companies);
  • contractual rights or contractual obligations;
  • unregistered land;
  • unregistered intellectual property;
  • the benefit of restrictive covenants.

Where there is considered to be material risk that hidden assets or liabilities may be present, then additional due diligence investigations may be justified. Those investigations may include:

  • reviewing historic financial records for e.g. rents received and paid;
  • reviewing historic corporate approval documents;
  • reviewing internal announcements;
  • reviewing registers of sealings (if applicable);
  • reviewing deeds packets.

When searches of public registers are carried out it can be useful also to search using former company names, rather than merely the current name. Consideration may also be given to possible typographical errors which may have occurred at the time of the original registration, and carrying out searches using those variants of the name involved. This may be particularly relevant if the company name includes digits which may have been transposed on the original registration.

Creating a template due diligence questionnaire

The due diligence processes for a corporate simplification project should include one or more standard due diligence questionnaires. Clearly, this will need to be adapted to suit the particular circumstances of the group or companies involved. For example, it will need to be adapted to take into account:

  • the functions within the relevant organisation;
  • the group’s processes for corporate approvals;
  • the business units involved;
  • typical assets and liabilities;
  • the geographical scope of operations, and requirements of local law;
  • the appropriate scope of desktop investigations to be undertaken by the core corporate simplification project team;
  • third parties, such as external advisers or agents, who should be consulted as part of the process.

Here is an example template due diligence questionnaire for corporate simplification projects. 

Getting started with a pilot batch

Corporate simplification projects can seem overwhelming, especially when a number of functions within the organisation need to be involved. It is usually advisable to start with a small batch of companies with relatively simple requirements. This has the advantage of allowing internal processes to be developed – including in relation to due diligence – and also making tangible progress at an early stage.

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