PLC - Due Diligence for Public Mergers and Acquisitions

12/31/12 PLC - Due Diligence f or Public Mergers and Acquisitions

1/16uslf .practicallaw.com/9-382-1874#a189987

Due Diligence for Public Mergers and Acquisitions

Resource type: Practice Note

Status: Maintained

Jurisdiction: USA

An introduction to due diligence in public mergers and acquisitions. This Note covers what due diligence is,

why due diligence is necessary, how to organize the process, what to look for and how your findings impact

the transaction.

PLC Corporate & Securities

Contents

What is Due Diligence?

Reasons for Due Diligence

Target Company Due Diligence

Scope of Due Diligence

Organizing the Due Diligence Process

Preparing the "Black Book"

Defining the Due Diligence Task

The Due Diligence Team

Due Diligence Request

Sources of Information

Distribution and Organization of Materials

Competitively Sensitive Information

Reviewing Materials: What to Look For

Categories of Materials and Common Issues

Specialist Review

Due Diligence Considerations for Private Equity Buyers

Impact on the Transaction

Recording and Communicating Your Findings

Importance of Communication

Due Diligence Summaries

Due Diligence Report

Can a Third Party Rely on the Due Diligence Report?

Due diligence is the investigation of a person or business. In the context of mergers and acquisitions, the

parties use the due diligence process to gather information about each other and about the business being

acquired. In a merger of equals (www.practicallaw.com/resource.do?item=:44405480) or in instances

where the buyer issues its securities as some or all of the merger consideration, the target company

http://uslf.practicallaw.com/9-382-1874#a449881






















http://uslf.practicallaw.com/resource.do?item=:44405480


2/16

usually conducts due diligence on the buyer. However, the due diligence process is usually more significant

for the buyer.

This Note focuses on the due diligence review of a public target company. It explains, from a buyer's

perspective, why due diligence is necessary, how to organize the process, what to look for and how your

findings impact the transaction. See also Public Mergers and Acquisitions Due Diligence

Check list (www.practicallaw.com/4-382-9194).

What is Due Diligence?

Reasons for Due Diligence

In any significant merger or acquisition, the buyer gathers information about what it is buying before making

a commitment. The buyer uses this information to decide whether the proposed acquisition would make a

sound commercial investment and to determine the issues relevant to the merger. In an extreme case, a

buyer can decide to abandon the transaction after performing due diligence, but more commonly (in a

negotiated deal) a buyer uses the information to negotiate certain contractual provisions (such as conditions

to closing) or to adjust the merger consideration. Generally, the representations and

warranties (www.practicallaw.com/resource.do?item=:44403030) do not survive the closing in public

mergers and a buyer is not protected against losses through indemnification (www.practicallaw.com/2-

382-3536) provisions. As a result, completing a thorough due diligence investigation is of critical importance

since the buyer cannot recover losses after closing.

Because of the SEC's (www.practicallaw.com/resource.do?item=:44404742) disclosure requirements, a

significant amount of information about potential target companies is freely available to the public through

the SEC's Electronic Data Gathering Analysis and Retrieval system, known as

EDGAR (www.practicallaw.com/resource.do?item=:44404052). Several factors give most buyers comfort

concerning public targets including the:

SEC's mandatory filing and reporting obligations.

Extensive Sarbanes-Oxley Act (www.practicallaw.com/resource.do?item=:44404670) requirements.

Antifraud provisions of the federal securities laws.

Requirements of the various securities exchanges.

Consequently, public company due diligence reviews usually proceed at a much quicker pace than that of a

private company. In addition, a buyer considering a hostile takeover can conduct a due diligence review

entirely from public sources and proceed without the cooperation of the target company's board of directors

and management (see Sources of Information: Publicly Available Information).

A due diligence inquiry should determine the following key information about the target company:

Confirm the assets and liabilities of the target company.

Investigate any potential liabilities or risks.

http://uslf.practicallaw.com/4-382-9194









Confirm the value of the target company.

Learn more about the operations of the target company.

Identify any impediments to the transaction, such as third party consents or anti-takeover devices (such

as a poison pill (www.practicallaw.com/5-383-2209)). For information on takeover defenses, see

Practice Note, Defending Against Hostile Takeovers (www.practicallaw.com/9-386-7206).

Confirm information provided by the target company in its disclosure

schedules (www.practicallaw.com/resource.do?item=:44404977).

Identify steps necessary to integrate the target company.

Determine whether any ancillary documents are needed.

Target Company Due Diligence

If the buyer intends to issue stock to the target company's stockholders as consideration or if the

transaction involves a merger of equals, the target company needs to conduct a due diligence investigation.

This is sometimes referred to as reverse due diligence. Assuming the buyer is a US public company

needing to register the stock issued in the merger, the Form S-4 (www.practicallaw.com/6-382-3493)

registration statement (www.practicallaw.com/resource.do?item=:44404574) contains a significant

amount of information about the buyer. However, well before the filing and distributing of Form S-4 to the

target company's stockholders, the target company should review the buyer's public filings and perform at

least a limited due diligence review.

If the buyer intends to issue stock, the target company should:

Confirm the value of the buyer' stock.

Assess the economic risks of receiving the buyer's stock.

Identify any impediments to the issuance.

Identify any impediments to closing.

In a merger of equals, the parties need to:

Confirm the value of the transaction.

Identify steps necessary to integrate the companies.

Learn more about each others' businesses.

Identify any impediments to the transaction.






PLC - Due Diligence f or Public Mergers and Acquisitions


Scope of Due Diligence

Many factors determine the scope of a due diligence investigation. It is important to determine the scope at

the outset because it influences the number of people needed, time requirements, need for outside experts

and depth of review. Common factors that determine the scope of a due diligence review include:

Deal structure. For example, in a reverse triangular merger (www.practicallaw.com/3-382-3772),

anti-assignment clauses pose no concern for the buyer (although change of control

clauses (www.practicallaw.com/0-382-3325) are a concern).

Industry. The industry of the target company can influence what areas of due diligence you concentrate

on. For example, acquisition of a pharmaceutical company requires extensive intellectual property due

diligence by the buyer.

Global presence. If the target business has global operations, it is important to assess its compliance

with the requirements of the Foreign Corrupt Practices Act of 1977 (see Practice Note, M&A Due

Diligence: Assessing Compliance and Corruption Risk (www.practicallaw.com/3-500-7212)).

Competition. If the buyer and target company compete with each other, they may want to (or be

required by antitrust laws) keep certain information confidential (such as, pricing) until after the

transaction is consummated (see Box, Competitively Sensitive Information).

Access to target company. The target company often restricts access to the management of the

business to only those necessary to facilitate the due diligence review to limit interference and preserve

the confidentiality of the merger discussions.

Cost. The buyer can limit the scope of the due diligence investigation to reduce its expenses.

Sometimes, a buyer conducts its investigation in stages and only increases spending when the

likelihood of consummation increases.

Time constraints. The parties may wish to complete the transaction by a certain date (such as fiscal

year end) or the target company may have enough bargaining power to limit the time allowed for due

diligence (for example, in an auction). Also, because of the possibility of information leaks and the

desire to maintain secrecy regarding the merger negotiations, timing becomes an important factor and it

is usually in both parties' interest to quickly conclude the review and execute the definitive merger

agreement.

Organizing the Due Diligence Process

Usually the corporate legal team (most often a junior corporate lawyer) acts as the "control center" for the

buyer's due diligence process. This entails defining the due diligence task, requesting materials, distributing

materials and ensuring communication among the due diligence team.







Preparing the "Black Book"

As a preliminary matter, the partner or senior associate often asks the junior associate to prepare a

binder (known as a black book) containing copies of certain public documents and information

concerning the target company. Members of the deal team use the black book to familiarize themselves

with the target company and to immediately assess any potentially significant issues. The black book

usually includes:

The main organizational documents.

Any poison pill plans.

Stockholder or voting agreements.

The annual, periodic and current reports for the last year.

The latest proxy statement.

Noteworthy press releases.

Share price information.

(Possibly) analysts' or other financial reports (for example, Thomson Reuters financial reports).

See Sources of Information, Publicly Available Information.

Defining the Due Diligence Task

Before you begin a due diligence review you should determine with your client the:

Due diligence budget.

Scope of review (see Scope of Due Diligence).

Type of oral or written report required (see Due Diligence Report).

Deadline for completion of due diligence review and delivery of report.

Any required use of outside consultants.

Areas to focus on.

Any threshold issues that could make or break the deal (known as deal breakers).

Any materiality threshold (can certain agreements and documents be eliminated from the review if the






value falls below a defined dollar amount?).

Need for any review of information for integration or transition planning (see Practice Note, Information

Exchange and Integration Planning in M&A: Antitrust (www.practicallaw.com/5-383-7853)).

Process for communication with management of the target company. For example, you might be

required to communicate through a third party such as an investment banker.

You can assemble the due diligence team once the due diligence task is defined. It is important to explain

to team members any limitations or restrictions (budgetary or other) and any areas your client considers

significant.

The Due Diligence Team

The make-up of the due diligence team depends on the specifics of the transaction, but usually includes

legal, business, accounting and tax specialists. Generally, the legal team consists of corporate attorneys

and other specialists (such as environmental, employee benefits, real estate, litigation and intellectual

property attorneys). The buyer can conduct its own business due diligence or hire investment bankers or

other consultants to review information. The buyer will usually also engage accountants and tax specialists

to assist with the financial review of the target company. In some cases it may also be necessary to retain

outside consultants in other areas such as regulatory compliance, environmental or insurance/risk

management. If the target company conducts any operations outside of the US, the buyer may need to

engage foreign or local counsel for diligence matters relating to those operations and confirm that no

impediments to the transactions exist under applicable foreign laws (such as government or regulatory

approvals).

Depending on the complexity of the transaction and the budget allocated to due diligence, the team can

range from two or three people to a team of more than 20. Because the due diligence team can be large and

comprised of multiple organizations, it is important to designate a point person to organize and coordinate

the process. The buyer can act as the point person, but often delegates this responsibility to its attorneys.

Due Diligence Request

Although a large number of target company materials are available publicly, there is usually a significant

amount of information that remains confidential or inaccessible. A buyer often submits a due diligence

request for this confidential and inaccessible information. The due diligence request consists of a list of

questions and requests for documents organized by topic (see Standard Document, Due Diligence Request

List (Public Mergers & Acquisitions) (www.practicallaw.com/3-383-0046)). Examine the target company's

public filings and agreements available on EDGAR (search the EDGAR Database) before making any due

diligence requests. The initial due diligence request is usually supplemented by further requests as the

negotiations proceed and the buyer learns more about the target company.

The size of a due diligence request depends on the scope of the due diligence review. The due diligence

request list is typically shorter for public deals than private deals because counsel has already reviewed

much of the material information by the time the request is submitted. Although a due diligence request

must be broad enough to include a wide range of information, you should tailor your due diligence questions

to the specific target company and the industry in which it operates. For example, the material contracts for



http://www.sec.gov/edgar/searchedgar/webusers.htm



a target company in the financial services industry would differ from those of a manufacturing company. You

can also tailor the request list to focus on certain areas that raised concerns in the preliminary review of

public documents.

If you are unfamiliar with the target company's industry, you should search the EDGAR database for recent

mergers of companies in the same industry (by using the target company's assigned Standard Industrial

Classification code (www.practicallaw.com/3-382-3833) (SIC code)). You can examine the agreements,

regulatory filings and required consents of other mergers to get a sense of the materials to request. If your

request is too generic or broad, the target company may not understand what documents you are

requesting. For example, if you request "all material contracts", the target company's view of what

constitutes a material contract may differ from the buyer's.

You should also review the due diligence request lists prepared by the business team and any other

specialists (to the extent that such requests are not consolidated into the legal request) to avoid requesting

duplicate information. For example, the legal team, the business team and the accountants may all want to

review the same supply contacts.

Sources of Information

Publicly Available Information

The bulk of due diligence review involves reading documents of the target company (for example, contracts,

financial reports and corporate records). You can easily access much of this information by retrieving the

target company's public SEC filings on EDGAR. Common target company documents to review include:

Annual and periodic reports (Form 10-Ks (www.practicallaw.com/resource.do?item=:44404161)

and Form 10-Qs (www.practicallaw.com/resource.do?item=:44404167)).

Current reports (Form 8-Ks (www.practicallaw.com/resource.do?item=:44404155)).

Proxy statements (Schedule 14As (www.practicallaw.com/resource.do?item=:44404676)).

Agreements and plans (filed as exhibits to the Form 10-Ks, Form 10-Qs and Form 8-Ks).

Governing documents (such as the certificate of

incorporation (www.practicallaw.com/resource.do?item=:44406178), by-

laws (www.practicallaw.com/resource.do?item=:44402728), certificate of

designation (www.practicallaw.com/resource.do?item=:44405201)) filed as exhibits to Form 10-K.

You can also review information about the target company from sources other than the SEC filings.

Examples of such sources include:

Analyst and rating agency reports.

The target company's website.

Press releases.










8/16

Documents

The target company (and its counsel) assemble due diligence documents and often store them on an online

data site (also known as an electronic data room). Sometimes, particularly in smaller transactions, the

target company can either send the buyer electronic or hard copies of documents. If the target company

wants to limit dissemination of materials and control the review process, it can create a physical data room

at its offices or the office of its attorney or investment banker.

When the materials are stored on an online data site, the target company determines and grants password

protected access. You should determine which due diligence team members need access to the data site

and then submit a comprehensive request for access to the target company.

Access to Management

Some information is difficult to learn from just reading documents. The buyer often asks to visit the target

company site and talk with members of management. It can be helpful for some members of the legal team

to participate in these meetings with management (sometimes called management presentations) to

understand the operations of the business. For more insight into the target's legal framework and existing

issues, buyer's counsel should meet, or hold a teleconference, with the target company's general counsel or

other in-house legal staff at the outset of the due diligence review. The teleconference allows you to ask

follow-up questions concerning due diligence materials and to receive complete answers based on your

questions.

Distribution and Organization of Materials

If the due diligence materials are available electronically or sent in hard-copy form, they need to be

distributed to the due diligence team. Usually a junior corporate attorney is responsible for distribution and

organization of the materials. If the materials arrive in hard-copy form, an index should be created (if not

already provided) to identify and track the materials provided. If the materials are stored on an online data

site, the data site usually generates an electronic index which can be printed out. If the materials are stored

online they need to be printed (if permitted) and distributed to the appropriate team member.

It is helpful to develop a system for organizing the materials at the outset. A common way to organize

materials is to place all due diligence items in folders with labels indicating the name of the document and

index reference. Often a paralegal can help with this process. You should also ask a senior member of your

team about the firm's record retention policy and confirm that process complies with the buyer's obligations

under its confidentiality agreement with the target company. Some firms retain a complete copy of all due

diligence materials, and if so, make an extra copy of the due diligence materials before distributing them to

the team. Because the data site is updated with new materials throughout the transaction, it is important for

one person to periodically check for any additions. Taking the time to organize the due diligence materials

will save you a significant amount of time later in the process. Often a question can arise about a document

you reviewed days or weeks ago. It will save you anxiety and impress your team if you can locate the

document quickly.

Competitively Sensitive Information

If the parties are competitors, the target company can impose additional restrictions on the

dissemination of materials. Federal antitrust regulations can prohibit competitors from sharing certain

information (for example, pricing). Even if not prohibited by law, a target company can be reluctant to



share information (such as customer names) before consummation of the transaction is certain. Parties

can redact sensitive information or develop a procedure to limit access to those materials. Often only the

attorneys receive access. In that case, the attorneys can review the documents for other important

terms (for example, change of control) and will be prohibited from sharing any confidential information

with their clients. The parties should determine if any documents are competitively sensitive and agree

on a procedure before beginning the due diligence review. For detailed information concerning the

antitrust issues surrounding the exchange of information between parties during due diligence, see

Practice Note, Information Exchange and Integration Planning in M&A:

Antitrust (www.practicallaw.com/5-383-7853).

Reviewing Materials: What to Look For

Categories of Materials and Common Issues

A corporate attorney encounters many different types of documents in a comprehensive due diligence review

and should watch for many different kinds of issues, which are determined by the specifics of the

transaction and target company. Some of the common categories of documents and common issues

encountered in a due diligence review are listed below (see also Public Mergers and Acquisitions Due

Diligence Check list (www.practicallaw.com/4-382-9194)). This list does not include specialist areas such as,

tax or employee benefits materials and is not intended to be exhaustive (see Specialist Review):

Organizational documents. (For example, certificate of incorporation, bylaws, certificate of

designation.) Common issues to consider include:

Capitalization and equity ownership. Is there a stockholder or group of stockholders that has

control of, or a significant stake in, the target company? Are there any subsidiaries? What equity is

outstanding? How much equity is authorized? Is there room for further issuances?

Consent issues. Are any votes or consents required in connection with the transaction? What

actions require consent of stockholders or the board of directors?

Special rights of stockholders. Is there a poison pill? What are the triggering events? What is

required to amend the plan or redeem the rights?

Dividends. What is the dividend policy? Can the board of directors change this policy without a

vote?

Unusual provisions. Look for any provisions that could impact the transaction or future operation

of the target company. For example, you should note if a stockholder is guaranteed representation

on the board of directors.

Minutes of meetings of board of directors and committees of the board. Common issues to

consider include:






Contingent liabilities. Look for any discussions regarding claims against the target company or

its management, defaults under agreements, threatened litigation, labor or employment concerns,

and investigations involving the target company or its employees.

Contracts (for example, customer and supply contracts, operating contracts and licenses). Common

issues to consider include:

Parties. Who are the parties to the contract?

Change of control. Is there a change of control provision? Does this transaction constitute a

change of control? See Box, Assignment and Change of Control.

Assignment (www.practicallaw.com/resource.do?item=:44405354). Is the contract assignable?

Is consent required? How is an assignment defined? Does the transaction structure require an

assignment? Does a change of control constitute an assignment? See Box, Assignment and

Change of Control.

Termination. When does the contract terminate? Is there an automatic renewal provision? Can

either party terminate without consent? Does a change of control give either party a right to

terminate the contract?

Economics. What are the basic economics of the contract? Are the economics of the contract

fixed or do they fluctuate? How is the pricing determined?


of the target company. Are there any provisions restricting the target company or provide benefits to

the other party? For example, you should note a most favored nation

provision (www.practicallaw.com/8-382-3637), non-compete

provision (www.practicallaw.com/3-382-3649) or exclusivity provision.

Merger and acquisition agreements. Consider the following:

Parties. Who are the parties to the agreement?

Purchase price adjustments and earn-outs. Are there any outstanding purchase price

adjustments or earn-outs affecting the target company?

Escrow (www.practicallaw.com/resource.do?item=:44402320). Are there any funds in escrow?

What are the funds earmarked for? What are the conditions of release?

Survival of representations and warranties and indemnification. Has the survival period of the

representations and warranties run out? Have any indemnification claims been made? Does the

target company anticipate future indemnification claims?








12/31/12


of the target company. For example, you should note if there is a current non-compete obligation or

if the target company has taken responsibility for any ongoing liabilities of the other party.

Finance documents. (For example, loan agreements, hedging agreements, guarantees, and

promissory notes.) Common issues to consider include:

Parties. Who are the parties to the agreement?

Basic terms. What debt is outstanding? What are the interest rates? When do the loans mature?

Are there any mandatory prepayment obligations or prepayment penalties?

Contingent obligations (www.practicallaw.com/resource.do?item=:44405243). It is important

to note any contingent obligations such as guarantees. It is also important to note if any debt is

guaranteed by third parties (for example, a parent company guaranty).

Restrictive covenants (www.practicallaw.com/resource.do?item=:44405123). Look for any

restrictive covenants impacting the transaction or future operation of the target company.

Change of control. Is there a change of control provision? Does this transaction constitute a

change of control?

Liens. Are there any liens on the target company's assets?

Sarbanes-Oxley compliance. Consider:

Certifications. What is the process for the CEO and CFO certifications?

Control procedures. What are the internal control and disclosure control procedures?

Auditor independence. How is auditor independence established? Are there any non-audit

services provided by the company's independent auditors?

Committees. What is the composition for the various committees (audit, compensation, and

nominating)? Are the charters consistent with the Sarbanes-Oxley requirements?

Litigation. Consider:

Pending claims. How many claims are currently pending? What is the estimate of damages?

What is the current status of each claim? What is the likelihood of success on the merits?

Litigation history. Were there any large claims paid out in the past? Any class actions? What

kind of claims is the target company a party to?

Litigation trends. What are the common types of litigation? What is the average amount of

damages? Are most claims settled or litigated? Are claims typically covered by insurance?



12/31/12


Assignment and Change of Control

If a merger is structured as a forward merger or a forward triangular merger, third party consents are

required for those target company contracts which contain anti-assignment clauses. Typically anti-

assignment clauses are not triggered in reverse triangular mergers unless the contracts contain change

of control clauses. However, as noted in Meso Scale Diagnostics, LLC v. Roche Diagnostics GMBH,

C.A. No. 5589-VCP (Del. Ch. April 8, 2011), a reverse triangular merger may constitute an assignment

by operation of law when considered together with the post-acquisition activities of the buyer. Although

this case was only a denial of a motion to dismiss by the defendant and not a final ruling on the merits of

the case, the Delaware Chancery Court's ruling shows a reverse triangular merger may trigger a consent

requirement under anti-assignment clauses when the buyer converts the target into a shell company

after the closing. A final decision by the court on the merits may clarify precisely what circumstances

would cause a reverse triangular merger to be treated as an assignment. For further information on this

case, see Legal Update, Delaware Chancery Court Finds Reverse Triangular Mergers May Trigger

"Assignment by Operation of Law" Provisions (www.practicallaw.com/2-505-6769). For more information

on different merger structures, see Practice Note, Public Mergers: Overview (www.practicallaw.com/4-

382-2164).

A change of control provision in an agreement gives the other party certain rights (such as consent,

payment or termination) in connection with an acquisition transaction. Not all change of control

provisions are triggered by the same action. A change of ownership, merger, sale of assets or change in

board members can trigger a change of control. A change of control provision may not always be clearly

labeled. It may actually be named as a change of control provision or it can be embedded in an

assignment or termination section.

Specialist Review

Legal specialists (such as real estate, employment, intellectual property and environmental attorneys) and

outside consultants (such as accountants and insurance specialists) conduct a portion of the due diligence

review. Often a junior corporate attorney distributes the due diligence materials to the specialists and

communicates any instructions from the client. Sometimes a document that appears to be a corporate

document needs specialist input. For example, a supply contract can contain significant provisions relating

to the intellectual property of the target company. In this case, the contract could need review by a

corporate and an intellectual property attorney. As the junior corporate attorney on a transaction, you may

spend a large portion of time facilitating the specialist due diligence review.

Due Diligence Considerations for Private Equity Buyers

A private equity buyer's view can differ on certain due diligence issues. Private equity buyers often avoid

risk as they try to make a relatively quick profit on a highly leveraged acquisition. Generally a buyer

already operating in the industry (known as a strategic buyer (www.practicallaw.com/resource.do?

item=:44405105)) can be better equipped to absorb an operational loss or a messy litigation. As a

result, private equity buyers often conduct more extensive due diligence reviews than other types of

buyers, even with the comfort that acquiring a public company usually provides a buyer.






As opposed to a strategic buyer, a private equity buyer may lack certain operational capabilities. For

example, if a private equity buyer buys a target company without its own payroll department or IT

systems, the private equity buyer needs to procure those services. A strategic buyer would likely have

those services already in place for its existing business. Therefore, a private equity buyer may need to

focus on operational due diligence.

For more information, see Practice Note, Buyouts: Overview (www.practicallaw.com/4-381-1368).

Impact on the Transaction

Due diligence is a necessary part of any significant acquisition. Your findings can impact the transaction in

the following ways:

Merger Consideration. If a due diligence finding affects the valuation of the target company, the buyer

can adjust the merger consideration. For example, if you discover a previously unknown $10 million

liability, the buyer can reduce its offer by that amount.

Representations and warranties. A buyer often uses the representations and warranties as

protection against unknown liabilities. Since the representation and warranties in public deals generally

do not survive the closing, this protection only becomes relevant to "bring down" the representations

and warranties from the period of signing through the closing. For example, if you discover during due

diligence that certain permits are important to the operation of the business, the buyer would likely

insist on a full representation and warranty that the target company is in compliance with all permits.

Although the target company made the representations when it signed the deal, it also needs to confirm

the representations remain true and accurate as of the closing date, or "bring down the rep". This bring

down condition of the representations and warranties is typically qualified (at least in part) by materiality

or material adverse change (www.practicallaw.com/resource.do?item=:44402940). Using the

example above, if failure to have certain permits results in a material adverse change of the target

company's business, then the buyer may have a right to terminate the deal.

Disclosure schedules. The buyer uses its due diligence review to verify the disclosure schedules.

Ideally the buyer should have an opportunity to investigate anything the target company lists on the

disclosure schedules. If the disclosure schedules do not agree with the buyer's due diligence findings,

the buyer can negotiate to add or remove certain disclosures (see Practice Note, Disclosure

Schedules: Mergers and Acquisitions (www.practicallaw.com/6-381-1367)).

Deal termination. In extreme situations, due diligence findings can cause a party to terminate the

transaction (known as deal breakers). Certain issues can either drastically affects the value of the target

company or otherwise impact the buyer's desire to make the acquisition. For example, if a buyer is

acquiring a company primarily for its supply channels and then discovers none of the supply contracts

are binding, the buyer can choose to terminate the deal. Identify any deal breakers early so that you

can focus on these issues and communicate any findings to your client as soon as possible.

Pre-closing covenants. The due diligence findings can raise issues that the buyer wants the target

company to correct before the closing. For example, if title defects exist in assets the buyer is






acquiring, it may require the target company to correct these defects before closing.

Recording and Communicating Your Findings

Importance of Communication

Constant communication becomes necessary as junior attorneys often conduct due diligence. It often takes

an experienced attorney to identify significant issues. It is important to raise any issues with senior

members of the team promptly because your findings can impact the negotiation of the transaction

documents or the merger consideration. If your client identifies any deal breakers or issues to focus on, you

should communicate any findings as soon as possible. It is good practice to have regular status meetings

with the internal due diligence team and give periodic informal reports (for example, through an e-mail or

telephone call) to your client.

Due Diligence Summaries

It is important when reviewing due diligence to keep careful notes of your findings. Often attorneys create a

written record summarizing the key terms and conditions of each document. You need to understand the

scope of the due diligence review to determine the level of detail you need to record. Different firms use

different forms of due diligence summaries and you should ask a senior member of your team if there is a

preferred style. Due diligence summaries maintain a record of what you have reviewed and will help you

recall important issues.

You will often be asked to report on your due diligence findings days or weeks after your review of the

materials. Without a proper record you may be unable to properly report your findings. Sometimes due

diligence summaries are shared with the client, but often the summaries are only used as an internal

record. For sample due diligence summaries, see Standard Documents, Due Diligence Summary Template:

Merger and Acquisition Agreements (www.practicallaw.com/0-382-1166), Due Diligence Summary Template:

Agreements (www.practicallaw.com/5-382-1164) and Due Diligence Summary Template: Organizational

Documents (www.practicallaw.com/2-382-1165).

Due Diligence Report

The ultimate product of a due diligence review is the due diligence report (also known as a due diligence

memorandum). Due diligence reports range from an oral presentation to a lengthy document with detailed

findings. You should ask your client what type of report they prefer at the start of the due diligence process.

Generally, the length and level of detail in the report corresponds with the scope of the due diligence review.

As with the due diligence review, a junior corporate attorney usually coordinates the preparation of the

report. Although each specialist usually writes up their own findings, you need to fit all of the pieces

together into a coherent product. If the report is lengthy, it is helpful to provide an executive summary

highlighting the significant findings and issues. The due diligence report should be clear and concise so that

your client can assess any issues quickly. Drafting the due diligence report can become a time-consuming

process as it involves drafting the corporate sections and refining and reformatting the specialist portions.






Can a Third Party Rely on the Due Diligence Report?

Sometimes, such as when the buyer finances the merger, it is asked to share the due diligence report

with a third party (for example, the financing bank or members of the buying syndicate). Some firms

permit the client to share the report, provided the third party executes a non-reliance letter. Although

most non-reliance letters state that sharing the report does not serve as a waiver of attorney-client

privilege, it is unsettled whether such a statement actually preserves privilege. While common in Europe

and gaining popularity in the US, you should find out whether the client plans to share the report with

any third parties. If so, verify whether any third parties expect to rely on your reports and then consult

with the senior member of the deal team to determine the appropriate course of action. When the client

shares the report, you should remind the client that the third party may review the report with a different

objective. Information in the report can reveal sensitivities about the target company that the client may

want to keep to itself.

Resource information

Resource ID: 9-382-1874

Products: PLC US Corporate & Securities, PLC US Law Department

This resource is maintained, meaning that we monitor developments on a regular basis and update it as soon as

possible.

Resource history

Meso Scale Diagnostics v. Roche Diagnostics

This Note was updated to address the potential implications of the ruling in Meso Scale Diagnostics, LLC v. RocheDiagnostics GMBH, C.A. No. 5589-VCP (Del. Ch. April 8, 2011). See .

Related content

Topics

Public Mergers and Acquisitions (http://us.practicallaw.com/6-380-7426)

Practice Note: Overview

Mergers: Tax Overview (http://uslf.practicallaw.com/topic0-383-6747)

Public Mergers: Overview (http://uslf.practicallaw.com/topic4-382-2164)

Practice Notes

Disclosure Schedules: Mergers and Acquisitions (http://uslf.practicallaw.com/topic6-381-1367)

Due Diligence for Private Mergers and Acquisitions (http://uslf.practicallaw.com/topic8-381-0512)

Information Exchange and Integration Planning in M&A: Antitrust (http://uslf.practicallaw.com/topic5-383-7853)

M&A Due Diligence: Assessing Compliance and Corruption Risk (http://uslf.practicallaw.com/topic3-500-7212)

Standard Documents


http://uslf.practicallaw.com/9-382-1874#null



Due Diligence Request List: Public Mergers & Acquisitions (http://uslf.practicallaw.com/topic3-383-0046)

Due Diligence Summary Template: Agreements (http://uslf.practicallaw.com/topic5-382-1164)

Due Diligence Summary Template: Merger and Acquisition Agreements (http://uslf.practicallaw.com/topic0-382-1166)

Due Diligence Summary Template: Organizational Documents (http://uslf.practicallaw.com/topic2-382-1165)

Checklist

Public Mergers and Acquisitions Due Diligence Checklist (http://uslf.practicallaw.com/topic4-382-9194)

Glossary

Due Diligence (http://uslf.practicallaw.com/topic1-382-3424)

Article: know-how

Virtual Data Rooms (http://uslf.practicallaw.com/topic6-386-5751)