21 Jun The Importance of Legal Due Diligence in Corporate Transactions
Acquisitions, purchases and investments are paths to the growth of an organization or a business entity. However, before an individual or a business organization considers partnering with another organization, buying out an organization or even considers buying immovable property, it is important that such individual or business organization carries out a due diligence of the organization or immovable property that it intends to acquire, invest in or buy.
The term “due diligence” includes both financial and legal due diligences. A buyer or investor undertakes both these due diligences through experts in the field to assess a situation, identify risks, lacunae or liabilities which an entity or property carries and analyze them, thereby helping the buyer or investor to make an informed decision and minimize their own liabilities in entering into the transaction.
For the purpose of this snippet, we will be focusing on Legal Due Diligence. Any reference therefore, to due diligence shall mean Legal Due Diligence.
What is Legal Due Diligence?
Legal due diligence is the process of collecting, understanding and assessing all the legal risks associated with a transaction. It is an investigation into a business by reviewing documents and interviewing employees. A legal due diligence investigation is completed when a business or investor is interested in buying a business or investing in that business.
A legal due diligence investigation is seeking information about the business to make sure that the investment or purchase is beneficial. The investigation seeks to reveal all important facts and potential liabilities. Once the facts are collected and analyzed, an informed decision can be made.
Why Is Legal Due Diligence Necessary?
Some of the primary reasons for conducting legal due diligence are outlined below:
- Better Understanding of the Organization: Legal due diligence is necessary to give the buyer/investor the information that it needs to learn about its target company and to structure its purchase.
- Helps to Value the Target Company. A legal due diligence will inform the investor of some of the following: contingent liabilities, restriction on businesses, pending litigations, insurance policies, employee benefits, intellectual property rights etc.
- Informs the drafting of Relevant Documentation. The information obtained during a legal due diligence process will be helpful for both parties to a transaction in drafting and negotiating any agreement. The information is particularly helpful in allocating risk when drafting representations and warranties, pre-closing and post-closing indemnification rights of both parties.
- Identify Impediments to Closing a Transaction: During a legal due diligence process, parties are able to identify and sometimes address impediments that might delay or hinder the success of the transaction. Some of the actions a legal due diligence expert will focus on are:
- The Company’s corporate documents, to determine the shareholders/Board of Directors of the company;
- The requisite corporate approvals required to complete the transaction;
- Contract documents, including assignment clauses, permits and licenses, to determine whether the transaction is contractually prohibited or whether specific consents are required etc.
5. Legal Due Diligence provides alternatives or solutions to reduce the legal risks identified during the due diligence process.
Despite the critical role of due diligence, it is not always well understood, especially by parties to a transaction. A comprehensive legal due-diligence investigation is critical to the success of any acquisition. The fundamental purpose of any due diligence is to validate assumptions with respect to valuation and to identify risks in the business.
Legal due diligence is a crucial component of any proposed acquisition. When done properly, a legal due diligence review provides valuable information to further the process of an acquisition and protects parties from unforeseen responsibilities.
Performing expert legal due diligence will save parties tremendous costs later on after an acquisition has been completed.