London | Frankfurt | Madrid | Milan | Rome

MODERN LAWYERSFOR CHANGING TIMES 'a City firm in a non-City location' - Legal 500

5 minutes reading time (937 words)

The Importance of Due Diligence and Disclosure

Why is due diligence and disclosure so important? The disclosure letter is one of the most significant documents in a sale of a business or shares and has major consequences for both the seller and the buyer. It has long-lasting importance to the deal and can have far-reaching consequences. Due diligence is assisting the buyer in determining that what they are actually buying is what they expect and at the same time protecting the seller from any future legal ramifications.

For the seller, correct due diligence and disclosure will give them valuable protection in the future if the buyer tries to bring a misrepresentation claim after the sale. For the buyer, due diligence and disclosure are vital and can either reassure the buyer about the key issues about the sale, or if a problem is revealed, can be used as a bargaining tool where the buyer can:

  • renegotiate the price;
  • require the seller to fix the issue before completion; or
  • not proceed with the sale.

The general principle in these situations is caveat emptor or "let the buyer beware". There is no duty on the seller to reveal any defects in the company or business to the buyer. The buyer will wish to have as much information as possible, though, to make sure they are not entering into a bad deal. Therefore, in order to protect themselves, there is the due diligence process, which gathers any relevant information in order to:

  • confirm they are paying the right price for the acquisition;
  • make sure the acquisition agreement is drafted to include any relevant indemnities that may be needed; and
  • ensure their plan for the operation of the business post-completion is valid.

The Aspects of Due Diligence

Due diligence is broadly broken down into two parts:

  • Financial due diligence. There are various cases (for example, Caparo Industries Plc v Dickman[1990] UKHL 2) that establish that the audited accounts of a company do not necessarily confirm the financial status of the company (unless the auditors have agreed to a duty of care in relation to the buyers). Financial due diligence should not only relate to the actual financial situation of the company but also the potential liabilities. Due diligence in this area will include reviewing items such as contracts, employees' pension schemes, any outstanding litigation or disputes and relevant taxes.
  • Legal due diligence. This is usually performed by the buyer's solicitors. Generally, this involves reviewing the contracts and key documents of the company.

Legal due diligence

This will in some ways be influenced by the industry and market that the company is involved with, but there are some general areas that should always be considered:

  • A major issue is reviewing any employment arrangements and examining any written terms of employment and employment policies together with any recent issues such as grievances or dismissals/redundancies.
  • Are there any other contracts in relation to any services they provide or goods that they sell?
  • Are there any licences and permits that are relevant and do these have any impact on the sale?
  • Are there any ongoing disputes with third parties (be it customers or suppliers)? How is this being resolved and will the resolution of the dispute be a condition before completion?
  • Compliance generally needs to be considered. In light of the new General Data Protection Regulations that are due to be implemented in May 2018, is the company data compliant? Is the business registered with the Information Commissioner's Office (ICO)?
  • Shareholders' agreements relating to share transfers need to be considered to determine how this will affect the sale. The rights of minority and majority shareholders will depend on how the purchase is structured.
  • Any intellectual property should be protected and assessed to address any issues of concerns that may arise from the sale.
  • The valuation of the business-buyers often will base their valuation on earnings before interest, taxes, depreciation and amortisation (EBITDA). Due diligence can also determine if historically there has been any events that have affected earnings, cash flow or income.
  • Leases on property should be carefully examined, for example to see if a sale could trigger any provisions within the lease.

The Disclosure Letter

Once disclosure is completed, the buyer will generally insist that any issues that the buyer discovered during due diligence are addressed by the seller with warranties and indemnities. The disclosure letter (accompanied by a disclosure bundle with related documentation) is, therefore, very important since it not only qualifies the warranties that the seller needs to make but it also can protect the seller from any breach of warranty claims.

The seller should consider capping its liability for warranty breaches within the sale documentation (this is usually a percentage of the purchase priced). The exact level of the cap will depend on the circumstances of that particular case.

Contact our Commercial Lawyers London Today

At Lewis Nedas Law, you can rely on us to do a proper job at reasonable cost. We have the experience, without the City of London overheads or steep hourly rates. Above all, we want to understand your commercial objectives, and will do our best to achieve them. We work closely with exceptional Counsel as appropriate.

You can rely on Lewis Nedas to tell you if your case has problems which make it desirable to negotiate a settlement with your opponents.

This article is intended to be no more than a general guide and does not comprise legal advice. You are strongly advised to take legal advice if you are involved in a commercial transaction.

For legal advice and assistance please contact Ian Coupland, Head of Commercial and Litigation, Lewis Nedas Law on 02073872032 or icoupland@lewisnedas.co.uk.

The Advantages and Disadvantages of Share Capital
Conflict of interest" in Relation to Directors' Du...

Accreditations
and Awards

legal 500 uk leading firm 2017 chambers leading firm 2017