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Due diligence

Due Diligence and Law

Due diligence is a process of verification, investigation, or audit of a potential deal or investment opportunity to confirm all relevant facts and financial information, and to verify anything else that was brought up during an M&A deal or investment process.  
Due diligence is completed before a deal closes to provide the buyer with an assurance of what they’re getting.
Examples of ‘due diligence’ in a sentence:
It spent a marathon two years on due diligence….
I have an open mind and our own due diligence has been reasonably satisfactory….
The company is expected to spend two months on due diligence.

Home assignments:

  1. Read the text and put questions to each paragraph.
  2. Type your questions in the form under the text.
  3. You need to write a one line summary for each color section of the text.
  4. Explain the features of legal due diligence.
  5. Describe the algorithm for conducting legal due diligence.
  6. Watch the video.
  7. Do the test.

What does the due diligence process cover and why is it necessary?
  1. Due diligence has become one of the buzzwords of the 21st century. Due diligence is a process that involves checking the validity of a position, action or status.

2. So, due diligence is a process of research and analysis that is initiated before an acquisition, investment, business partnership or bank loan, in order to determine the value of the subject of the due diligence or whether there are any major issues involved.

3. One of the most crucial components of the due diligence process is identifying cases of unresolved litigation.

4. The origins of the term “due diligence” can be traced back to US legislation that sought to protect investors against misinformed investments. Here, investment brokers were required to disclose all essential information about the business being invested in. In case they failed to do so, they could be held liable and faced prosecution. 

5. However, brokers raised concerns regarding the fact that they themselves might not always have access to the required information, and in such cases, they should not be held responsible for withholding the same.  

6. Due diligence plays an important role not just in business but, in the overall proper functioning of the economy.  Also due diligence has outsize role in everyday life.

7. For example, a prospective employee claims that they graduated from a prestigious university and have extensive work experience in a certain area.  The employer would verify this information with the university as well as former employers.  This type of due diligence may also involve criminal background screening. 

 8. In some industries criminal background screening is compulsory.  The human resources department of the potential employer, for example, conducts due diligence in this respect so as to verify the criminal status of the candidate. 

 9. A bank also conducts due diligence for loan applicants to make sure that they have not defaulted on previous loans or that they are not over-stretched financially and at risk of defaulting.

 10. Another example is that of a client who conducts due diligence on potential suppliers to check that they will be able to perform the expected services or deliver the goods at the required quantity and quality levels.  This due diligence may entail verifying references or researching a supplier’s track record or their reputation in the market.

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4. Do the test:

Vocabulary

due diligence – a comprehensive appraisal of a business undertaken by a prospective buyer, especially to establish assets and liabilities and evaluate commercial potential; reasonable steps taken by a person to avoid committing a tort or offence.

M&A (mergers and acquisitions) – is a general term that describes the consolidation of companies or assets through various types of financial transactions, including mergers, acquisitions, consolidations, tender offers, purchase of assets, and management acquisitions.

be held liable – having (legal) responsibility for something or someone. When liable refers to legal responsibility, it’s used with “for”: “You’re liable for the court costs” (meaning you have to pay them).

to be prosecuted – to get legal action against for redress or punishment of a crime or violation of law
If someone is prosecuted they are being tried in a court of law.

the validity – the state of being legally or officially binding or acceptable.

buzzwords – a word or phrase, often an item of jargon, that is fashionable at a particular time or in a particular context.

a business partnership – a legal relationship that is most often formed by a written agreement between two or more individuals or companies.

bank loan – a sum of money borrowed by a customer or business from a bank.

Unresolved Litigation – any dispute between the Respondent and any other party adverse in interest, including third party and cross-claims, where either a legal proceeding has been commenced for an injunction, a mandatory order, a declaration or the recovery of money, or a threat of legal action has been made in writing.

Background screening – the process of investigating the backgrounds of potential employees and is one of the most informative ways to collect the data quickly and efficiently in order to help companies make informed decisions regarding prospective job applicants.

Additional information and literature on the topic "Legal Due Diligence"




 Legal due diligence:  special provisions

Conducting a legal due diligence is usually the preliminary step taken by an investor intending to enter into an asset or share sale transaction, claims Noor Kapdi.

The purpose of a legal due diligence is to assess the potential risks of a transaction by investigating the obligations and liabilities of the target company.

This provides objective and reliable information to a potential purchaser as to whether to proceed with the transaction or ring fence, exclude or limit the risks, and negotiate warranties or the purchase price.

The scope of the due diligence is usually determined by the type of business conducted by the target company and the size and the type of acquisition envisaged (such as whether it is a sale of shares or a sale of business).

Depending on the requirements of the specific due diligence, the due diligence team could be multidisciplinary, including financial and technical experts (in addition to legal experts).

A purchaser should always ensure that there is a condition precedent in the sale agreement regarding the successful completion of a legal due diligence to the satisfaction of the purchaser.

This will ensure that the purchaser has an exit opportunity from the sale agreement if the legal due diligence results are not satisfactory to the purchaser. A seller will usually expect a non-disclosure agreement to be signed by the potential purchaser prior to the legal due diligence being undertaken.

A legal due diligence generally covers an investigation of the following areas: corporate, commercial contracts, employment, intellectual property, information systems, environmental, health and safety, regulatory compliance, competition, litigation, property and tax.

A due diligence should also provide a framework to enable understanding of the jurisdiction in which the target company is operating.

Whilst a full and detailed due diligence on the target company is always recommended, with limited exceptions only, a high-level due diligence will achieve similar results.

In the latter case, red or yellow flags highlighting “deal-breaker” or “commercially negotiable” issues respectively will be indicated. Documents are usually provided by the seller in response to a specific due diligence questionnaire prepared by the purchaser’s lawyers. It is also useful to have face-to-face interviews with key management of the target company to obtain first-hand information or clarification in regard to specific issues.

A prudent purchaser should utilize the results of a due diligence investigation as a negotiation tool in the transaction. For instance, any potential liabilities discovered (such as tax liabilities, litigation, outstanding amounts due by debtors, fines/penalties imposed) can be used as a pricing chip to reduce the amount of the purchase price.

Where risks have been identified, the seller could provide warranties or indemnities to protect the purchaser from any future liabilities which may arise from these risks. Where consents and approvals are required, to assign contracts or licenses or in relation to change of control provisions or pre-emptive rights, these can be incorporated as conditions precedent in the sale and purchase agreement.

Furthermore, where specific issues require action by the seller prior to the implementation of the transaction, these may also be added as conditions precedent in the sale and purchase agreement.

The more thorough the due diligence is, the more specific the ensuing contractual protection can be.

Although a due diligence may not uncover or quantify every risk in the transaction, it provides a comprehensive platform from which to negotiate the transaction, especially in instances where there is full disclosure by the seller.

It gives the purchaser a bird’s eye view of the target company’s business in order to make an accurate assessment of the pertinent issues and limit any potential future exposures.

STUDENT PROJECT: LEGAL DUE DILIGENCE
Dutch private limited company (BV) “Broers kooplieden” intends to buy the Ukrainian insurance company “Arsenal Gold”. The founders of the Dutch company are three citizens of the Netherlands: B., C. and T. The founder of Ukrainian insurance company “Arsenal Gold” is a Ukrainian citizen K.
Tasks for the project: 1. Develop an algorithm for conducting LDD; 2. Creating Legal Due Diligence report.

Study the due diligence algorithm of the Ukrainian company DLF Attorneys-at-law

Legal Due Diligence algorithm:

1. Preparation for Legal Due Diligence:

Stage 1
Defining goals of a Legal Due Diligence
Target asset definition

Stage 2
Signing a contract for Legal Due Diligence performance
Signing agreements on non-disclosure of confidential information
Holding a constituent meeting
Assignation of contact persons from each of the parties for Legal Due Diligence
Teams formation
Development and coordination of communication protocols between teams

Stage 3
Development of questionnaires and requests for documents
Creating a Virtual Data Room


2. Data collection, analysis, and interpretation:

Providing and receiving information and documents
Preliminary analysis of the received information and documents
Formation of additional queries based on the results of the preliminary analysis
Providing/receiving additional information and documents
Final analysis of the received information and documents

3. Presentation of Due Diligence results:

Creating a Legal Due Diligence draft report
Familiarization of the customer and representatives of the target asset with the draft report, recording their comments
Approval of the Legal Due Diligence report
 

Additional information can be obtained by clicking on the link: How to effectively perform Legal Due Diligence in Ukraine

Literature:

Sample Due Diligence Checklist

Guidance on due diligence for EU companies to address the risk of forced labour in their operations and supply chains

Creative Commons and copyright law

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