THE IMPORTANCE OF THE LEGAL DUE DILIGENCE

The importance of the legal due diligence

Legal due diligence is the process of collecting, understanding and assessing all the legal risks associated during a M&A process. During due diligence, the acquirer reviews all the documents pertaining to a target company and interviews people associated with it. The idea behind this investigation is to understand if there will be any future legal problems due to this acquisition or not.

We pay great attention while carrying out the Merger and Acquisition process and conducting its legal due diligence report due to its importance and for its great effect on the business; as,

Firstly, it gives the acquirer a better opportunity to understand the target company and its operations before purchase. Moreover, it acts as an icebreaker between the legal counsel of both organizations so that they can work together to push the deal through.

Secondly, the Top of FormBottom of Formbuyer can use the information obtained through legal due diligence to determine the right amount to pay for the transaction. It also gives a chance for the buyer to closely analyze the financial, structural and operational aspects of the business so that subtle things such as lawsuits against the company, employee and labor arrangements, indemnification processes and intellectual property details can be ascertained.

Thirdly, the information obtained during the legal due diligence process can help both the buyer and the target company to draft appropriate merger and acquisition documents and other ancillary documents as may be needed. It also plays a role in negotiating the right value for both parties, based on the legal obligations of the target company;

Lastly, the legal due diligence process will help to identify the possible problems that can act as impediments to closing the deal. When both parties know the possible impediments, they can take steps to address the same to ensure the smooth completion of the agreement.

Conducting legal due diligence

Legal due diligence is the process of collecting, understanding and assessing all the legal risks associated during a M&A process. During due diligence, the acquirer reviews all the documents pertaining to a target company and interviews people associated with it. The idea behind this investigation is to understand if there will be any future legal problems due to this acquisition or not.

Legal due diligence is intended to be carried out to evaluate any legal issues that may affect the value of the target company. Such an exercise is also required to identify any prerequisites and conditions that must be fulfilled to achieve successful completion of the transaction, or consents and approvals that may be required to duly transfer ownership of the shares or assets of the target business. It is also vital for the determination of the method of payment, negotiating the needed securities and highlighting the main areas of risk and how such risks may be mitigated by agreeing on proper risk allocation mechanisms including adequate representations, warranties and indemnities.

The legal due diligence process starts with the acquirer’s due diligence checklist and request for the disclosure documents of the seller subject to confidentiality restrictions. The scope of the investigation varies according to the type of the proposed acquisition as it will usually be more extensive on the acquisition of the entire share capital of a company than on an asset acquisition.

Depending on the type of the proposed acquisition, a legal due diligence generally covers an investigation of the following areas:

Constitutive records

First of all, the acquirer should know the incorporation framework of the target company. Therefore, the acquirer’s lawyers should study among other things the articles and memorandum of association of the target company, all general assembly and board of directors’ meetings, names of authority signatories and the authority and capacity of each, shareholders register and list of all current shareholders showing amounts of shares by percentage owned by each, all shareholders' agreements, voting trusts, proxies and registration rights agreements.

Management and Employment

The acquirer’s lawyers will need to obtain full details of the target’s workforce, and in particular the contractual terms that apply to its management team. The terms of employment should be checked in addition to all severance agreements, pension and profit sharing plans in which employees participate, including any such plans which have been previously terminated but the assets of which have not been completely distributed to plan participants, all incentive and non-incentive stock option plans adopted for the benefit of employees, all welfare benefits plans (e.g., medical, dental, life insurance, accidental death and dismemberment) which were adopted for the benefit of employees, all governmental filings relating to the documents described above including related to employees’ handbook or bylaws.

Litigation
Copies of all lawyers' audit responses and summaries of all presently pending or threatened claims, actions, suits, injunctions, legal proceedings, arbitrations, amicable settlements, or any other legal or administrative proceedings by or against the target company, including, without limitation, employment or labour claims (e.g., grievances, administrative charges, wage and hour claims, workplace safety matters, civil litigation, unfair dismissal, unfair competition and workers’ compensation) should be carefully examined.

Tangible and Intangible Asset

A target company should provide the acquirer a list of all tangible assets which are owned by the seller; such as real properties also rented or leased properties including all the relevant information and contracts regarding the assets, all the documentation regarding intangible assets; for instance, patents, trademarks, copyrights, trade names, franchises, licenses, and other intangibles.

The acquirer needs to ensure that the assets of the target company have the value as stated, no restrictions are being imposed on the rights of the target company on these assets and there are no risks that may depreciate the value of the assets.

For instance, on an asset acquisition, the acquirer needs to verify whether the consent of the landlord will be required for the assignment of any leasehold premises included in the sale.

Licenses and Permits

It is important to check on all licenses, permits or certificates issued to the target company by governmental authorities, which a particular target business should have. These will need to be checked to make sure that they are still valid and they cover all the operations of the business and whether the change of control in case of a share acquisition shall not affect the validity thereof.

Key contracts

The significant contracts into which the target has entered should be examined in order to (i) verify the obligations and the rights of the target company that will flow down to the acquirer and that there are no non-arm’s length trading relationships; (ii) investigate the chances to renew the contracts that are due to expire; (iii) figure out the effect of change of control on such contracts and the requirements that need to be satisfied to avoid any potential termination; and (v) investigate the assignment or novation of contracts on an asset acquisition.

Loans
On an asset acquisition, the acquirer will need to enquire whether any of the assets which are being transferred are the subject of a charge to decide whether any such charge will have to be removed on completion, or the consent of the charge needs to be obtained for the asset to be transferred.

On a share acquisition, the acquirer should request copies of all loan or lien documents, including notes, trust deeds and mortgages, security and finance agreements and financing statements in order to discern the nature and extent of the target’s borrowing commitments and obligations.