The importance of legal due diligence (DDR) prior to acquisition

In this article, we present a brief overview of the importance of conducting legal due diligence prior to a company (or share) acquisition.

Legal Due Diligence (Legal Due Diligence Review or DDR) is a comprehensive legal audit and analysis conducted by legal counsel prior to executing a transaction involving a company, business, or asset. Its purpose is to determine the target entity's legal status, legal risks, and potential liabilities.

The following matters can be identified during the DDR process:

• The validity of rights to land and real property owned, possessed, or used by the company;

• The validity of special licenses and permits;

• Material legal risks or potential liabilities arising out of contracts and agreements executed by the company;

• Pending or threatened disputes before courts, arbitration tribunals, or other competent authorities, as well as outstanding debts or liabilities established by legally effective court judgments;

• Outstanding tax, social insurance, or other accounts payable and liabilities;

• Loan repayment obligations, pledges, or encumbrances held by banks and non-banking financial institutions;

• Risks of liability or compensation claims arising from employment relationships;

• Compliance of the company's asset and intellectual property registration and ownership with applicable laws and others.

  
  

Because decisions regarding corporate acquisitions and investments carry inherent risks, it is essential to pre-assess the target company's legal status and potential liabilities. Legal due diligence is conducted specifically for this purpose, enabling buyers and investors to evaluate the actual condition and legal risks of the company in order to make well-informed decisions.

A company that appears operationally sound on the surface may, in fact, owe outstanding taxes or other government liabilities, have executed major transactions without requisite corporate authorizations, be embroiled in litigation, or be in breach of its licensing conditions. Executing a transaction without verifying these factors beforehand exposes the buyer to significant, unforeseen financial and legal liabilities and complications.

Furthermore, a DDR does not merely uncover risks; it also assists in negotiating more favorable transaction terms. For instance, depending on the findings, the buyer can safeguard its interests by adjusting the purchase price downward, demanding specific representations and warranties, or incorporating tailored conditions into the definitive agreement.

Therefore, during a corporate acquisition, rather than relying solely on counterparty-provided disclosures such as financial metrics, it is imperative to commission a detailed legal DDR. Conducted by legal counsel using independently verified information from external authorities, a DDR serves as the primary instrument for safeguarding investment security.

Sources:

[1] IBA Corporate and M&A Law Committee, Legal Due Diligence Guidelines, September 2018

Disclaimer: This article is intended for general informational purposes only and have been prepared in accordance with the laws in effect at the time of writing. For legal advice, please consult a professional attorney.