I have read articles and written about why legal due diligence is important for M&A transactions and buyers should not merely rely on sellers’ warranties. I have yet to come across any articles suggesting  that there may be valid reasons to skip legal due diligence in M&A transactions.

Whenever potential clients (buyers) say they do not need legal due diligence, I’m concerned whether they are acquiring business or companies with issues which they are not aware of or not prepared for.

The usual reasons given for not requiring legal due diligence:

1. The business of the target is “straightforward”.
2. The potential buyers are closely acquainted with the targets and the sellers.
3. The purchase price of the target is deemed too low to warrant legal due diligence.

In essence, the potential buyers do not foresee any issue with the target due to any or a combination of the reasons above.

The starting point for any acquisition is “caveat emptor” or “let the buyer beware”. A buyer buys at its own risk. Without any specific obligation imposed on the seller, the seller is not obliged to disclose any adverse issues relating to the target business or company.

In respect of all the reasons stated above, unless the buyer is involved in the management of the target, the buyer may not be aware of issues which affect the value or liability of the target. Even if the buyer paid a modest sum for the target, the buyer could still be exposed to more liabilities than what it has bargained for. This may happen for example, if the target is involved in litigation which the buyer is unaware of.

Further, if the target holds licences for its operation or operates in a regulated industry, it’s prudent to conduct legal due diligence on the licences held by the target and its regulatory compliance. Otherwise, how could the parties ensure all necessary approvals from regulators for the change of shareholders, directors and management of the target are obtained, and verify that there is no non-compliance issue which may jeopardise the acquisition?

If buyers do not want to conduct full legal due diligence for any of the reasons above, they should consider conducting a limited legal due diligence on specific areas of the target business or company where there may be concerns of non-compliance.

Seller’s warranties should not be a substitute for due diligence. Due diligence could uncover issues and provide buyers with opportunity to make an informed decision as to whether the issues are material enough for the buyers to negotiate a price reduction, seek contractual protection in the transaction agreements or abort the deal.

I’m curious to know… is there any good reason not to conduct legal due diligence in M&A transactions?

#malaysiancorporatelawyer

#mergersandacquisitions

#legalduediligence

This post was first posted on LinkedIn on 22 February 2024.