In the current economic climate, with concerns around companies’ liquidity and trading prospects, it is more important than ever that parties looking to acquire companies or assets, or enter into investment arrangements, undertake effective legal due diligence on the target companies before entering into agreements with them. This is to ensure that all potential risks and issues which may affect the transaction are identified and appropriately dealt with during the negotiations of the transaction.
This briefing is designed to outline the due diligence process by highlighting the key documents and information that we would expect to be requested and reviewed and the public searches that should be undertaken in Guernsey in respect of potential transactions to be entered into between businesses.
What is Legal Due Diligence?
In general terms legal due diligence is an analysis conducted by legal (and other business or financial) advisors on a target company or business. Its purpose is to determine any challenging issues early in a purchase or investment process, thus enabling a purchaser or an investor to determine whether it wants to proceed with a purchase and, if it does, enables the parties to negotiate a resolution on areas of risk before a deal concludes. This is also an opportunity to revisit the purchase price if the analysis raises queries with regards to the value initially attributed by the seller to the business to be sold. Should parties not engage in such pro-active steps, they may end up fighting after the sale when there is little scope to negotiate and matters become costly when bringing claims for breach of promise or warranty and indemnity claims post-completion. This is specifically important when acting for sellers.
What does Legal Due Diligence entail?
The scope of the due diligence is usually determined by the type of business conducted by the target company as well as the size and scope of the acquisition envisaged (for example whether it is a shares sale or a business sale). Legal due diligence will usually run alongside commercial and financial due diligence investigations undertaken by relevant experts.
Generally, in the context of an acquisition, a legal due diligence exercise will cover investigations of the corporate structure, the legal ownership of assets (which might include the legal status of real and intellectual property and investments), regulatory compliance, current or pending disputes and litigation, intellectual property and contractual obligations and tax matters as well as company specific matters depending on the business of the company (for example employment, environmental and health and safety matters). There are of course the reviews into the state of affairs of the business and the right of that business to future income, such as client contracts for services for which it is to be paid, and the certainty of future business flows.
Where the due diligence is conducted in relation to an investment or for the purposes of financing, then the due diligence is most likely to focus on the structure and ability of the company to enter into investment and financing arrangements, any existing financing and security and the financial health and prospects of the business concerned.
The due diligence will also provide a framework to enable understanding of Guernsey law and regulatory requirements as applicable to the company in question.
Engaging Guernsey Legal Counsel
As the due diligence exercise can have a major impact on the timing and a success of a transaction (and given that timing in the current market conditions may be a critical issue), we would encourage parties to engage external counsel at the outset of transactions as they will be able to assist with all aspects of a due diligence exercise.
The Legal Due Diligence Questionnaire
The due diligence process often starts with the acquirer/investor sending to the seller a list of requests for documents and information. To avoid becoming overwhelmed by a due diligence exercise, a purchaser/investor should work with its external legal advisers to prepare a due diligence questionnaire that is relevant to the company concerned.
Provision of Legal Due Diligence Documents
Historically, the provision of due diligence documentation involved a party having to attend at the target’s offices to review hard copy documents in a physical data room so it can review and make notes on the documents made available. Alternatively, the target would procure for the delivery of lever arch files containing the disclosed documents to an address as agreed between the parties for inspection
In recent years, like many things, data rooms have progressed on-line with sellers and targets often setting up virtual data rooms in a cloud based solution which allows for more timely and convenient access to such documents
Legal Due Diligence Report
The volume and scope of information contained in a due diligence report will vary depending on the nature of the business and the requirements of the purchaser/investor. They can be lengthy documents or sometimes they can be more protracted, highlighting “material” matters. If the latter approach is taken then the acquirer/investor will need to agree how materiality is to be determined, as setting a monetary value might not necessarily flush out all important issues. The Ferbrache & Farrell general approach is to prepare a full report which fleshes out all issues although with an executive summary, thus highlighting key material issues but providing more substantive detail in the body of the report. The adage “let the buyer beware” should always be at the forefront of these disclosure exercises so that they tease out any issues affecting the value, both present and future, of the business acquired.
Corporate documentation to be reviewed
In the due diligence process, an acquirer/investor should ensure that the following documents are provided as part of the information on the corporate structure:
- the constitutional documents of the company (namely, the certification of incorporation and the governing documents (memorandum and articles of incorporation or partnership agreement);
- the company registers including the register of directors, the register of secretaries and the register of members);
- minutes and resolutions of both directors and shareholders;
- shareholder agreements;
- contracts both showing expenses and revenue of the business; and
if the target is a regulated entity, its regulatory licence (and any applicable conditions or directions) and any register of complaints.
Searches to be undertaken
Parties should undertake appropriate searches on Guernsey public registers before entering into transactions. These will include:
- company registry searches (to check if the target exists);
- litigation searches (to check if the counterparty is involved in litigation which may have an impact on the transaction or consideration, or if any petitions have been filed for its winding-up); and
- regulatory searches (to check the regulatory status of a counterparty and what licences the counterparty holds).
There is no “standard” way to conduct due diligence as it involves a fact-based approach depending on the target company being acquired/invested in.
A properly conducted legal due diligence exercise undertaken at an early stage with the help of external counsel involved can give a purchaser/investor the necessary confidence to proceed with a transaction knowing it has identified all material risks and have subsequently put in place appropriate restrictions in an attempt to mitigate such risks.