M&A – Detailed legal due diligence is both a benefit to the seller and buyer?

Latvian law leaves all responsibility for the risks related to selling or buying a company in the hands of the respective parties to the transaction. In turn, sellers and buyers are mostly characterized by recklessness, time constraints, and a lack of bad experience. It is rarely the case the sellers or buyers of a company are willing to devote significant time and resources to conduct a detailed legal due diligence or achieve a proper systematic disclosure of information. A detailed legal due diligence is just one of several ways of valuable fact-finding. Depending on the context of the transaction and the business model in question, the following categories within a legal due diligence could be part of a transaction: financial, tax, merger control, technical, AML/KYC, environmental, IT, HR, etc. Normally, the buyer chooses the most important legal issue only and devotes resources in this direction.

One of the basic principles of the sale of a business is the following - the seller is not responsible for any of the risks that have been adequately disclosed to the buyer. From this premise, follows the findings of this article on the various aspects of a legal due diligence and its methodology.

The purchase price is always connected with the relevant information about the company disclosed to the buyer, or the buyer’s assumptions about the possible or most probable situation with the company. Except for real estate transactions, it is often the case the buyer has limited opportunities to conduct a legal due diligence exercise in M&A transactions, without the seller’s involvement.

Thanks to publicly available information (www.kadastrs.lv, www.zemegramata.lv, etc.) and the opportunity to examine the asset in real life, the buyer can independently identify the possible legal risks within the real estate transaction quite accurately. As Blackstone’s Schwarzman said that real estate is easier business as buildings don’t talk and you cannot be misled by the building. However, this is not objectively possible in other cases, unless the company’s annual reports with detailed notes prepared by a recognized audit company are indeed available.

If the seller has signed an NDA (non-disclosure agreement), then the seller limits its liability to only the information adequately disclosed. The seller must be able to prove in court or arbitration what information and to whom it has been disclosed to.

The seller can accelerate the pace of the transaction if it has carried out a detailed legal due diligence independently, i.e., the seller’s legal due diligence (vendor due diligence). The seller’s legal due diligence could be sufficient to give the buyer a range of the purchase price. Notwithstanding the seller’s contribution to the preparation of the research, the buyer may also decide to carry out an independent legal due diligence either before or after signing the purchase agreement.

The methodology for disclosing information is crucial to all of the parties involved. Firstly, the seller seeks to “put on record” certain specific information which has been adequately disclosed. Secondly, the buyer seeks to understand the information disclosed and also to “put on record” all the relevant information adequately disclosed to distinguish it from the undisclosed information for which the seller is responsible. It is the methods of disclosure which are undervalued by both parties in practice, but it is precisely these issues which determine the outcome of disputes between the parties in the courts or arbitration.

The buyer can choose to use either a hard-copy format or digital format (virtual data rooms - VDR). If the hard-copy format is chosen by the buyer, the challenge is much greater than utilizing a digital format. Both parties want to record the disclosed documents and their content, but it is difficult to do so on paper since attaching copies of documents or listing them in such a way is incomplete and inefficient.

In turn, the digital format is more convenient, accurate and sustainable. Although the costs are significant and initially imposes a burden on the administrative staff in the beginning, these amounts are usually insignificant in the context of the value of the transaction. The most typical VDR providers can be found here, for example, at https://www.softwareadvice.com/virtual-data-room/.

A specific methodology should be applied when disclosing information of a commercially sensitive nature (especially if the potential buyer is a competitor). It is recommended to address this issue at an early stage when signing the NDA or Term Sheet.

Following the legal due diligence and the moving towards the closure of the transaction, the parties shall agree on an independent person who will hold the data on the information disclosed, or the parties may apply a digitally secure solution for the storage of data, i.e., which information was or was not disclosed to the buyer.

In conclusion, the author would like to underline each company needs to build or create a database for different purposes in a timely manner. Organized data storage is always a sign of a well-managed company that enhances trust in existing management and increases the value of the company, as well as in the context of an M&A deal.

by Gints Vilgerts, Managing Partner, Latvia

Team

Related Experience

VILGERTS assisted Summus Capital OÜ with the issue of unsecured bonds in the amount of EUR 10 million, arranged by Signet bank.  Summus Capital OÜ, established in 2013, is an Estonian-based investment company which has diversified commercial real estate portfolio in the Baltics. The group possesses a portfolio of cashflow generating commercial real estate properties in the retail, office, logistics and medical segments. The VILGERTS team included managing partner, Gints Vilgerts and senior associate, Kristīne Mora.  Other lawyers involved, included Kaido Loor.

Assistance to Latvijas valsts meži concerning the obligation of a contracting authority to assess independence of bids by related tenderers.

Advising and representing Lursoft in the Latvian courts to appeal the GDPR fine imposed by the regulator.

Assistance to a waste management company concerning market investigation by the Competition Council.