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Key Elements of Legal Due Diligence

The standard M&A deal usually commences with the formalisation and signing of a letter of intent and a non-disclosure agreement. Following this, a data room is assembled in alignment with the buyer’s legal due diligence checklist. Concurrently, negotiations on transaction documents ensue, driven by insights gained through the due diligence process. For the buyer, the primary aim of due diligence is to evaluate the risks and liabilities associated with the target company and the envisaged M&A deal, facilitating a well-structured deal and risk mitigation.

Legal, tax, and financial due diligence are typically undertaken by the buyer, with variations based on the target’s sector and the nature of the transaction. Virtual data rooms are the contemporary norm for due diligence, supplemented, if necessary, by on-site technical due diligence based on the target’s industry or business requirements.

In this article, we will examine the legal due diligence phase of the M&A process. 

The extent of legal due diligence hinges on the industry and activities of the target. Crafting a due diligence checklist that considers these factors is crucial to ensure relevant questions are posed for the target company, saving time, and fostering a professional working environment for all involved parties.

Legal due diligence usually covers the following key elements:

Corporate:
  • Copy of the articles of association
  • Extracts from the trade register
  • Copy of the share ledger
  • Copies of board resolutions and the minutes of the general assembly
Contracts: 
  • Copies of contracts with key customers
  • Copies of distribution agreements
  • Copies of supply agreements
Finance:
  • Copies of loan agreements
  • Copies of security agreements such as mortgages or pledges
  • Copies of guarantees
Immovable properties:
  • Copies of title deeds of the target company
  • List of encumbrances over the immovable properties
  • Copies of lease agreements
  • Copies of construction and use permits
Employment:
  • Copies of employment agreements
  • Information regarding the total number of employees
  • Evidence of payment of social security contributions
  • Potential employment-related liabilities
Licences and Regulatory Compliance:
  • Copies of the licences and permits required for the relevant sector
  • Identification of missing licenses or permits
  • Details of commercial transactions between the target company and related parties, such as shareholders and board members
Intellectual Property:
  • Copies of records of registered intellectual property rights, such as patents and trademarks
  •  Copies of licence agreements
Litigation:
  • Information on pending or threatened litigation relating to the target company

Scope Expansion of Due Diligence 

Incorporating environmental, social, and governance (ESG) aspects in due diligence has gained prominence globally. The scope regarding these matters depends on the industry and operations of the target company.

For instance, if the target company has factories or power plants, the scope must include questions such as whether the target company:

  • Has all the necessary permits to operate such factories or power plants and is in compliance with environmental regulations
  • Has ever been subject to a complaint or penalty due to environmental matters
  • Has corporate policies on the protection of the environment and the reduction of pollution and waste
  • Publishes sustainability reports
  • Acts responsibly more generally

The scope in relation to social and governance matters may include, among other things:

  • Compliance with good labour practices (i.e., working hours, health, and safety)
  • Compliance with laws on data protection and privacy of employees
  • Relationships with the community
  • Diversity both among employees and in the composition of the board of directors
  • Corporate transparency

Compliance with Personal Data Protection 

Given the likelihood of personal data being disclosed during due diligence, adherence to data protection laws is imperative. To ensure compliance:

  • Only data that is strictly necessary for the due diligence
  • Ensure data subjects are aware that their data will be disclosed to the potential buyer and its advisors, and obtain their consents when required by applicable legislation
  • The non-disclosure agreement between the parties must contain provisions regarding personal data protection

Due Diligence Report

Following due diligence, the buyer’s legal advisors prepare a comprehensive due diligence report. The specifics of the deliverables expected by the buyer should be defined in advance. While some buyers prefer detailed reports, many lean towards executive summaries focusing on key points impacting value, purchase price, liability, or future activities of the target.