Instead of a full legal due diligence report which sets out salient terms of contracts entered by the target companies, some buyers prefer to have a red flag report, which only highlights legal issues.

In respect of contracts entered by the target companies, a red flag report may cover the following:

1. Whether the counterparties may terminate the contracts unilaterally or upon certain events triggered by the M&A transactions, such as change of control or shareholding provisions.

2. Whether the target companies or the counterparties may terminate the contracts without cause.

3. Whether there are any liquidated damages, penalties, uncapped liability or indemnity, or service level clauses which may lead to loss-making contracts.

4. If the target companies provide deliverables (e.g. reports) to their clients, who owns the intellectual property right in the deliverables.

5. Whether there are any covenants and exclusivity provisions in the contracts which will restrict how the target companies conduct their business.

6. Whether there are any extension or renewal clauses.

7. Whether the counterparties have the right to assign the contracts to third parties without consent from the target companies.

8. Whether there are other onerous provisions which may affect the business or financial position of the target companies.

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This post was first posted on Linkedin on 18 October 2022.