What Due Diligence is and Why It is Important

Due diligence is probably one of those legal jargon terms you have heard of but never knew what it meant. It represents, hopefully, something you are already doing to protect yourself and your business.

For illustrative purposes, we will say John asked his neighbor Pat to watch his dog while he is away on vacation. The dog is kept indoors during the day, but is let out in the fenced in back yard at night. Pat is aware that the fence is in bad shape. The dog escapes and is killed by an oncoming car. Pat does not even bother taking the dog to the vet, even though he is still breathing.

When John returns, he finds his precious dog is passed. Angry, he sues Pat for the cost of the funeral and veterinary bills. Pat is liable as he was probably grossly negligent and did not exercise due diligence. Due diligence is the care that a reasonable person would use to avoid harm to other people and their property. Pat knew the fence was in bad shape, and a reasonable person would have declined to keep the dog inside a damaged fence. Further, Pat found the dog breathing and should have taken him to the vet. This is what a reasonable person would have done, especially since the dog was not his. Pat is probably going to also be sued on the grounds of gross negligence since he did not take the dog to the vet, but yet he was found alive and the dog was not his.

A fiduciary relationship occurs when a third party (Pat) is responsible for overseeing property (the dog) that belongs to another person (John). When a fiduciary relationship is present, not only does the trustee (Pat) have to take care of the property, he has a higher standard that he is held to while doing so.

Even though fiduciary relationships usually occur with estates, stocks and bonds, the concept is more easily understood when a simple example is utilized.

Same concepts apply to your S Corporation, partnership, or Limited Liability Company. You must take better care of other people’s property in your possession that you would your own. Failure to do so (exercising due diligence), could result in a lawsuit, unhappy customers, and even jail time. Even if you have a corporation, the corporate veil may be pierced is you, as an officer, acting in a grossly negligent manner. Consider an oil company that is responsible for an oil spill in the Atlantic, and the President was privy to information of a dangerous situation prior to the spill and did not act. Sounds like gross negligence. Basically, if every business owner treated every customer like he would himself and every piece of property he does not own like his did, there would be much fewer lawsuits