Commercial LawContract LawWhat you see is not always what it seems: What is legal due diligence and how does it work?

May 20, 20210

One area of the due diligence process stands head and shoulders above the others in terms of its complexity and its importance: Legal Due Diligence (sometimes referred to as ‘LDD’). Although you can do your own due diligence, the breadth of legal due diligence, which includes everything from intellectual property to litigation, could be too much for your in-house counsel.

Some of the ins and outs of the legal due diligence process are covered below.

Why conduct legal due diligence?

 

Legal due diligence aims to obtain an understanding of the target business from a legal standpoint. As in every other part of the DD process, the ultimate goal is to ‘check under the hood’ to make sure everything is in working order. The legal due diligence process begins with the purchaser, or rather the purchaser’s legal team, asking, “Is there any legal justification why we should not purchase this firm?”

This is a question that needs to be answered. When it comes to their legal records, few target firms are likely to have a fully clean slate. The aim of your legal due diligence should be to identify the “red line” problems or deal-breakers.

What does legal due diligence cost?

Legal due diligence is not cheap, but it is a lot less expensive than discovering legal skeletons six months after the transaction has closed. It’s an unavoidable cost.  Do not cut corners or you may end up paying the price down the line. Instead, create an agenda with the legal experts you hire, establishing where and when the costs will arrive so that everyone knows what to expect.

Ensuring a smooth process

The most efficient way to conduct legal due diligence is by using a virtual data room for legal due diligence, which will be shared between the purchaser, the seller, and the legal teams on both sides. In tandem with their attorney, the purchaser should agree to a checklist of legal documents that will be requested from the seller.

Obtaining a legal opinion on the target firm

There will always be some element of risk, even though the legal due diligence process finds no red flags. This is where ethical due diligence differs somewhat from the rest of the procedure: Many of the pitfalls you will be looking for will not be obvious; instead, you will be asking questions about what could happen rather than what has happened.

For example, suppose you are acquiring a small pharmaceutical firm that sells drugs with some potential side effects that have not caused any issues until now. What are the side effects and what kind of liability would your company accrue should one of your customers be hit with them? Or several customers? Or even worse side-effects?

Answering questions like these is where your highly-priced legal team pays for themselves: They will provide you with an expert legal opinion on whether you should acquire the company from a legal perspective. The answer will rarely be a straight ‘yes’ or ‘no,’ but at least you’ll be making a far more informed decision on the back of their advice.

Legal due diligence in a foreign country

When buying a foreign company, forming a joint venture, or starting a business relationship, the value of performing legal due diligence cannot be overstated. This holds true for foreign companies visiting your country as well as your business expanding internationally: new risks arise as a result of different legal environments. As a result, they must be properly assessed.

 

Conclusion

It is a straightforward process: conduct thorough legal due diligence now to reduce the risk of unwelcome legal liability after the deal closes. The world of law is far too complicated to be left to chance. You offer your acquisition the best chance to build long-term shareholder value by performing a comprehensive LDD.

 

Article by:

Varuni Weerasinghe, LL.B (London)

Paralegal

Velox Partners

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