ESG Due Diligence in M&A: The Indian Perspective

Executive Summary

ESG (Environmental, Social, Governance) due diligence has evolved from a "nice-to-have" to an essential component of M&A transactions in India. With SEBI's Business Responsibility and Sustainability Reporting (BRSR) requirements, increasing lender focus on ESG, and growing liability for environmental and social violations, acquirers ignore ESG at their peril. This article provides a practical framework for ESG due diligence in Indian M&A, covering key areas, red flags, and deal structuring considerations.

Key Drivers:

• SEBI BRSR mandatory for top 1,000 listed companies
• Lender ESG covenants increasingly common
• Environmental liabilities can be material
• Social issues create reputational and operational risk
• Governance failures lead to post-acquisition surprises

Introduction

When Tata Steel acquired Bhushan Steel, the deal included not just manufacturing assets but also environmental liabilities, labor issues, and governance problems. When Hindustan Unilever acquired GSK Consumer Healthcare, ESG alignment was a positive factor in integration.

ESG due diligence is no longer about ticking boxes - it's about understanding risks that can make or break a deal.

Section 1: Why ESG Due Diligence Matters in India

The Indian ESG Landscape

Deal-Breaker Potential

Environmental:

• Pollution control violations → Operating license risk
• Hazardous waste non-compliance → Criminal liability
• Climate litigation exposure → Stranded asset risk
• Forest/environmental clearance gaps → Project viability

Social:

• Labor disputes → Business disruption
• POSH violations → Management liability
• Community opposition → Project delays
• Supply chain issues → Reputational damage

Governance:

• Related party transactions → Value leakage
• Board composition issues → Regulatory non-compliance
• Anti-corruption gaps → FCPA/UK Bribery Act exposure
• Whistleblower retaliation → Cultural problems

Section 2: Structuring ESG Due Diligence

Integration with Traditional DD

M&A Due Diligence Framework:

TRADITIONAL DD:
├─ Financial DD
├─ Legal DD
├─ Tax DD
├─ Commercial DD
└─ Technical DD

ESG DD (Integrated or Separate):
├─ Environmental DD
│   ├─ Compliance
│   ├─ Liabilities
│   └─ Climate/transition
├─ Social DD
│   ├─ Labor/employment
│   ├─ Health & safety
│   └─ Community/human rights
└─ Governance DD
    ├─ Board & management
    ├─ Ethics & compliance
    └─ Stakeholder management

Timing Considerations

Team Composition

Section 3: Environmental Due Diligence

Key Areas of Inquiry

Permits and Compliance:

Environmental Compliance Checklist:

PERMITS:
□ Environmental Clearance (EC) valid and conditions met
□ Consent to Establish (CTE) current
□ Consent to Operate (CTO) current and compliant
□ Hazardous waste authorization
□ E-waste authorization (if applicable)
□ Forest clearance (if applicable)
□ Coastal clearance (if applicable)
□ Groundwater abstraction permission

COMPLIANCE RECORDS:
□ SPCB inspection reports (last 5 years)
□ Show cause notices and responses
□ Pollution control equipment records
□ Environmental monitoring data
□ Consent condition compliance reports
□ Annual environmental statements
□ Emission/effluent test reports

Contamination Assessment:

Phase I ESA Components:

1. Site history review
2. Regulatory records search
3. Physical site inspection
4. Interviews with knowledgeable parties
5. Report with recommendations

Climate and Transition Risk

Assessment Areas:

Red Flags and Deal Implications

Section 4: Social Due Diligence

Labor and Employment

Key Review Areas:

Labor DD Checklist:

COMPLIANCE:
□ Employment contracts (permanent and contract labor)
□ PF/ESI registration and compliance
□ Minimum wage compliance
□ Contract labor license (CLRA)
□ Factory license/Shops & Establishment
□ Standing Orders
□ Trade union agreements

DISPUTES:
□ Pending labor litigation
□ Industrial disputes history
□ Strike history (last 5 years)
□ Disciplinary proceedings
□ Retrenchment/lay-off history

HUMAN RESOURCES:
□ Employee headcount and tenure
□ Attrition rates and trends
□ Compensation benchmarking
□ Benefits and entitlements
□ Key person dependencies

POSH Compliance

Assessment Framework:

Red Flags:

• No IC constituted
• Complaints not investigated
• Retaliation against complainants
• Pattern of similar complaints
• Management named in complaints

Health and Safety

Key Areas:

Community and Human Rights

Assessment Areas:

Section 5: Governance Due Diligence

Board and Management

Review Areas:

Governance DD Checklist:

BOARD COMPOSITION:
□ Board size and composition
□ Independent director qualification
□ Committee constitution (Audit, NRC, CSR)
□ Board diversity (gender, expertise)
□ Meeting attendance records
□ Board evaluation results

MANAGEMENT:
□ Key management stability
□ Succession planning
□ Background checks
□ Conflict of interest disclosures
□ Compensation benchmarking
□ Employment agreements review

Ethics and Compliance

Related Party Transactions

Assessment Approach:

Red Flags:

• Non-arm's length pricing
• Related party revenue concentration
• Asset transfers at book value
• Service agreements without clear deliverables
• Loans without commercial terms

Section 6: BRSR Alignment Assessment

Why BRSR Matters for M&A

For Acquirer:

• Listed acquirer must consolidate target's ESG data
• Integration into BRSR reporting
• ESG performance affects acquirer's ratings

For Target:

• BRSR readiness indicates ESG maturity
• Gaps require post-acquisition investment
• Good BRSR performance is positive indicator

BRSR Due Diligence

BRSR Compliance Assessment:

SECTION A: GENERAL DISCLOSURES
□ Accurate corporate details
□ Operations locations
□ Employee demographics
□ Supply chain disclosure

SECTION B: MANAGEMENT & PROCESS
□ Policy existence for each principle
□ Grievance mechanisms
□ Sustainability report/disclosure history

SECTION C: PRINCIPLE-WISE PERFORMANCE
□ P1: Ethics and transparency
□ P2: Product sustainability
□ P3: Employee well-being
□ P4: Stakeholder engagement
□ P5: Human rights
□ P6: Environmental protection
□ P7: Policy advocacy
□ P8: Inclusive growth
□ P9: Consumer responsibility

BRSR CORE (Assurance-Ready):
□ GHG emissions data (Scope 1, 2)
□ Water consumption data
□ Energy consumption data
□ Waste generation data
□ Gender diversity metrics
□ Employee training hours

Integration Considerations

Section 7: Deal Structuring for ESG

Representations and Warranties

Environmental Warranties:

Standard Environmental Representations:

1. COMPLIANCE REPRESENTATION
   "The Company is in compliance in all material respects
   with all applicable Environmental Laws."

2. PERMIT REPRESENTATION
   "The Company holds all Environmental Permits required
   for its operations, all such permits are valid and
   current."

3. LIABILITY REPRESENTATION
   "There are no pending or threatened claims, actions,
   or proceedings relating to Environmental Matters."

4. CONTAMINATION REPRESENTATION
   "To the Company's knowledge, there has been no Release
   of Hazardous Substances at, on, or from the Properties."

5. DISCLOSURE REPRESENTATION
   "All Environmental Reports have been made available
   to Buyer."

Social Warranties:

Standard Social Representations:

1. LABOR COMPLIANCE
   "The Company is in compliance with all applicable
   labor and employment laws."

2. LITIGATION
   "Except as disclosed, there are no pending or threatened
   employment-related claims."

3. POSH
   "The Company has constituted an Internal Committee
   and is in compliance with POSH Act requirements."

4. BENEFITS
   "All employee benefits are fully funded and compliant
   with applicable law."

Indemnification

ESG-Specific Indemnities:

Survival Periods:

Section 7A: Key Judicial Precedents for ESG Due Diligence

Labour Law Cases Relevant to Social DD

1. BHEL v. State of U.P. (2003) - Supreme Court

Issue: Whether BHEL was the employer of gardeners engaged through a contractor.

Holding: The Supreme Court applied the control test and found BHEL was the true employer:

• BHEL exercised direct supervision
• Maintained attendance records
• Had managerial involvement

"When a contractor's engagement is a sham, the principal employer is deemed to be the real employer."

DD Implication: Acquire must assess whether contract labour arrangements are genuine or sham - potential liability for regularization and back-wages.

2. NTPC v. Karri Pothuraju (2003) - Supreme Court

Issue: Whether canteen workers engaged by contractors are entitled to regularization as NTPC employees.

Holding: Where statutory obligation exists (Section 46, Factories Act) to maintain canteen, workers are employees of principal employer regardless of contractor arrangement.

DD Implication: Statutory obligations (canteen, security, etc.) create employer liability for contractor workers. Check all such arrangements in target company.

M&A/Takeover Cases

3. Harinarayan G. Bajaj v. Union of India (2007) - Bombay HC

Issue: Whether indirect acquisition of control through a holding company triggers SEBI Takeover Regulations.

Holding: Indirect acquisitions via holding company do not trigger 1994 Take-Over Regulations if no shares of listed target are directly acquired.

"The narrow scope of the 1994 Regulations excluded indirect control through an unlisted holding company."

DD Implication: Structure of acquisition matters for regulatory triggers. Indirect holdings require careful analysis under current SAST Regulations (which have since been amended).

Environmental Liability Cases

4. AP Pollution Control Board v. CCL Products (2019) - Supreme Court

DD Implication: Environmental bank guarantees are readily enforceable. Verify all guarantees given by target and ensure these are factored into deal pricing.

Governance/FEMA Cases

5. ND Investments v. Union of India (2015) - Bombay HC

Issue: FEMA violations for remittances made before establishing Indian subsidiary.

Holding: Court reduced pre-deposit requirement but affirmed that FEMA violations carry serious penalties. Tribunals must consider prima facie hardship.

DD Implication: FEMA compliance history is critical for targets with foreign investment. Historical violations may result in pending penalties or show-cause notices.

Due Diligence Checklist Enhancement Based on Case Law

Escrow and Holdback

When to Use:

Price Adjustment

ESG-Related Adjustments:

Price Adjustment Framework:

QUANTIFIED LIABILITIES:
├─ Known remediation costs → Deduct from price
├─ Pending litigation → Discount by probability-weighted liability
├─ Compliance capex needed → Deduct NPV of required spend

UNQUANTIFIED RISKS:
├─ General ESG weakness → Overall discount negotiation
├─ Transition risk → Scenario-based adjustment
├─ Reputational concerns → Strategic value adjustment

Section 8: Post-Acquisition Integration

100-Day ESG Plan

ESG Integration 100-Day Plan:

DAYS 1-30: ASSESSMENT
├─ Detailed ESG baseline
├─ Gap analysis vs. acquirer standards
├─ Priority identification
├─ Quick wins identification
└─ Resource requirements

DAYS 31-60: PLANNING
├─ Integration workplan development
├─ Budget and timeline
├─ Responsibility assignment
├─ Communication plan
└─ Stakeholder engagement plan

DAYS 61-90: EXECUTION
├─ Policy harmonization
├─ Compliance remediation
├─ Reporting integration
├─ Training rollout
└─ Monitoring framework

DAYS 91-100: REVIEW
├─ Progress assessment
├─ Remaining gaps
├─ Long-term plan
├─ Board reporting
└─ External communication

Value Creation Opportunities

Section 9: Recommendations

For Acquirers

1. Start Early: ESG DD from preliminary stage
2. Engage Specialists: Technical expertise for environmental sites
3. Materiality Focus: Prioritize deal-breakers; don't boil ocean
4. Integration Planning: Build ESG into Day 1 planning
5. Protect in Docs: Strong warranties, indemnities, escrows

For Sellers

1. Pre-DD Preparation: ESG data room readiness
2. Address Known Issues: Fix fixable problems before sale
3. Disclosure Approach: Full disclosure reduces post-closing risk
4. BRSR Compliance: Demonstrate ESG maturity
5. Narrative: Tell positive ESG story proactively

For Advisors

1. Integrated Approach: Don't silo ESG from other DD
2. Sector Expertise: ESG issues vary by industry
3. Quantification: Help clients value ESG factors
4. Deal Terms: Draft appropriate protections
5. Integration Support: Continue beyond closing

Conclusion

ESG due diligence in Indian M&A has transitioned from optional to essential. Key takeaways:

The acquirer who skips ESG due diligence may save time and cost in the short term - but risks purchasing problems that will cost multiples more to fix later.

For sellers, ESG-ready companies command premiums; those with ESG gaps face discounts or deal failure.

ESG due diligence is not about being virtuous - it's about being smart.

Sources

• SEBI BRSR Framework
• Environment (Protection) Act, 1986
• POSH Act, 2013
• M&A Due Diligence Best Practices - IBA
• ESG Integration in M&A - PRI