Legal Due Diligence An introduction RA Dr Bernd Grama, LL.M (Columbia) Literature Heidinger Albeseder; Due Diligence (Orac 2001) Hofmann; Due Diligence – Möglichkeiten und Grenzen des Managements (Verlag Ö, 2006) Essentials 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 Distinguish: 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 Types Buyer’s DD (most common) Seller’s Legal DD IPO 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 litigation 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 Limits: It is a misconception that full transparency of the target corporation can be created through and during a due diligence process Reasons: 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 Procedure Timing 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 Procedure 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) Binding? 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 Purpose? 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 Timetable 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 Advantages 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 Enforceability 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 unresolved The confidentiality agreement 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 materialize) 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 disclosure 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 Therefore 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 diligence 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 etc.) Coordinate meetings with accountants who are conducting Financial DD 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 Pro 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 Transparency Con 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 corporation Liabilities assumed for third parties Trust agreements For affiliated companies Pledge of shares For others Silent partnerships Special dividend rights Affiliated companies Participations in other companies Shares in corporations Cooperation Arrangements ARGE Joint Venture Review Contents Governing bodies Personnel Board of directors Organization chart Supervisory Board Management contracts Advisory Board Collective bargaining agreements Plant agreements Social security benefits Members of work councils Proxy employees Pension fund coverage Strikes and lock-outs Workforce reduction Review Contents Contracts Litigation 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 (AGB) Review Contents Real Estate Public law permits List and details of all real estates Trade licenses Extracts from land register Purchase agreements Leases 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 involved” → 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 Consequences of the legal due diligence 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 END Thank you for your attention!
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