Due Diligence: Welcome AI, but Keep the Human Element

The legal market is welcoming (and fearing) the introduction of Artificial Intelligence (AI) in due diligence processes.

AI will liberate junior lawyers from the often tedious (and necessarily error prone) work of cataloguing contract information, and at the same time will take work away from law firms and lawyers.

We are of the idea however that while the cataloguing work (summarizing data about contracts and financial transactions) can well be left to AI, the interpretation of such data needs a human element.

What is the purpose of a due diligence? Prior to entering into a long term relationship, such as an equity or commercial joint venture relationship, it is important for a company to determine that the potential business partner shares its ethical standards and is prepared to follow business practices consistent with its company’s.

The due diligence is not only intended to catalogue data, it has a specific objective: and that is to evaluate potential risk areas and to screen a potential contractual partner, its business relationships and practices, its government relationships as well as its reputation.

At the heart of the due diligence is the attempt to gain a thorough understanding of the structure, background, characteristics, practices and also motivations of the contractual partner.

A company seeking a long term contractual relationship must emerge from the due diligence process satisfied that it wants to do business with the partner on an intensive and long-term basis.

The following key areas are (among others) always of concern in joint ventures and should be a specific focus of due diligence:

• corporate governance and controllership, including keeping accurate books and records;
• business contracts and business practices;
• potential for improper payments, or corrupt business practices;
• regulatory compliance, including historic compliance with core licensing needs;
• employment matters;
• existing or potential litigation;
• tax compliance; and
• environmental matters, such as a history of land contamination or pollution.

While a software can catalogue all relevant information for quick and easy access, interpretation can and must be left to an experienced professional.

The phase of desktop review and analysis is essential to depict a preliminary profile of the partner, identify the main areas of risk and potential concern, and define the need and the subsequent perimeter of in-depth examinations.

However, also this apparently more objective and depersonalized phase of work, needs a human element to be planned and executed in the most effective way. Even very accurate and comprehensive corporate information does not tell us how our partner is perceived, its track record, the origins of its business, its network of contacts, its political exposure etc. To this regard, a key component of the desktop phase is represented by a critical analysis of the information that comes from outside what can be considered the perimeter of a standard due diligence process, i.e. from outside the target company. For example, it is important to:

• Reconstruct the target’s public and media profile, if any, and ascertain if any red flags have been reported, if there have been allegations of wrongdoing or non-transparent behavior, and if the target has never responded to these reports or released any denial. This analysis must include social media open to public, electronic media, national and local press outlets.
• Look at the target’s track record and try to answer questions such as: what is the origin of the business? Did the company develop in a regular and constant way or was there a sudden growth? Does the company have a long-lasting and deeply rooted presence in a local territory? Are there any previous issues, such as a bankruptcy or frequent and inexplicable changes in the business scope or in the geographic area of activity?
• Identify and reconstruct the profile of the key individuals involved in the ownership and managerial structure of the target company: their corporate profile beyond the target company, their professional background and career, their media profile, etc. can help a lot in placing the target company in a broader and clearer context and in understanding its modus operandi.
• Enlarge the scope to map the target’s network of business partners and influential contacts and identify potential areas of risk and concern by answering to questions such as: Is there a strong and potentially risky relationship with the public sector or the political establishment? What is the reputation of our partner’s partners?

Then? Once this critical and analytical phase of desktop study has been performed?  A human needs to go on the ground and meet people. Only human sources can provide insight and add value to assess the actual reputation, integrity and market standing of the target.

AI and standardized procedures provide a very valuable support, especially because they help perform the most mundane and time-consuming part of the due diligence process, which is gathering, processing and indexing the information. But when it comes to analyzing, combining,  cross-checking, understanding and supplementing this information, AI cannot substitute the awareness and the experience of professional figures who know where to look, what to look for, who to look at and how to look beyond.

 Stefania Lucchetti and  Francesca Castelli

© 2017. For further information Contact the Authors

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