When businesses prepare for a merger, acquisition, financing event, restructuring, or other significant transaction, due diligence is often one of the most important parts of the process. While due diligence is commonly associated with reviewing financial records and contracts, it can also play an important role in helping directors and decision-makers fulfill their fiduciary obligations under California law.
For California corporations, directors are generally expected to make informed decisions that align with the best interests of the corporation. As a result, due diligence may serve as an important mechanism for evaluating risk, reviewing material information, and supporting sound corporate governance practices before major business decisions are made.
Why Due Diligence Matters in Corporate Governance
Due diligence is commonly used to review and evaluation important information before a transaction moves forward. Depending on the transaction, this review may include financial records, contracts, litigation exposure, intellectual property, employment matters, regulatory compliance, and corporate governance documents.
From a governance perspective, due diligence can help directors:
While every transaction is different, conducting a thorough review process may help demonstrate that directors engaged in reasonable inquiry before approving major corporate actions.
Understanding Fiduciary Duties Under California Law
Fiduciary obligations may vary depending on the type of entity, the individual’s role, and the governing documents. For California corporations, corporate directors generally owe fiduciary obligations to the corporation and its shareholders, commonly described as including the duty of care and the duty of loyalty. Corporations Code § 309 provides that directors must perform their duties in good faith, in a manner they believe to be in the best interests of the corporation and its shareholders, and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.
These duties are often referred to as part of a director’s fiduciary obligations and may become especially important during significant corporate events, including:
Because these transactions can carry substantial financial and operational implications, directors often rely on due diligence to better understand the potential risks and liabilities associated with a proposed deal.
The Importance of Informed Decision-Making as a Fiduciary
California fiduciary duty standards generally emphasize informed and good-faith decision-making. In practice, this often means directors and decision-makers may want to ensure they have access to sufficient information before approving major transactions or strategic changes. In appropriate circumstances, directors may also rely on information and advice from officers, employees, counsel, accountants, financial advisors, and other professionals. However, directors should still make reasonable inquiry when the circumstances indicate that further review is needed.
Although due diligence does not eliminate business risk, it can help businesses identify issues earlier in the process and better evaluate how those issues may affect negotiations, transaction structure, or future operations.
In some situations, diligence findings may also influence:
Planning Ahead Before Major Transactions
Businesses considering growth opportunities, investment rounds, acquisitions, or succession planning may benefit from organizing key records and governance materials before entering negotiations.
Some commonly requested materials may include:
Preparing these materials with an attorney in advance can often help streamline the diligence process and reduce delays during transactions.
Due diligence is not only a transactional exercise; it can also be an important part of sound corporate governance. By identifying material risks, reviewing key documents, and addressing issues before closing, businesses can make more informed decisions and better position themselves for a successful transaction. Companies considering a significant transaction should work with experienced counsel early in the process to evaluate legal risks, prepare diligence materials, and structure the transaction appropriately.
