EPISODE 6 – DUE DILIGENCE: CONDUCTING LEGAL INVESTIGATION
Business leader and Vice Chairman of IBM, Gary Cohen, once remarked that “if you don’t invest in risk management, it doesn’t matter what business you are in, it’s a risky business.” It is a golden rule for a person or company to conduct proper investigation before commencing commercial relationships; which is where Due Diligence (DD) becomes relevant. DD is of various types, depending on industry and transaction, which may involve the services of a team of professionals including lawyers, accountants, financial analysts, and so on. In this article however, the focus is placed on Legal DD – the process of understating the actual, potential and contingent liabilities of the company, from a legal standpoint.
This episode serves to set out the basics of Legal DD in corporate and commercial transactions, the process, common issues and helpful tips. In this episode, Victoria Oloni, a tech-enthused legal practitioner with Detail Commercial Solicitors, also shares her two cents on the subject matter.
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What is Legal DD?
“HealthCo (the Acquirer) is a corporate magnate within the Canadian healthcare sector looking to expand into the African Market through a potential acquisition of WellNaija (the Target), the 3rd largest pharmaceutical company in West Africa.”
One of the first and prudent steps which the Acquirer in the above scenario must take is conducting a Legal DD.
Legal DD is essentially a fact-finding mission carried out by a party on an undertaking to identify and assess any potential legal risks before commencing business relations with such undertaking. In the above scenario, a Legal DD process would influence several decisions including pricing, valuation and even consummation of the transaction, based on the legal issues identified. Aside acquisitions, Legal DD may be conducted for different transactions including mergers, equity and debt financing, joint venture arrangements, projects, Initial Public Offerings (IPOs), arrangement and compromise, and other forms of investments.
?Victoria agrees that the main purpose of a Legal DD exercise is to carry out a full assessment of all possible legal risks. She explains further that Legal DD may either be conducted by a potential financier/investor for a target company or even by the company on itself, and it may also be conducted on two levels; (a) high-level due diligence, containing red or yellow flags highlighting “deal-breaker” or “commercially negotiable” issues; and (b) full and detailed due diligence.
In the scenario above, it is typical for the Acquirer to conduct the Legal DD, after all, the Acquirer’s interest is immediately at stake where there are flaws in the eventual acquisition. Nonetheless, the Target may also conduct an independent Legal DD. The party undertaking the Legal DD would usually engage a team of lawyers to conduct the actual process – a no-brainer.
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The Legal Due Diligence Roadmap
Victoria suggests that the first step for an effective Legal DD process is putting together a legal team. She explains that a good Legal DD exercise is preferably conducted by a team that is put together for that purpose, rather than a single individual – for example, in a power or energy transaction, the finance arm of a law firm will not conduct a Legal DD without input from the power team particularly for things like regulatory, environmental and insurance issues. It is worthy of note that the party conducting the Legal DD may engage the services of a single firm or a pool of firms.?
It is imperative to elucidate the point that the team composition is largely determined by the transaction type. The legal team ought to pay attention to certain nuances of the transaction, including the experience of the team in the relevant industry, as well, the jurisdiction(s) of the transaction. For instance, a deal with a cross-border nature would require the engagement of local counsel in different justifications, and may also require a central coordinating firm/legal team that would generate standard form templates to be used by the local counsel in the different jurisdictions.
Upon setting up the team, the next step is to prepare and issue an Information Request List (IRL) to the Target, which is an overview list of requested information and documents. The IRL may be arranged in sections to ensure it covers the relevant areas to be included in the final Legal DD Report. It is noteworthy that responses to the IRL would ordinarily form part of the disclosures to warranties and representations made in the core agreement of the transaction. Victoria is of the view that the IRL should be relevant to the nature and the specific terms of the transaction/project structure or the nature of business of the Company, and not a one size fits all document.
In response, the Target company would proceed to furnish the requested information and documents, typically by creating a Virtual Data Room (VDR) – simply a secure cloud storage folder that houses the requested documents, with limited access to the parties and the Legal DD team. Note that a physical data room may also be adopted.
Once the VDR has been created and access granted, the Legal DD team will proceed to conduct a review exercise and populate a Legal DD Report. Victoria provides the table below highlighting the sections of a Legal DD Report as well as the documents and information commonly reviewed during the review exercise:?????????
Upon conclusion of the initial review, additional information, documents and even confirmations may be requested. It is also prudent to conduct independent searches to confirm the veracity of the information disclosed by the Target. Such search may be done at the Land Registry (where fixed assets are involved), the companies house (the Corporate Affairs Commission (CAC) in the case of Nigeria) and even the courts (to confirm any pending or potential litigation).
A corollary to the review process is a Legal DD Report. Victoria points out that the Report should describe all the reviewed documents, analysis of key risks identified, and make recommendations. A good Report not only details the material issues, but also provides practical recommendations on how each issue could be dealt with. Depending on the severity of the findings, these recommendations range from requesting further information, conducting further due diligence, factoring the issue into the valuation of the Target and completion of remedial actions, among others.
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Common Issues During a Legal Due Diligence Process
Chiefly, confidentiality is a concern. While it’s the duty of a lawyer to keep under wraps information obtained from clients, it’s advisable for the parties to put in place a confidentiality agreement with advisors to prevent the risk of leakage of valuable and sensitive information into the public domain. The confidentiality agreement may also include non-compete clauses and lock-up periods during which the parties agree to deal exclusively with each other for a certain period with respect to the transaction.
Other common issues, as highlighted by Victoria, include:
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Take away...
The purpose of a Legal DD exercise is risk identification, and as Victoria notes, an effective Legal DD process must (a) identify risks; (b) identify the causes and consequences of the risk; and (iii) recommend risk mitigants to avert the identified risks. She adds that such risk mitigants may include making certain requirements conditions precedents, conditions subsequent, representations and warranties or indemnities.
To optimize the process of disclosures, Victoria recommends the creation of a VDR, as opposed to using multiple email exchanges to send across the required documentation. Documentation here may be categorised into separate sections to allow both the client and the lawyers to keep track of the information exchange process.
Finally, the Report must be well-drafted and structured to enable the party conducting the DD process to easily and confidently rely on it as a pre/post-completion guide to the “legal architecture of the transaction.”
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Previous Episodes:
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ABOUT THE CURATOR:
Tayo Fabusiwa is an associate in a leading law firm in Nigeria, where he advises clients on transactions, market-entry requirements and regulatory compliance. He is the founder of Legal Pages, a content-based platform committed to helping law students and young lawyers access opportunities and resources. His work with the platform got him listed in YNaija’s 2019 Establishment List. Tayo was also nominated in the “Ideator of the Year” and “Entrepreneur of the Year” categories of the 2019 Law Gala Awards, Nigeria.
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ABOUT THE CONTRIBUTOR:
Victoria Oloni is an innovative lawyer with significant interest and competence in Corporate and Project Finance, Digital Economy, Data Protection and general intersections of Technology and Law. Victoria Oloni is a Trainee Solicitor at Detail Commercial Solicitors where she is actively involved in providing legal advisory as part of the firm’s Corporate & Commercial practice area.
Litigation/Compliance/Dispute Resolution|Realtor.
2 年Well done Tayo