Legal Due Diligence
We also undertake the job to help our clients regarding Legal Due Diligence of properties they want to buy or to take on rent, which helps them to understand the legalities/ documentation thoroughly.
What is Legal Due Diligence?
Legal = Connected with Law
Due = Appropriate
Diligence = Meticulous care or attention
“Making sure that you get what you are paying for”
Background of Legal Due Diligence
“Due diligence” – “A measure of prudence, activity, properly expected from and ordinarily exercised by a reasonable and prudent person under the ICAI 3 particular circumstances, which is not measured by any absolute yardstick but depends on the relative facts of a particular case.
“Real Estate Due Diligence”
The inspection and investigation of Real Property, Personal Property or a Business Entity, before a buyer makes the final decision whether to consummate an acquisition, merger, or a loan transaction. Due Diligence consists of – A scrutiny of all, or specific parts, of the legal affairs pertaining to a property with a view of uncovering all legal risks involved in acquiring the property and to provide the buyer an extensive insight into the nature of the property and risk involved in purchasing the same. Due Diligence often improves the buyer’s position by pointing out the risks involved in purchasing the property and ensures that necessary precautions in relation there to.
Why Legal Due Diligence?
Last decade has witnessed the rapid growth in the economic development of India leading a vast expansion in Real Estate Sector. There are several instances where the investors face several legal disputes and to pay high cost for real estate commercial decision taken without a proper legal due diligence. Due Diligence tool is highly essential which covers all the possible areas of anticipated liabilities.
Due Diligence assessment process removes uncertainty from key decisions that must be made when analyzing the cost/benefit of any real estate transaction. A comprehensive inquiry should be designed to provide a buyer with clear pictures of where their strategies and decisions are taking them or to put it simply – what it is they are buying. Due Diligence process is to eliminate unknown risk. Potential buyers need to ensure that their properties are suitable-legally and from a practical business perspective-for their intended use. In- depth due diligence is necessary to determine what a property is really worth.
Area of Legal Due Diligence
Proceeding with due diligence means to leave no stone unturned which may lead to legal defect in the title of property and any risk intact with the transaction. There are a multitude of details, which must be considered when dealing with purchasing a parcel of real estate. The function of due diligence is to independently verify all representations made by a prospective seller as well as to uncover pertinent facts which have not been disclosed but which are important from viewpoint of the buyer. Due diligence is not merely ‘maximum data collection’, but it is the best and elaborated commercial-legal analysis, in order to structure the transaction with all foreseeable risks, and to prevent any potential harm. The nature of due diligence shall vary from transaction to transaction and shall be dependent on numerous factors including but not limited to source from which the land/property is being acquired, purpose for which the land/property is being acquired, tenure of the lease (in case of leasing transaction) and so on.
Steps for Legal Due Diligence – before Purchasing of Property:
Intended use of the property: - Buyers must have an understanding of zoning and land use issues. Upon identifying a property, the potential buyer should determine that a property’s intended use is lawful under the law of land. If not, whether such property can be used for intended purposes with necessary approvals/permits.
Title of the property- The title of the property forms the foundation of any contract. According to the Indian Contract Act 1872 and Transfer of Property Act, 1882, no seller can pass on to the purchaser a better title than what he already possesses. The title of the seller must be clear and free from any encumbrance. Before buying a property, it is foremost requirement to verify the title of the seller and marketability of property.
Sale by holder of power of attorney:- If the sale documents are being executed by a person holding power of attorney on behalf of the owner, the said power of attorney should be scrutinized closely. The person must not only possess the power to sell property, the power of attorney should also be validly executed before the appropriate authority. An agreement holder who also has a power of attorney to sell the land and/or building is normally a developer. Alternatively, a person may have paid the entire consideration to the owner and hold`s on to the property for some time to sell it at a later date for a profit. Such power of attorney must be properly stamped and registered. It should also not be revoked.
Check the original documents:- Beyond the physical condition of the property, there are a multitude of intangibles that have to be taken into account when evaluating a site for acquisition. Every document concerning the land, building and its operation must be examined. This includes leases (with any and all extensions and modifications), notes and mortgages, (whether the buyers are assuming them or not), title policy, certificate of occupancy, tax history, licenses (in some jurisdictions), parking lot contracts, etc. Inspect the all the original documents of the seller and scrutinize them carefully before buying the property.
A public notice may be placed in newspapers calling for claims in respect of the property being purchased. Claims can even come afterwards; public notice helps in proving that you purchased the property bona fide and in good faith. In case the original documents are not available or have been lost, the certified true copy may be considered for verification of title with due affidavit from the seller.
Inspect the plans:- If the building is under construction or constructed, then inspect the plans to check whether the concerned authority has sanctioned them.
Payment of stamp duty:- Always verify documents of title to check payment of stamp duty. If the ownership of Property has changed hands more than once, examine all the documents for payment of stamp duty by the predecessors.
Minor’s Property: In cases where a minor owns the property, prior approval of the court is required to enable the minor’s father/natural guardian to sell the property. In the absence of such permission, the sale could be void – able at the option of the minor on attaining majority.
Check the minimum tenure of land if taken on lease:- If the property that is being purchased is a building built on a land which is given on lease, lease rent would have to be paid for the land owners. If the lease is to expire shortly, it is possible that the lease rent may increase substantially. Hence, the terms of the lease must be verified before buying the building.
Other precautions that need to be taken:
Check the occupation certificate: Completion/Occupation certificate should be inspected to ensure that the building has been built legally, especially in case of new buildings. Check the Carpet/Built-up/Super built up/Salable area: Areas can be verified by taking actual measurement of the property, if the same is ready.
Other precautions that need to be taken: Proper Execution of ‘Agreement to sell’ and ‘Sale Deed’ needs to be carried out. Payment of proper stamp duty under Stamp Act, 1899-Registration of these Deeds should also be ensured.
How to carry out Legal Due Diligence?
Real property acquisition in India may differ in format, processes and procedures in different parts of the country which makes it necessary for an buyer to spend time and resources scouting for properties, verifying title, physical inspection of the premises, identification of the encumbrances it is subject to and ensuring tax liabilities on it. In other words, before an acquisition, a buyer has to carry out an extensive due diligence not only on the property but on the financial viability of its owners.
The findings made during a legal due diligence process will be summarized in a due diligence report, offering a complete picture of the legal situation of the property in question. In addition to conveying a general overview, the report will clearly flag those areas, which require particular attention thereby making it easier to evaluate the impact of the legal findings on the acquisition as a whole. The report will often pinpoint those areas where specific representations and warranties are needed, including a suggested wording hereof.