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What is legal due diligence?
The potential buyer of a company or a business will want to carry out investigations and make enquiries about what it is acquiring. This process is called due diligence. Depending on the subject matter of the transaction, the due diligence will include commercial, financial (including tax) and legal due diligence.
The scope of due diligence will vary depending on the structure of the transaction and the nature of the business, the breadth of its activities and how long the business has been carried on.
The due diligence required for a company acquisition will likely be more extensive than the due diligence for a business acquisition. A company acquisition will mean that the buyer, through the acquired company, will inherit all the liabilities of the target company, including both known liabilities (for example, obligations to perform contracts) and unknown liabilities (for example, unpaid tax and liability for past breaches of contracts or legal requirements). In the case of a business acquisition, a buyer is more able to choose whether or not to assume responsibility for the obligations and liabilities of the business and assets being transferred.
The legal due diligence process involves the buyer (or its advisers) asking the seller a list of questions for the seller to answer and, where appropriate, to supply copies of relevant documents. The buyer will then ask any necessary follow-up questions.
How are issues arising during due diligence dealt with?
Issues which come to light in the due diligence process can then be dealt with in a number of ways:
- renegotiation of transaction terms: the terms of the transaction may change, for example by the buyer seeking a reduction in the purchase price or, in the case of an asset acquisition, excluding the relevant asset or liability from the business transfer
- pre-conditions to transaction: the buyer may require the seller to carry out certain pre-sale actions, such as obtaining any missing legal consent or an assignment of intellectual property or other assets used in the business
- warranties or indemnities: specific warranties or indemnities in the sale documents, breach of which will give rise to the buyer being able to claim for damages or loss which has been suffered
- withdrawal: if the issue is sufficiently material and cannot be solved, or the parties are unable to agree terms to address the issue to their mutual satisfaction, the buyer may choose to withdraw from the transaction