Business case for legal due diligence in M&A transactions
Often, in a merger and acquisition (“M&A”) transaction, whether in a sale and purchase of shares of a company, its assets or business, the buyer would most likely insist on the right to carry out a due diligence audit over the target company (in a share acquisition) or its assets/business, (in an asset or business acquisition), as part of the condition to purchase. It is quite common for the buyer to carry out legal, financial and technical due diligence, although commercial due diligence is becoming more important.
Practical Tips for Buyers
When conducting due diligence, it is important to request for full access to documents and information on the target company, including the right to make copies of materials or documents, and the right to take away such materials out of the premises of the target company, for further review if necessary. Buyers should also request for exclusivity of negotiations whilst due diligence is still being carried out, particularly when the transactional agreement has not been signed by the parties.
It would also be good if the seller identifies one or two contact person(s) that the buyer can liaise with, preferably officers from the target company who know the target company well, and are able to answer questions about the target company. These persons will also direct the buyer and its advisors to the appropriate personnel to talk to, to obtain the required information.
Due Diligence Issues
In our experience of conducting legal due diligence, we encountered many issues, some of which resulted in the buyer deciding not to proceed with the M&A transaction. Some of the issues are:
- Irregular passing of board of directors’ resolutions – directors authorising transactions to enrich themselves;
- Target company not contributing to Employee Provident Fund for its employees;
- Terms of contracts of employment between the target company and the employees contravene labour laws;
- Target company’s conduct of business contravenes relevant applicable laws – for example, operating in the premises where certificate of completion and compliance was never issued, or operating under expired/revoked licenses/permits;
- Target company’s conduct of business breaches existing agreements with third parties.
Whilst some issues are not ‘deal-breakers’, they are often dealt with by the parties as part of the conditions for completion. As mentioned above, there were instances where the buyer requested for a reduction of the purchase price, or to set aside a portion of the purchase price in escrow to cater for the issues uncovered post-completion, or to have stronger indemnity provisions in favour of the buyer.
The principle of caveat emptor (let the buyer beware) should influence the buyer to act prudently in an M&A transaction. Due diligence is a good step preceding an acquisition exercise which enables a buyer to make informed decisions vis-à-vis the target company or its assets/business.
Juhaida Mior Zulkifli, Associate
Mergers & Acquisitions and New Venture Practice Group
Azmi & Associates
14th Floor, Menara Keck Seng, 203 Jalan Bukit Bintang,
55100 Kuala Lumpur, Malaysia
Tel: +6 03 2118 5000 ext 5064 Fax: +6 03 2118 5111
www.azmilaw.com E-mail: juhaida@azmilaw.com