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Legal Due Diligence – Lengthy, Dear and Dull?

Date: 15/09/2020 | COVID-19, Corporate

When you are planning to purchase or invest in a company or a business, solicitors always recommend that a legal due diligence exercise is carried out. This is so there are no nasty surprises. They want to be sure that you do, in fact, buy what you think you are buying, and that you pay a price that properly reflects the risk involved in the deal.

Before approaching lawyers you will usually have done your own due diligence to some extent and may wonder why anything more is needed. Your view may be that it’s overkill and your money is better spent on other things.

Whilst a full and detailed due diligence exercise is always ideal, it is costly and often that, along with the amount of time available, dictates a more high-level approach.  Usually a high-level legal DD report will be quite short and will be quicker to produce as it will not provide summaries of contracts or other areas. Instead it will flag up key legal issues arising from a review of certain agreed categories of documentation where you feel there is significant risk.

So what should you be asking for when you commission a high level legal DD report?  Whilst you may have a good grasp of where the commercial risks lie, are you aware of the hidden legal risks?  Clients often ask us for input when working out the scope of the legal due diligence exercise they want to carry out to make sure they cover all the key areas.

Some of the legal issues that clients are often unaware of can carry significant risk for example:

Sellers: Exactly who are the sellers and what consents do they need to obtain before they can sign up to the deal? Failure to clarify this can mean your purchase is not valid.

Corporate Information: Does what is on the public record match what’s in the statutory books?  Have all the shares been properly issued with the required consents and authorities in place?  Have the proper processes been followed in relation to any share buy backs?  Are there any historic liabilities relating to previous acquisitions or disposals?  Failure to deal with these points can mean taking on more liabilities than you thought or failing to buy all the shares in a company.

Finance: Will any grants be repayable on a change of control?  Are there old charges on the register that need to be cleared?  Will the transaction trigger any repayment penalties?  Not looking at this can lead to surprise cash flow issues if repayments must be made unexpectedly.

Property: Are there any change of control provisions hidden in leases?  Are there any historic liabilities for properties previously occupied?  Are there any properties owned or leased by the business but not used by it?  Not getting the consents needed from landlords can lead to termination of leases and all the related costs that brings.

Contracts: Are there any unwritten contracts that are key to the business?  Are all the contracts in the name of the correct parties?  Are there any contracts that are unusual or not in the ordinary course of business?  Do any contract contain minimum purchase obligations or fixed prices?  Do they terminate on a change of control?  Lack of understanding of the contractual position can lead you to overpay for a business.

Claims: What is the potential for claims against the company or its directors?  Actions against businesses and their directors are increasing, for example breach of furlough restrictions is currently hitting the headlines and claims could be costly.

Failing to understand these risks properly will be expensive.  Commissioning a high level DD report covering agreed areas will give you a birds eye view of the risks involved and allow you to make informed decisions, whether that be to decide not to go ahead with a deal, to chip the price or to get appropriate indemnities in the contract to protect yourself against specific risks.

A focused legal DD exercise need not be lengthy, dear or dull and it can save you both time and money by giving you the tools you need to negotiate the best deal.

If you need help in working out what due diligence you should carry out on any potential target, contact our Corporate team.

The matter in this publication is based on our current understanding of the law.  The information provides only an overview of the law in force at the date hereof and has been produced for general information purposes only. Professional advice should always be sought before taking any action in reliance of the information. Accordingly, Davidson Chalmers Stewart LLP does not take any responsibility for losses incurred by any person through acting or failing to act on the basis of anything contained in this publication.

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