The financials were audited. The balance sheet was clean. The standard due diligence checklist came back with no red flags. And yet the thing that almost sank the deal never appeared on any financial statement at all — because contingent liabilities, by their very nature, don't show up until someone specifically goes looking for them.
An acquisition looks deceptively simple from the outside: agree a price, sign a share purchase agreement, transfer ownership. The real work happens in due diligence — the process where the buyer's advisors dig into the target company's financial, legal, tax, and operational history before money changes hands, specifically to find the things that aren't obvious from the audited numbers alone.
In this case, the target was a mid-sized manufacturing business with clean financials and a straightforward growth story — exactly the kind of target that makes buyers relax slightly. That relaxation is precisely when the standard-checklist approach to diligence starts to matter.
What a Balance Sheet Genuinely Cannot Show You
A contingent liability is, by definition, a possible future obligation depending on the outcome of an uncertain event — a pending lawsuit, a disputed tax assessment, an ongoing labour claim. Indian accounting standards require companies to disclose contingent liabilities in the notes to their financial statements, but disclosure quality varies enormously in practice, and a liability that a company genuinely believes is unlikely to crystallise sometimes gets described in language vague enough to not register as a real risk to an outside reader skimming a note.
That's exactly what happened here. Buried in a footnote, in a single sentence, was a reference to "certain employee-related claims pending before the labour authorities" — described with no monetary estimate and no real detail, the kind of line that a checklist-driven review might note and move past, since the company's own auditors had assessed it as unlikely to result in a material outflow.
Following the Thread Instead of Ticking the Box
Pulling on that thread specifically — requesting the underlying case files rather than accepting the footnote's characterisation — revealed something the company's own summary had genuinely understated: a group of former employees, terminated during a restructuring several years earlier, had filed claims alleging the terminations violated procedural requirements under labour law, and one of the claims had already seen an unfavourable interim order at the labour court. Taken together, the realistic exposure across the group of claims was a meaningfully larger figure than the vague footnote implied — enough to matter to the deal price, though nowhere near enough to derail the acquisition entirely.
How a Real Liability Gets Turned Into a Manageable One
Finding a liability like this doesn't have to kill a deal — it changes how the deal gets structured. In this case, the resolution was a combination of tools that are fairly standard in Indian M&A practice once a genuine issue surfaces: a specific indemnity clause in the share purchase agreement making the seller responsible for any payout arising from these named claims regardless of the general limitation periods that would otherwise apply to warranty claims, and a portion of the purchase consideration held back in escrow specifically earmarked against this exposure, to be released to the seller only once the claims were resolved or a defined period had passed without a material payout.
The Lesson for Anyone on Either Side of a Deal
If you're buying a business, the real value of due diligence isn't running through a standard checklist — it's the willingness to pull on the threads a checklist flags as low-priority, especially vague disclosure language around litigation or employee matters, which is exactly where sellers' own risk assessments tend to be most optimistic. And if you're selling a business, this cuts the other way: a liability disclosed vaguely and later found to be understated doesn't just cost you money at the escrow stage, it costs you credibility in a negotiation where credibility is the thing that actually determines how favourable the final terms turn out to be.