Bitcoins, Investments, Big-Ticket Purchases and the Importance of Due Diligence
Photo by: The Sun
The Bitcoin fever has swept across the globe, hitting the shores in Singapore with tidal forces that few would have expected just a few months ago. It has had a polarizing effect on people in general. In one camp are those who swear it will form a new-age currency that will parallel traditional forms of payment. Those who are a little bolder even believe that it will replace the fiat currency in time to come. On the other side of the crypto valley are those who fervently believe that the Bitcoin holds no intrinsic value, and who cry cautionary tales of the Bitcoin bubble bursting.
We shall leave the technical and speculative commentary on the future of Bitcoins and other cryptocurrencies to those who are better versed on the topic. The purpose of this article is really to delve into the benefits of due diligence. The lack of consumer due diligence remains equally prevalent in cryptocurrency trading as it does in other typical trades and investments.
Cryptocurrencies have been touted to cut out the middle-man. Whilst this is true to a large extent, investors have unfortunately developed a blind spot to an obvious stakeholder – digital exchange companies. Plenty of retail investors rely on such companies to carry out their trades on a daily basis without actually doing much due diligence on how these companies are run. Without due diligence, one certainly cannot anticipate and mitigate against even the most obvious of risks. These risks are further compounded by the lack of regulations which really leaves the doors wide open to such companies charging exorbitant transaction fees if they so desire. Certain companies reportedly charge fees as high as 6% of the trade value per transaction. A wise investor should spend some time not only learning about the product but about the intermediaries that he or she will be transacting with during the cryptocurrency trading process. Some of the relevant indicia one should look out for includes the company’s credibility, adherence to compliance (where relevant), credit reports and litigation history.
Not surprisingly, the low incidence of consumers conducting due diligence checks is prevalent in many other aspects beyond the cryptocurrency trading realm. This is despite its relatively low cost and ease of access. Perhaps the problem isn’t so much the reluctance to conduct due diligence but rather the lack of awareness about what due diligence is capable of achieving coupled with a lack of appreciation of the risks that can be mitigated through proper due diligence. To underscore the need for due diligence it may be useful to consider some real scenarios that we have dealt with.
We have seen several cases involving clients who purchased second-hand vehicles from used car dealerships only to later experience major problems. In one instance our client paid the deposit to the dealership but subsequently found out that the dealership did not have title to that car. The car in question did not belong to the dealership and unfortunately, that client ended up paying a considerable sum of money without ever getting the car.
In several such cases, we ran due diligence checks on the dealership and discovered certain red flags. For example, the searches would show that the director(s) involved had histories of opening and closing multiple car dealerships within the span of a few years, and/or had been sued many times over the years. After revealing the findings of our due diligence searches to clients, they often wistfully expressed that if they had known about the state of affairs of the dealership and the director(s) as the case may be, they would never have dealt with them. Unfortunately, if it reaches this stage, it is too late and you will have to expend considerable sums of money and time in taking legal proceedings to recover your losses.
Other typical cases involve persons who loan monies or invest in schemes with fraudsters who claim they represent a particular organization or otherwise distort their identity and/or forge documents to hoodwink such persons into parting with their money. These people often end up having to spend considerable sums of money in legal fees trying to claw back their investments. These examples underscore the importance of due diligence. Had due diligence been conducted in these examples, many such cases would not have ended the way they did as the correct identities, history and business interests of such individuals would have come to light. Having discussed the importance of due diligence and the associated risks of not performing due diligence, it is necessary to spend some time on identifying when exactly due diligence may be necessary, discussing what information can be obtained and what are the expected costs.
Due diligence should be carried out for all investments and transactions where the sum of the investment or purchase/sale price or value of the contract is significant. These are some examples of situations in which you should consider conducting due diligence searches.
Investments and loans often involve considerable amounts of money and high risks to the investor/lender. Depending on the context, you may want to conduct due diligence searches on the company/business or individual you are investing in or loaning monies to. Due diligence searches will reveal:
- The company’s capital
- Whether the company is involved in any ongoing/past litigation or winding up proceedings
- Details about the directors of the company
- Whether the directors have been involved in litigation in their personal capacity and the nature/value of those claims
- The stage of any judicial proceedings (which may be very relevant in certain situations)
In the case of investments and loans with Individuals:
- Whether the individual has been involved in any ongoing/past litigation or bankruptcy proceedings
- The nature/value of any litigation proceedings (E.g whether the individual has been sued for breach of contract or fraud and the amount that was claimed, whether the lawsuit was successful and resulted in a judgment against him/her
- The stage of any judicial proceedings (which may be very relevant in certain situations)
If you are buying a home or a car, or engaging an interior design company to carry out renovation works, you may want to conduct due diligence searches on the previous owner of the property, the car dealership (and the individual directors/owners of the dealership) or the owners of the interior design company as the case may be. Such information will be useful in identifying the following information:
- Whether previous owners of the property have been engaged in litigation/bankruptcy proceedings. If there are positive results you will want to safeguard yourself against having to deal with creditors or debt recovery agencies who may show up at your door looking to recover payments from the former owner.
- If you are buying a car, you will want to know whether the dealership has been sued before and identify the nature of these lawsuits. If they have a track record of being sued by former customers for breach of contract/fraud or other related causes of action, it is a red flag and you may want to re-consider dealing with them. For more detailed searches, you can even find out information about the individual directors/owners of the dealership to help identify risks.
- Similarly, in the case of engaging interior design companies, you will want to find out if they have been sued before and if so what was the nature of those claims. With this information, you can make a more informed decision about whether to engage such a company.
Costs and Other Practical Considerations
The costs of conducting due diligence searches can range from anywhere around $100 to over $1,000 or even more depending on:
- the number and complexity of the searches;
- whether it is necessary for your lawyers to study and interpret the results and provide you with a legal opinion;
- whether there is a need to consult other professionals (e.g accountants, auditors etc)
However, in most cases searches can be performed in a modular manner; if the preliminary searches come back ‘clean’ (i.e there are no red flags) then it unless there are exceptional reasons, there is probably no need to conduct further searches and incur additional costs.
Searches are somewhat akin to buying insurance – whilst it is important to be insured, it is also important to do it within your means. So if for example, you are making an investment of $5,000 into a company, it is probably infeasible to spend a lot of money on due diligence. In such cases you may want to just conduct basic searches. However, as you scale up the value of your investment or purchase, so do the risks. Because of this, it makes perfect sense to invest a little more if necessary on more comprehensive due diligence searches.
If after this entire commentary, you still remain unconvinced about the value of due diligence, perhaps this quote by the famous American columnist Esther Pauline Lederer will convey our message in fewer words and in a more potent form – “if you think education (information) is expensive, try ignorance”.
What we can do
At I.R.B. Law LLP we have experienced lawyers who will be able to advise on how you can protect your investments. Our main concern is to provide you with as much information possible before making a decision so that your investment is safe.