Before conducting a merger or acquisition, the due diligence process is an important and integral step in evaluating the target of a business transaction. Legal Due Diligence, also known as Legal DD, is one of the activities in the overall due diligence plan including financial, human resources, and environmental aspects, etc. to collect and evaluate all legal documents and information related to the target subject. This activity allows the parties involved to carefully examine any legal risks before formally entering into the deal.
The necessity for Legal Due Diligence
As mentioned, due diligence in general is an investigative process that involves examining and reviewing various contents and aspects related to a potential deal, such as checking operations and managing and appraising documents related to the target subject. Due diligence is important as it helps to identify potential risks that may arise during a transaction process.
From the seller’s perspective, legal due diligence will help business owners to consider compliance with the legal regulations from the establishment of the business and throughout its operations. In cases where shortcomings are discovered in the operation process, appropriate and timely adjustment plans can be made. This ultimately improves the legal documentation of the business, creating advantages when attracting investment and engaging in M&A transactions.
From the investor’s side of view (the buyer), Legal Due Diligence is the process in which investors and their professional teams collect, research, review, and evaluate information about the target company or a specific entity involved in the M&A transaction. This objective is to identify legal issues that may affect the transaction and potential risks that may occur during and after the execution of the M&A deal. This allows the investors to gain a comprehensive understanding of the nature, condition, and risk involved, to make decisions on whether to proceed with the transaction, the method of implementation, the transfer price, any prerequisites conditions, or requirements that the seller must commit to or fulfill when making the deal.
Basic issues when undergoing Legal Due Diligence
Legal Due Diligence will include a comprehensive review of legal issues from the establishment of the target company, such as capital contribution, and organizational structure, to legal compliance during its operations, business activities, and more. Within the scope of this article, we list some notable contents and aspects that investors should pay attention to, as follows:
Legal Due Diligence will focus on the appraisal of company incorporation documents, relevant licenses, and business compliance. From these documents, information such as the date of establishment, type of enterprise, operation duration, business lines, company headquarters, branches, representative offices, etc., will be evaluated. In this aspect of due diligence, the reviewing party will assess the compliance with legal regulations of the target company, by considering whether the target company has obtained the necessary licenses to carry out its business activities. Additionally, it also considers the company’s ability to meet the conditions prescribed by law to conduct business activities (tax, labor, fire protection, etc.).
1. For capital and capital structure
Evaluation will be conducted on the registered capital, the actual contributed capital, the types of assets contributed, and the actual contribution status.
2. Business assets
Major assets of the target company such as land use rights, warehouses, factories, or special assets such as intellectual property rights or assets requiring ownership registration such as cars and trucks will be closely examined for the legal ownership of the target company. In addition, it is also necessary to focus on assets that are being pledged and mortgaged as collateral in transactions.
3. Critical contracts/agreements
When conducting Legal Due Diligence on important contracts and agreements of the target company, the focus should be placed on significant contracts with major customers, major suppliers, exclusive distribution contracts, loan agreements, security contracts, insurance contracts, This will allow investors will determine the legal rights and obligations held by the target company.
Typically, this aspect is separated into a separate category within the legal due diligence process. In some cases, if the target company has a large workforce, the labor aspect may be evaluated separately (HR Due diligence). Specifically, the target company needs to specify labor-related information such as the registration of internal working regulations, collective labor agreements, internal regulations related to labor management, etc. Furthermore, legal due diligence also approaches agreements entered into between the company and its employees such as labor contracts, confidentiality agreements, anti-competition agreements, Based on this information, the legal due diligence report will provide legal opinions on the risks related to the labor field.
5. Intellectual property
This content lists the intellectual property assets owned by the target company, typically copyrights, and industrial property rights (trademarks, patents, industrial designs, etc.). Additionally, it may also include technology transfer, licensing contracts, or other transactions that the target company is involved to determine financial obligations in the use and transfer of intellectual property rights during operation.
Listing disputes that the target company is involved in as a plaintiff, defendant, or related party with rights and obligations. Disputes can occur not only in civil matters but also in labor, commercial, and criminal matters. Evaluating this aspect is extremely important to identify legal risks, potential liabilities for damages, or other financial obligations that the target company may have to fulfill in the future.
In addition to the above-mentioned issues, the Legal Due Diligence process may cover additional areas and content based on the needs and objectives of the investor to ensure an effective evaluation and risk mitigation.
Outcomes of Legal Due Diligence
The legal due diligence process is documented in a Legal Due Diligence Report. This report provides investors with a comprehensive overview of the legal status of the target company in various relevant areas. The contents of the report not only include risk classification and detailed recording of risks, assessed from a legal point of view but also provide a list of legal risks ranked from high to low levels for investors to take note of. This helps investors in mitigating the risks they may face and provides insights into key issues to consider when conducting mergers, acquisitions, and acquisition transactions.
It can be seen the important role of the Legal Due Diligence phase before conducting M&As. Successfully execution of this stage requires the coordination of various factors. Therefore, to gain a clear understanding and receive specific advisory support regarding legal due diligence before conducting M&As, investors should consult a professional legal organization for specific advice. After receiving the Legal Due Diligence Report, investors need to consider and evaluate the risks, and their magnitude to make decisions on whether to proceed with the transaction. They should also establish binding conditions, determine the transfer price, and address other relevant matters when conducting the transfer of ownership transaction.