Due diligence: ensure the scope of the investigation!

Participating in foreign property development projects is always a risky type of investment, one which frequently ends up in disputes. Therefore, it is highly desirable to carry out proper due diligence investigations into investment projects. But what should be the scope of such an investigation? A recent procedure concerned a dispute between investors and the investment company about precisely this question. Contract Lawyer Hidde Reitsma explains the Dutch Court’s ruling.

Bad investment in US property development project

In this case, the investors had put money into a property development project of an American developer via the investment company Westplan. It turned out that the developer was not as reliable as his respectable appearance suggested. The property development project never came off the ground, the developer disappeared, and the investors lost their money.

Dutch investors: unsound due diligence investigation

The Dutch investors claimed that Westplan had not carried out a proper due diligence investigation before the investment. The Investment Statement specified that Westplan should carry out this investigation. According to Westplan, there had been a preliminary investigation into the investor, which had not yielded any causes for concern. There was no reason to doubt the investor’s solvency and credibility, according to Westplan.

Content due diligence contractually specified

The Dutch Court considered that the Investment Statement should specify the content and scope of the due diligence investigation to be carried out by Westplan, and Westplan’s associated obligations. The statement in question merely provided that Westplan would make the investment only after Westplan’s satisfaction of the subjects listed therein. According to the Dutch Court, satisfaction would only be possible if there was full clarity about the subjects investigated. This was necessary to make a proper assessment of any risks associated with the investment.

Investigation carried out satisfactorily?

The question is now whether Westplan could have been satisfied with its own investigation. The Dutch Court considered that it could. Westplan had made enquiries about the developer’s reputation in its business network and with a number of banks. None of the parties approached had any doubts about Westplan. The developer had fully complied with its obligations in respect of some other projects. The investors pointed out some media reports about the developer’s bad reputation. However, these media reports dated from long after the due diligence investigation.

Westplan held to limited investigation

Finally, the Dutch investors’ lawyer submitted that they had been misled. If they had known how limited the scope of the due diligence investigation would be, they would never have made the investment. The Dutch Court also dismissed that complaint. It was up to Westplan to carry out the due diligence investigation at its discretion. The fact that the investors assumed that the investigation would have been more comprehensive did not mean that Westplan’s investigation was unsatisfactory. The investors’ assumption could not be based on the Investment Statement.

AMS Advocaten in due diligence investigations

This judgment not only shows how important it is to conduct a proper due diligence investigation for significant investments, but also how important it is to establish the parameters of such an investigation.