#10226 - Due Diligence - Mergers and Acquisitions (Private Acquisitions)

Due Diligence

• Common law principle of ‘caveat emptor’ (let the buyer beware) applies.

SCOPE OF DUE DILIGENCE

• Will generally focus on constitutional framework of target & ownership of assets & liabilities.

• Any legal issues that may affect value or prospectus of target should be investigated.

• Identify any preconditions/consents that may be satisfied/required to transfer legal title of share/assets.

• Will investigate these areas:

  • Commercial Areas of Risk – e.g. risky market (property development)/financial difficulties. Scope of this will depend on buyer’s knowledge of company/market.

  • Type of Transaction -

    • Shares = more extensive as all assets and liabilities are transferred.

    • Assets = less extensive. May be willing to accept liabilities if seller gives buyer indemnity as liabilities may effect goodwill. Need to see how/if assets will fit into buyer’s business structure.

  • Extent of Contractual Protection – if through purchasing through insolvency/auction = few protections. The more the buyer already knows about protection, the less DD will need to be done (however in current market, buyers do full DD just to be safe).

  • Limiting Factors –

    • Time constraints - if seller is in strong position, may give shorter negotiation time

    • Financial resources & manpower – buyer will be working within a budget so need to be aware of it.

  • Confidentiality – must be aware that certain docs (e.g. joint venture agreements, customer lists etc) will be subject to confidentiality restrictions. Can be mitigated by confidentiality agreement

• When undertaking DD, will need to do public searches (CoHo, Land registry etc) and send out a ‘DD questionnaire’ to seller’s sol..

• A data room (real or virtual) will be set up to review the info given & keep the information safe/confidential

OTHER TYPES OF DUE DILIGENCE

Commercial advisors

• Gets info such as financial position, market position & business plan of target company

• May also get business review of lender if borrowing to acquire.

• Usually undertaken by senior member of purchasing company.

• If they don’t have the expertise, use professional business advisors

Accountants

• Produce a report which will be central to negotiations:

  • Shows strength and weaknesses of target and will form the basis of many warranties & indemnities.

• Buyer’s solicitors should liaise with accountants to define areas of responsibility & ensure no areas of crossover.

• Need to know terms of any confidentiality agreement between parties.

• Report should cover 1) commercial activities, 2) management structure and employees, 3) taxation, 4) profitability, 5) balance sheet strength, 6) accounting system and polices & 7) premises.

COMMON AREAS OF INVESTIGATION

Corporate info

• Company search at CoHo on target & selling company. Limitations = no compensation for buyer if info filed at CoHo is inaccurate or incomplete (situations may have changed from date of filing to current date.

• Check constitutional documents to check pre-exemption rights & see if D’s have power to dispose of assets.

• Check who the current D’s and SHs are to ensure you are dealing with the correct people. Also D’s SCs.

• Check registers and minutes to see if allotment/transfer of shares have been done legally (s550/561 CA) & if any other decisions have been made following the correct procedure.

COMMON AREAS OF INVESTIGATION CONT.

Financial info

• Accounts – this info will form basis of warranties or indemnities in final SPA.

• Loans

  • Request info of all target’s loan docs. to ascertain target’s borrowing liabilities (e.g. are any on demand?)

  • If share transfer, check if seller SH has given any guarantees as buyer may be asked to try and get seller released from obligations before transfer & give indemnities to seller if obligations are not obtained.

  • Will need to check that al guarantees to member companies do not continue after transfer.

• Charges

  • Buyer will want all assets sold free of charges - need to check if charges are registered properly.

  • If not - still enforceable against the Co (fine and payable immediately). Buyer of shares has no protection.

• Credit Reports – quick, up-to-date method of obtaining info on Co’s liquidity & creditworthiness.

• Checking solvency of seller

  • Bankruptcy searches at Land Charges Department against individual seller of shares.

  • Check CoHo to ensure no insolvency proceedings have been made against corporate seller of shares.

  • Make telephone enquiry to Central Registry of winding-up petitions to get up-to-date info.

  • Any transactions entered into after insolvency proceedings have started may be void.

Key Contracts

• Contracts fundamental to business

  • For asset sale, need to assign/novate benefit of contracts.

  • Check long-term contracts (distribution/agency/raw materials/IP licences/employee contracts/leases etc)

  • Check for any change of control clauses/expiry/legality (competition) issues (bigger concern for sale share)

• Rights triggered by Change of Control – D’s SC = golden parachute clause (payment on change, assuming they will be dismissed). Employees may have right to buy shares at a favourable price under share option schemes.

• Non-arm’s length trading relationships –

  • Profit figures may diminish after sale if there are contracts between target and a Co in which SH of target has an interest in.

  • If there are any inter group relationships, these may not continue after sale. Buyer uses ‘transitional services agreement’ to overcome this – seller agrees to continue support services for 12-24 months after sale whilst buyer sorts out alternative arrangements.

Employees

• Terms of Employment – check rights of employees/Ds (may need to make people redundant on sale if restructuring business). Check for any recent employee disputes. Need more info about people who work for the target but are no employed by them. May not work for them after sale.

• Collective Agreements – e.g. trade union recognition agreements. Need to see if any consultation requirements are to be followed on purchase of the target.

• Retaining D’s and Managers – may be necessary to continue success of target, esp. if they have expertise.

• Restrictive Covenants

  • Restraint of trade & non-solicitation clauses = can’t compete & can’t disclose confidential info of target.

  • If not in SC, can’t be implied (unless covenant relating to highly sensitive material)

  • Valid and enforceable at common law only if they 1) protect legitimate trade interest of employer (e.g. protect goodwill), 2) are not against public interest and 3) are reasonable.

  • Restraint of trade - look at time & geographical limits. Non-solicitation – only last 12 months customers

  • Disclosure of info after termination can only be effective in relation to highly confidential info and trade secrets (Faccenda Chicken ltd v Fowler)

  • If freely negotiated in sale of shares, court more likely uphold the covenants than if in employee contracts.

  • Even if valid, will not survive a repudiatory breach by employer (General Billposting Co Ltd v Atkinson)

    • Applies even if covenant states it can be enforced regardless of reason for termination (Briggs v Oates)

COMMON AREAS OF INVESTIGATION CONT.

Pensions

• Need copies of trust deed & rules under which the pension funds are administered

• Two types of pension scheme. Target could have both:

  • Final Salary Scheme – members guaranteed level of benefit on retirement. No direct correlation between contributions made and benefits received, therefore may be in surplus or deficit on acquisition.

  • Money Purchase Scheme – dependent on return of investment.

• Need to see whether pension scheme is a stand-alone, discrete system that can be transferred or larger scheme involving other employees.

• If larger scheme, need to arrange a transfer out, at completion, appropriate funds for those employees transferring to the buyer.

• Must ensure fund is sufficient for the trustees to fulfil their obligations = value of fund assessed by actuaries.

• Surplus & Deficit dealt with by an appropriate adjustment of purchase price.

IP rights

• Search at UK Intellectual Property Office and instruct patent agent to do patent search

• Need to check who owns them (target/SH/Employee?). Need to check if they have given out any licences.

• If using IP via licences, an asset sale will need to speak to 3^rd party to renegotiate licence.

Bribery Act 2010

• 4 offences – offering a bribe, accepting a bribe, bribing public official, failing to prevent bribery – covers all transactions. Criminal penalties of up to 10 years and/or unlimited fine. Fines will be substantial (R v Innospec)

• Buyer needs to check if it will obtain any liabilities under this act via the acquisition. Corruption risk assessment.

• Can reduce purchase price accordingly if risk is high.

Property

• Need full title investigation, unless timetable rules it out

  • Inspection/valuation/survey – physically go and look at it. Either buyer or surveyor does This

• Need certificate of title given by seller’s solicitors –

  • Properties have good and marketable title.

  • Standard certificate Issued by Land Law Committee of the City of London Law Society.

  • Seller’s sol can be sued if it has been prepared negligently.

  • If false statement/omission is result of client, seller’s sol will not generally be liable if certificate makes it clear that info provided was based on info given by the client.

  • No remedy for buyer unless warranty obtained direct from seller that info in certificate = true and accurate.

• Need Property Warranties given by Seller in SPA

  • Include warranties stating 1) target has good title to...