In Indonesian acquisition transactions, legal due diligence rarely confirms that “everything is clean.” Instead, it serves as a structured process to identify legal red flags—issues that may not be immediately visible from financial statements or management presentations but can materially affect the transaction.
Many investors enter the Indonesian market with a strong commercial thesis, only to encounter unexpected legal exposure during due diligence. These findings often result in valuation adjustments, revised transaction structures, enhanced indemnities, or, in certain cases, termination of the deal altogether.
Importantly, most red flags discovered during Indonesian company due diligence are not the result of deliberate misconduct. They arise from historical practices, evolving regulations, incomplete documentation, or misunderstandings of regulatory requirements. However, from an investor’s perspective, intent is irrelevant—liability attaches to the company, and therefore to the buyer post-acquisition.
This article outlines the most common legal red flags identified during Indonesian company legal due diligence, explains why they matter, and highlights how they typically affect acquisition transactions.
Why Legal Red Flags Matter in Acquisition Transactions
From a transactional standpoint, acquiring a company means acquiring not only its assets and opportunities, but also its existing and contingent liabilities. Legal red flags directly influence:
- purchase price and valuation assumptions,
- scope of representations and warranties,
- indemnity and escrow requirements,
- conditions precedent to closing, and
- post-closing integration feasibility.
In Indonesia, certain red flags do not automatically invalidate a transaction, but they often shift risk allocation significantly toward the buyer unless properly mitigated.
Corporate Structure Red Flags
Unregistered or Improper Share Transfers
One of the most frequently encountered issues during due diligence is the discovery that historical share transfers were never properly registered with the relevant authorities.
Common situations include:
- share transfers agreed privately but not recorded in notarial deeds,
- outdated shareholder registers, or
- discrepancies between corporate documents and actual ownership arrangements.
This creates uncertainty regarding legal title to shares, potentially undermining the validity of the acquisition itself.
Nominee Shareholder Arrangements
Nominee arrangements remain one of the most serious red flags for foreign investors.
In these cases, shares are legally held by Indonesian individuals or entities, while the economic ownership belongs to another party under private agreements. While such structures may have been used historically, they pose significant risks:
- lack of enforceable control for the beneficial owner,
- exposure to ownership disputes, and
- potential regulatory violations.
For foreign buyers, nominee structures can complicate ownership transfer and expose the investment to challenges post-closing.
Incomplete Corporate Governance Records
Legal due diligence frequently uncovers gaps in corporate governance documentation, such as:
- missing or improperly conducted shareholders’ meetings,
- absence of meeting minutes,
- unregistered changes in directors or commissioners.
These issues may call into question the validity of past corporate actions, including approvals for loans, asset transfers, or major contracts.
Licensing and Regulatory Red Flags
Mismatch Between Business Activities and Licensed Scope
This is arguably the most common and impactful red flag in Indonesian due diligence.
Companies often operate activities that do not fully align with their licensed business classifications (KBLI). Examples include:
- trading companies engaging in manufacturing,
- service companies conducting regulated activities without sector-specific permits.
Such mismatches can expose the business to administrative sanctions, license revocation, or forced operational changes after acquisition.
Expired or Dormant Licenses
It is not uncommon for companies to continue operating with:
- expired licenses,
- unfulfilled OSS-RBA commitments, or
- permits issued but never activated.
While operations may have continued uninterrupted, regulatory enforcement post-acquisition can result in unexpected disruptions.
OSS-RBA Non-Compliance
The OSS-RBA system requires ongoing compliance and reporting. Red flags include:
- failure to submit mandatory reports,
- non-fulfillment of risk-based licensing commitments, and
- inconsistent data across regulatory filings.
These issues may not surface during routine operations but can become critical during regulatory reviews triggered by ownership changes.
Contractual Red Flags
Change of Control Clauses
Material contracts often contain provisions allowing termination or renegotiation upon a change of ownership.
During due diligence, investors frequently discover that:
- key customer or supplier contracts may terminate automatically after acquisition, or
- third-party consent is required before closing.
Failure to address these clauses can materially affect post-closing revenue and operational continuity.
Informal or Unwritten Agreements
Many Indonesian companies operate based on long-standing relationships supported by informal arrangements, emails, or oral understandings.
From a legal standpoint, these arrangements:
- may be unenforceable,
- provide limited protection in disputes, and
- complicate valuation assumptions.
Investors must assess whether commercial reliance on such agreements presents unacceptable risk.
Undisclosed Debt or Guarantees
Another recurring issue is the existence of:
- off-balance-sheet liabilities,
- personal guarantees issued by directors on behalf of the company, or
- related-party loans not properly documented.
These obligations may not be apparent from financial statements but can significantly affect the buyer’s risk profile.
Employment and Labor Red Flags
Employees Without Proper Employment Contracts
Due diligence often reveals that employees:
- lack written employment agreements, or
- work under outdated or non-compliant contract terms.
Under Indonesian labor law, such situations can increase the employer’s exposure in termination or dispute scenarios.
Significant Severance Liabilities
Statutory severance obligations in Indonesia can be substantial. Red flags include:
- long-tenured workforces without proper provisioning,
- planned restructuring post-acquisition without cost assessment.
Failure to account for these liabilities can materially alter transaction economics.
Misclassification of Outsourced Workers
Improper outsourcing arrangements may result in workers being legally deemed permanent employees of the company, creating unexpected obligations and dispute risks.
Land and Asset Ownership Red Flags
Operational Assets Not Owned by the Company
A frequent discovery is that:
- land, buildings, or key assets are owned by founders or related parties rather than the company itself.
This raises concerns regarding:
- security of tenure,
- enforceability of use rights, and
- transferability post-acquisition.
Defective or Restricted Land Titles
Issues such as:
- nearing expiration of land rights,
- zoning inconsistencies, or
- encumbrances in favor of third parties
can materially affect the usability and value of operational assets.
Tax and Financial Legal Exposure
While tax due diligence is conducted separately, legal due diligence often uncovers:
- unresolved tax disputes,
- unpaid assessments, or
- non-compliance with VAT obligations.
Because tax liabilities attach to the legal entity, buyers may inherit exposure unless properly addressed in transaction documents.
Litigation and Dispute Red Flags
Legal due diligence frequently identifies:
- ongoing employment disputes,
- land ownership conflicts,
- supplier or customer litigation.
A common issue is the non-disclosure of disputes perceived as minor by sellers but material from an investor’s risk perspective.
How Red Flags Affect Deal Structuring
Legal red flags rarely operate in isolation. Their impact is typically managed through:
- purchase price reductions,
- escrow or holdback arrangements,
- enhanced indemnities,
- pre-closing remediation obligations.
Not all red flags are deal-breakers, but failure to address them properly can expose investors to long-term risk.
Practical Case Illustration
Consider an investor acquiring a retail distribution company. During due diligence, it is discovered that key supplier agreements include change of control termination rights. Post-closing, the supplier exercises this right, disrupting inventory supply and revenue.
While the company appeared financially sound at signing, the overlooked contractual red flag fundamentally altered the investment outcome.
How Investors Typically Respond to Red Flags
Experienced investors respond by:
- reassessing valuation assumptions,
- restructuring the transaction,
- delaying closing pending remediation, or
- withdrawing from the transaction if risks are unmanageable.
The effectiveness of these responses depends largely on early identification and proper legal structuring.
Conclusion
Most acquisition failures in Indonesia are not caused by poor business fundamentals, but by undiscovered or underestimated legal exposure. Legal red flags uncovered during due diligence are not merely technical findings—they shape the commercial reality of the transaction.
For investors, understanding and addressing these red flags before closing is essential to protecting capital, preserving deal value, and ensuring long-term investment success.
Disclaimer
This publication is for general informational purposes only and does not constitute legal advice. Each transaction must be assessed based on its specific facts and applicable Indonesian laws and regulations.
