Legal Due Diligence An introduction RA Dr Bernd Grama, LL.M (Columbia)

Legal Due Diligence
An introduction
RA Dr Bernd Grama, LL.M (Columbia)
 Heidinger Albeseder; Due Diligence
(Orac 2001)
 Hofmann; Due Diligence – Möglichkeiten
und Grenzen des Managements
(Verlag Ö, 2006)
What is due diligence?
 No legal definition of DD in Austrian Law
 DD is an extensive examination of the company to be acquired
(review of all important documents)
In other words:
 to identify the big problems and the black holes prior to the
acquisition of assets or shares of a company
 DD is conducted before a buyer/seller is committed to a deal
 Due Diligence is a multi-disciplinary exercise -> team work!
Roots of Due Diligence
 U.S. Securities Act of 1933
 The issuer (among other parties like all those who signed the
registration statement) is liable for wrong or missing information
about material facts in the letter of registration.
 But the issuer is able to free himself form liability if he is able to
prove that after reasonable investigation he had reasonable
ground to believe that the statements were true and not misleading
(due diligence defense).
 The requirement of a reasonable investigation to become free from
liability is the reason why the management started to keep records
of the financial and economical situation of their company
 This was the origin of due diligence
 During second half of 20th century  important for all kind of
transactions (provides information and discloses risks)
Legal Due Diligence
Legal due diligence (lawyers)
Financial DD (accountants)
Commercial DD
Tax DD
Environmental DD
Technical DD
Human resources
Further specialist DDs: Marketing, media expertise…
Legal Due Diligence
Buyer’s DD (most common)
Seller’s Legal DD
Internal control measures
Other reasons
Main reasons for legal DD
1. Identification of any defects in the enterprise (defects of title), that
might give rise to a warranty claim or a claim for damages
2. Determination of liabilities connected with the business to avoid
3. Secure transfer of all existing contractual relations and submission
of all required statements of consent and authorisation
4. Examination of all legal and administrative requirements for a
continuation of the conduct of business
5. To comply with standard of a prudent business merchant
(management board of acquiror)
Legal Due Diligence
Legal DD is usually performed by the buyer’s lawyers, but:
 Chartered accountants also review legal documents (corporate
documents, important contracts)
 Lawyers typically ask for financial statements and related reports
It is a misconception that full transparency of the target corporation can
be created through and during a due diligence process
 Time pressure -> priorities
 Not only consider past documents –> also their future relevance
 Highly complex matters
What does legal DD cover?
Typically legal due diligence covers
1. Company structure / shareholdings
2. Transactions
3. Contracts and trade agreements
4. Real estate and other major assets
5. Permits
6. Public subsidies
7. Collective labor law issues / Individual labor law issues
8. Pensions
9. Product Information
10. Insurance
11. Intellectual Property
12. Litigation
13. Environmental Issues
Example: M&A Transaction
 The purpose of a due diligence during an M&A transaction is to
gain information about
 the target company and
 risks of the transaction.
 A due diligence review is done in almost all M&A transactions,
provided that the value involved is somehow significant
Timing of the due diligence process varies
Depends on the circumstances of the particular transaction:
1. before a share purchase agreement (SPA) is signed but after
execution of a letter of intent (LOI) (common scenario)
2. after an SPA has been signed but before closing
3. after closing with the contractual possibility of a post closing
adjustment of the purchase price
1. Letter of intent (LOI)
2. Confidentiality Agreement
3. Request list and preparation of DD
4. Review of documents (→ Data Room)
5. Report
6. Consequences
Letter of Intent
There is an agreement to agree
Letter of intent (LOI)
Letter of intent is a preliminary agreement, also known as:
memorandum of understanding, commitment letter, heads of terms
 Written document between parties
 Negotiations have reached an advanced stage
 Agreement on intentions and expectations
 Function
 Summarize the broad terms of what has been agreed on
 Put in writing a “step-plan” how negotiations shall go forward
Letter of intent (LOI)
generally no → not binding on the parties in their entirety.
but many LOIs contain provisions that are binding, such as:
 non-disclosure / confidentiality agreements,
 a covenant to negotiate in good faith, or
 a stand-still or no-shop provision promising exclusive rights to
negotiate - EXCLUSIVITY
 explain the key points of a complex transaction
 provide exclusivity for negotiations for a certain period
 provide security if deal collapses during negotiation (break-up fee)
Typical topics
Opportunity to agree on the timetable
secure access and necessary cooperation
Key warranties and indemnities
To flag the main warranties and indemnities expected
Purchase price and consideration
Price negotiations should be in the final phase
Standstill agreement
Not to conduct negotiations with third parties for a limited time
→ affects the buyer’s bargaining position
Binding provisions
Various binding provision can be negotiated
Speeds up a deal and makes final agreement easier
Parties agree on basic terms and structure
→ LOI serves as a roadmap for the final agreement.
Contains binding provisions which help get the deal done
Some binding provisions are important to agree on
Period of exclusivity
→ Standstill agreement
It can help to secure financing
For banks and other lenders
→ before committing to finance a transaction
Depends on:
1. The context of the negotiations
2. The language used in the LOI
a) Intent to be bound
b) Parties agreement to the essential terms
3. The size and complexity of outstanding issues which remain
The confidentiality
Non-public business information
Confidentiality Agreement
Confidentiality Agreements restrict the
distribution and
use of information disclosed in the due diligence process
1. Potential buyers are often competitors
2. Seller may be reluctant to disclose non-public information to any
potential buyer
3. Buyers are generally unwilling to make their offer unless given
access to non public information (such information is generally
crucial in determining whether the envisaged business model will
Confidentiality Agreement
Who is bound?
 Entire company of buyer and seller?
 Seller will insist that buyer includes all team members in the NDA/CA
 Advisers (e.g. lawyers)
What is covered?
 Basically everything except:
 Information which is generally available to the public
 Information which was already in the possession of the receiving party
 Information which is independently developed by the receiving party
 Information which is received from another source without any restriction on use or
How long does it last?
 Time limit → usually between 1 and 5 years
Breach of confidentiality
Violation gives the other party the right to sue for
 Cease and desist and
 Compensation for damages suffered (eventually penalty clause)
In practice
 Very difficult to prove if
a) an obligation has been violated
b) a loss has been suffered
 Practically no court cases for breaches of confidentiality
 If possible: Penalties regardless of fault in the NDA/CA
Request list and preparation
of DD
Request List and preparation of DD
 Send due diligence request list to target management
 Target Management has to install a data room (either at the premises
of target company or in the office of seller‘s counsel)
 Data Room needs to be well prepared – decisive for success of due
 Set up due diligence team – team leader (specializations; often junior
associates involved) (multi-jurisdiction discipline)
 Make sure that team members have some preliminary information
regarding target
 harmonize formatting (numbers, dates, abbreviations for the target
 Coordinate meetings with accountants who are conducting Financial
The review of the documents
„no warranties for obvious deficiencies which are evident in
public records”
§ 928 ABGB
Doing the due diligence review
Where to get the information?
1. Data room
The data room enables interested parties to view material relating
to the business in a controlled environment
Data room rules state if documents are allowed to be copied
2. Written questionnaires
Directed to the management of the company
Covering the issues of the → Request list
3. Site visits
Legal team might visit the site of the target company
Data room
Traditional data room
 Physically secure continually monitored room in the seller’s offices
 Should contain hard-copies of all relevant documents and information
 Only one legal due diligence team can enter the room at the same time
(sometimes data room at seller’s office and at seller’s counsel)
Data room
Virtual data room
 Alternative to the physical room, in the form of an extranet
 An Internet site with limited and controlled access
using a secure log-in supplied by the vendor/authority
 can be disabled at any time by the vendor/authority if a bidder withdraws
from the transaction process
 Usually no forwarding, copying, or even printing of displayed documents
 Record is kept for each document – who saw it, when and for how long
Virtual Data Room screenshot
Pros and cons of virtual data rooms
Is accessible 24/7
No need for couriers to move or update documents
Many DD teams can access files at the same time
Information can be added or removed at any time
Cost and time saving
Can be difficult and time consuming to open documents
Screen handling is more tiresome
Security issues
Review Contents
Corporate Issues
 Present group structure (extract from the commercial register)
 Minority rights of shareholders
 Articles of Association/Charter
 Shareholders’ agreement
 Contracts and other titles for acquisition of shares
 Related Party arrangements
 Minutes of Meetings (board, shareholders)
 Corporate restructurings (mergers, spin-offs…)?
Review Contents
Third party influence on the
Liabilities assumed for third
 Trust agreements
 For affiliated companies
 Pledge of shares
 For others
 Silent partnerships
 Special dividend rights
 Affiliated companies
Participations in other
 Shares in corporations
Cooperation Arrangements
 Joint Venture
Review Contents
Governing bodies
 Board of directors
 Organization chart
 Supervisory Board
 Management contracts
 Advisory Board
 Collective bargaining
 Plant agreements
 Social security benefits
 Members of work councils
 Proxy employees
 Pension fund coverage
 Strikes and lock-outs
 Workforce reduction
Review Contents
 Contracts for services
 Disputed legal relations
 Consultancy agreements
 Current and imminent proceedings
 Lease contracts
 Arbitration proceedings
 Outsourcing
 Reserves in balance sheet
 Franchise
Insurance coverage
 Supply contracts
Risk evaluation
 Standard terms of business
Review Contents
Real Estate
Public law permits
 List and details of all real
 Trade licenses
 Extracts from land register
 Purchase agreements
 All contracts
 Side Agreements
 Rent adjustment (attention:
§12a (2) MRG)
 Plant permits
 Zoning plans
 Construction permits
 Emissions certificates
 Environmental impact assessment
 Environmental documentation
 Environmental audit
The due diligence report
„Heavy on facts, light on advise“
Due diligence report
Lawyer reports client on all issues revealed
→ Lawyer‘s general duty of care
With special regard to:
1. Missing information or data (often incomplete)
2. All revealed risks
3. Nature and size of debt, liabilities
In Austria and Germany: key recommendations
USA and UK: Usually no legal advise and conclusions
→ No legal opinion
Report disclaimers
 No recommendation to buy or sell
 “DD report only contains advice according to Austrian law or jurisdiction
→ Lawyer disclaims responsibility for legal consequences in other
jurisdictions (if local law firm engaged to conduct due diligence)
Reliance Letter
Common in private equity transactions (buy-in or transaction by
private equity companies)
 often the due diligence report is forwarded to the financing
banks in private equity deals
 The reliance letter states the terms and conditions, especially
limitations of liability of law firm
Consequences of the legal due
1. Cancellation of the transaction
2. Reduction of the original purchase price
3. Restructuring of the deal
4. Reps and warranties (→ SPA)
5. Conditions precedent
Costs of DD
 DD is very expensive
 DD-team consists often of 4-10 lawyers
 Spend 5-10 days (10 hours per day) in the data room (hourly
rates of associates range between EUR 220 to 280)
 Drafting of report takes 2-4 days (10 hours)
 Costs between EUR 30K to 250K
Thank you for your attention!