LAV Z. DIMOVIĆ
A buyer acquiring an ownership interest in a company acquires more than the prospect of future profits. The acquisition brings the buyer into an existing corporate structure that may include debts, disputed receivables, unresolved property issues and contractual obligations whose financial significance is not always apparent from the basic documentation.
Legal due diligence is a systematic review of facts and legal relationships that may affect the value, lawfulness and feasibility of a proposed transaction.
Its purpose is not simply to identify risks, but to assess their implications for the decision to acquire and the terms on which the acquisition can proceed.
Reviewing ownership and corporate documentation
The starting point is the company’s registration particulars, founding document, changes in membership and the documents under which ownership interests were acquired.
An acquisition requires examination of pre-emption rights, any restrictions on transfers, pledges and other third-party rights, as well as the authority of the individuals involved in entering into the agreement.
An entry in a public register does not always remove the need to review the document on which that entry was based, particularly where there have been numerous changes in ownership or disputes between members.
Contractual obligations and hidden financial risks
Loan agreements, security interests, guarantees, advance payments received, liabilities to related parties and disputed receivables warrant particular attention.
For example, the seller of an ownership interest may also be a creditor of the company under an earlier loan. Acquiring the seller’s interest does not, in itself, extinguish that claim.
These circumstances should be identified before the final price is agreed, because they directly affect the financial outcome of the transaction.
The review also covers material commercial contracts, particularly provisions concerning a change of control, accelerated payment obligations or the counterparty’s right to terminate.
Reviewing real estate and other assets
Where a substantial part of a company’s value rests on real estate, the review needs to examine title documentation, mortgages, registered annotations, third-party rights and other restrictions on disposal.
It may include the chain of title, construction and occupancy documentation and the terms on which the company uses particular premises.
For businesses that depend on software, trademarks, domain names or other intangible assets, it is necessary to establish who owns the relevant rights and whether the company will remain entitled to use them after the change in ownership.
Proceedings, employees and regulatory approvals
The review may cover court and administrative proceedings, employment obligations, contracts with employees and licences required for the business.
It is particularly important to establish whether a change in ownership requires approval from a competent authority or consent from a business partner.
The scope of the review depends on the transaction and the documentation available. Legal due diligence does not replace a financial audit or tax analysis, although its findings often identify matters requiring further specialist examination.
Contractual protection following the review
An identified defect does not necessarily mean that the transaction must be abandoned. It may be possible to remedy it before signing or to adjust the price, the seller’s liability or the payment arrangements.
Depending on the circumstances, the agreement may include specific representations and warranties, retention of part of the price, deferred payment or appropriate security.
Due diligence fulfils its purpose when its findings are translated into clear contractual terms and the buyer has sufficient information to assess the risks being assumed.