What is legal due diligence?
A Legal due diligence is an exercise in which legal risks are assessed during a merger or acquisition transaction. As a rule, said exercise is based on a review of documents belonging to and related to an entity which is the Target of an acquisition.
Similar to, and often in conjunction with, a financial audit (the Financial Due Diligence), legal due diligence is normally limited to a review of available documents. It is therefore commonly referred to as “Documents only“necessary verifications. It requires legal professionals to gather, understand and assess the legal risks, if any, associated with a potential acquisition.
Who orders legal due diligence?
The due diligence exercise is often commissioned by potential buyers in order to verify the viability of the proposed acquisition based on the risks described in said exercise. This exercise is known as Due diligence of buyers.
Occasionally, especially when suppliers are preparing a tendering process for the target, sellers will commission a due diligence process and an often detailed due diligence report, to facilitate the target’s review by the target. potential bidders. This exercise also allows sellers and the target to tidy up their house (at the document level) before engaging in a detailed discussion with the preferred bidder, which will nevertheless require conducting their own due diligence process. reasonable before or as a condition of the sale. . When it is the sellers who request the review of documents relating to the asset they are considering selling, the process is called Supplier due diligence.
Is Legal Due Diligence Required by Law?
There is no legal obligation to perform a due diligence exercise before buying or selling any asset or shares of a company. It is however recommended and practical to do so, especially when the asset or stocks are of considerable value.
That being said, small and medium-sized entities are also encouraged to perform legal due diligence exercises prior to an acquisition (or sale) as the benefits of identifying risks generally outweigh the costs incurred during the exercise. Potential buyers of shares in a Maltese company face not only ownership, in whole or in part, of the target’s profits or assets, but also the broader liability of the existing and contingent liabilities of the target. acquired company.
It is therefore recommended to conduct a thorough investigation of the potential target before any deals are made and the money is exchanged. Legal due diligence (associated with financial diligence) will allow the buyer to gain better visibility on the viability of the proposed acquisition.
When does legal due diligence typically begin?
Legal due diligence should be initiated during the early stages of discussions related to a potential sale. After the initial expression of interest and possibly the initial negotiations between the parties, and once a realistic possibility is established that, subject to necessary verifications, the sale can be successful, buyers should insist on initiating the due diligence process. . It is not uncommon for a stock purchase agreement to be signed before the start of the due diligence process, but the purchase obligation will be contingent on a satisfactory outcome (for the buyers) of the investigation. due diligence. Buyers must commit legal and financial advisers to make the necessary requests to the sellers for the documents to be provided to them so that they can carry out this examination. Typically, a Time range is fixed in which this process must be concluded, and the professionals, engaged to carry out this exercise, should respect the aforementioned deadlines.
Should documents be signed before legal due diligence begins?
Before the start of the due diligence exercise, the parties will be strongly advised to perform a Non-disclosure agreement which would require buyers (and their advisers) to keep documents and information disclosed during negotiations and the exercise of due diligence, as private and confidential between the parties. It is not uncommon for the nondisclosure / confidentiality agreement to contain non-solicitation provisions prohibiting the potential buyer from soliciting employees or customers of the target or the sellers against whom the potential buyer will receive. important information.
What documents are reviewed during the exercise?
To begin with, advisors would normally provide sellers / targets with a Due diligence checklist establishing a list of documents and files that they would expect the vendor / target to provide for the exercise Assessment will be limited to the documents provided. It is therefore imperative that this first collection of documents be thorough so that the advisers can assess the entity on the basis of these documents.
The documents would generally be divided into a number of categories and would cover aspects such as: business, Equipment trade and financing agreements, property, employment, litigation, intellectual property, environmental, regulatory and other compliance and Insurance. Tax and accounting matters are often left to financial advisors to deal with, with input from the legal team only when necessary. Each section of the Data chamber would include relevant documents for each category, where applicable.
Since the representations and warranties given by a seller regarding the target in a purchase contract will be limited to the extent that disclosure has been made to the buyer prior to the sale, the seller has a material interest in ensuring that the documents made available to the Purchaser in the Data Room are as complete as they are accurate and that they give a true picture of the legal situation of the Target.
Any omitted documents which could have an impact on the sale and which would not be produced during the exercise will not exclude the seller’s liability in the event of a claim for breach of warranty.
What expertise is required to perform a legal due diligence exercise?
Given the variety of legal documents generally made available for review during a due diligence exercise, a number of lawyers specializing in the relevant sectors should be involved in the process. After gaining access to the data room, the person at the head of the team would conduct an assessment of the types of documents available and then determine which team members would be most suitable to be involved.
It is for this reason that it is generally the large firms that are responsible for carrying out these legal due diligence, given the wider range of skill that these companies have by their very nature. The legal team would then be able to review documents within its area of expertise and highlight any concerns of potential buyers (or sellers as the case may be). These concerns will then either be resolved as Previous condition upon acquisition or excluded from representations or guarantees included in the share purchase agreements. The price of the acquisition may also be affected by the findings of the due diligence exercise.
How are the documents accessible?
Lawyers will have access to the documents either physically or through online access. The first option would involve the physical presence of the lawyers in the offices of the Target or at a place specially designed for this purpose and the provision of the physical files of the professionals for examination over a period of a week or two.
The most common approach, however, is to use the variety of online services available specifically for setting up virtual data rooms (VDR). Documents are uploaded electronically to a designated online portal and lawyers have access to them for a period of time. The systems often allow you to receive notifications for each new uploaded document and allow professionals to access the documents at their desks. These methods are generally preferred by lawyers and clients, also because they are more cost effective.
What independent research is usually done in Malta?
Independent research external to the data room or the VDR is also generally carried out as part of the due diligence exercise depending on the nature of the target. This research may include:
- Research on the online portal of Malta Business Register (the “MBR”);
- Obtaining Good quality certificates and Function certificates of MBR;
- Research at Public register for charges recorded on the target in general or on any building it may own;
- Research with local authorities such as Malta Financial Services Authority or the MGA for any license whose target is a regulated entity;
- Research at Court registry in Malta for any pending litigation;
- Research at Labor court for disputes involving employees; and
- Intellectual property saved search trademarks, patents or drawings;
Other considerations to keep in mind during the acquisition process are potential competition law implications and foreign direct investment considerations. Both assessments are usually done after a more final decision has been made to proceed with the transaction.
What is the result of a legal due diligence exercise?
Following the evaluation of all the documents provided and the examination of the independent research carried out, a Legal Due Diligence Report is produced. Said report can take different formats depending on the client’s needs and budgets. Reports typically include a abstract which would present the main findings for ease of reference.
Longer reports would provide a description of all documents reviewed. Some buyers request that important points be marked with a green, orange or red flag to distinguish the importance of the findings to the intended transaction. The other reports only include questions that should be considered as Red flags and delete any other description of the documents under review. Such reports may also include other inquiries to be made to sellers on the basis of the documents provided or omitted.
Typical red flags can include large commercial contracts that contain change of control limitations, potential large or pending litigation, financial agreements indicating large loans, or real estate leases with impending expiration dates. A well-written due diligence report should be able to distinguish substantial risks from more ordinary risks and will be an important tool in effectively structuring the purchase contract, confirming price considerations and limiting or qualifying representations and warranties given by sellers. .
A satisfactory due diligence exercise and a DD report will often be a condition for the completion of a purchase transaction and, therefore, at the end of the fiscal year, and subject to the satisfaction of other conditions precedent, the parties will generally move to the conclusion of the transaction. .