Without adequate protection, buyers may be left with unexpected liabilities or without a remedy if, after the deal is completed, it transpires that the agreements made or expectations generated prior to completion have not been upheld. There are numerous ways in which lawyers can help clients mitigate this risk, such as seeking competition clearance in advance, conducting thorough due diligence and ensuring various contractual provisions are in place in favour of the buyer, including warranties and indemnities.

Due diligence

Due diligence refers to the process under which a potential buyer and its advisors carry out an in-depth investigation into many aspects of a target company, in order to gain a solid understanding of that company’s business and/or market. Due diligence can help a potential buyer to decide whether to go ahead with the purchase and if so, at what price and on which terms.

Vendor due diligence: this refers to the process under which a seller and its advisers carry out an investigation into the company (or group of companies) that the seller is intending to sell. The findings of this investigation are then typically set out in a “vendor due diligence” report, which the seller may then make available to a select number of bidders. This can significantly speed up the sale process and avoid the target’s management team having to repeatedly answer identical questions for different prospective buyers. The process can also enable the seller to identify and rectify at an early stage any issues that consequently come to light, which can reduce the risk of potential buyers walking away from the deal or attempting to negotiate a lower purchase price. 

When conducting due diligence, companies (or their lawyers) are usually given access to a “data room” (nowadays this is typically an online database) containing comprehensive information about the target company, including: commercial contracts, financial records, and information on existing assets and liabilities. This helps bidders to understand the target in greater detail and provides advisers with an opportunity to discover (and subsequently deal with) any potential issues. 

Sellers may put restrictions in place to prevent potential buyers (which may well also be existing competitors) from discovering too much about the company, thus reducing the ability of prospective buyers to use such information to their own advantage if the deal falls through at a later stage. A confidentiality agreement could mitigate this risk.

Confidentiality agreement / non-disclosure agreement (NDA): these are designed to restrict and control a party’s access to and use of sensitive/confidential information relating to another party. A seller will typically require a prospective purchaser to sign an NDA before granting them access to a data room. This is to ensure that the prospective purchaser is deterred from disclosing sensitive, confidential information about the seller/target that it discovers during the due diligence process, or using the information for a purpose unconnected to the proposed acquisition (e.g. to solicit one of the target’s customers or suppliers).

Acquisitions will typically involve the transfer of tangible assets such as inventory, machinery, buildings and vehicles and intangible assets such as shares and intellectual property rights. Due diligence can help ascertain which assets will actually be included in a deal; whether the seller has the legal right to sell the assets in question; whether assets are subject to any charges or restrictions (for instance a mortgage, or a right of usage granted to a third party such as an easement); and whether the relevant assets are in a satisfactory condition.

Liquidity: how easily a business’ assets can be converted into cash. If a company is highly liquid, it can easily convert its assets into cash. This may be important if a bidder plans to sell some of the target’s assets post-transaction.

Contracts

Lawyers must check whether key stakeholders such as employees, suppliers, distributors and customers have change of control clauses in their contracts. If such stakeholders are able to terminate their contracts with the company following an acquisition (on the basis that there has been a change in ownership, or “change of control”), this may reduce the buyer’s ability to operate effectively post-acquisition. 

If such clauses exist, prospective buyers must assess whether these stakeholders are key to the success of the business and consider whether they may attempt to leverage a new owner’s dependency on their offerings to secure more favourable contractual terms, or simply terminate their contracts. 

If this is likely to be the case, prospective buyers (or their lawyers) could consider whether viable alternatives exist that may reduce the bargaining power of existing stakeholders, or whether negotiations with these stakeholders should take place before a purchaser commits to an acquisition. Those stakeholders might, for instance, be willing to waive the relevant change of control clauses in advance of the deal completing.

Change of control clause / break clause: these clauses can enable parties that are contracted to work with a business (e.g. suppliers, customers or employees) to terminate the contract - without incurring any liability for breach of contract - if control of that business changes hands (e.g. if it is acquired by a third party).

Lawyers may consider devising ways in which to incentivise those involved with the company to remain so, for instance through offering existing actors in the supply chain long-term contracts, or providing key employees with share options, pay rises, or guarantees relating to the security of their employment. This is advice typically given by lawyers in the Employment (or Benefits) departments of law firms. 

Buyers may also require sellers to sign non-solicit clauses to mitigate the risk of sellers luring certain key contributors (e.g. employees or suppliers) away from the company post-acquisition.

Non-solicit clause: a contractual promise from a seller to a buyer not to approach and attempt to poach, for instance, certain key employees, suppliers, distributors or customers of the newly purchased company for a given time period or in a particular jurisdiction.

Liabilities

Unless the contrary is agreed, once a business has been acquired, the purchaser assumes responsibility for any existing liabilities of the acquired business. Due diligence must thus be conducted before a sale to ensure that there are no outstanding liabilities of which a potential purchaser is unaware, as such liabilities could significantly impact upon the financial viability of the proposed transaction. It is therefore essential that the purchaser is made aware of such liabilities, as this may influence their decision to buy and the price they are willing to pay. 

Liabilities that lawyers would typically look out for include: 

• Debt: including outstanding loans, unpaid overdrafts, payments owed to suppliers, distributors or customers and bonds that have been issued and have not yet matured (meaning that the company must continue to make coupon payments to bondholders and will eventually have to repay the original price of the bonds, i.e. the “principal” amount). A purchaser could also require a warranty that no undisclosed debt exists.
• Outstanding litigation: if pending litigation is settled post-acquisition, the purchaser will be liable to pay any damages awarded. It is thus essential for the purchaser to secure an indemnity from the seller against any such costs that may later arise and/or an undertaking that any on-going litigation will be settled before the acquisition is completed. This could also cover any litigation that is not pending, but arises in the future as a result of the target’s activities pre-acquisition. 
• Pension scheme liability: purchasers will be liable for future pension payments that a company is obligated to make, including financial entitlements that have accrued as a result of work carried out pre-acquisition. Lawyers must thus check whether a target has enough capital set aside to fulfil these liabilities and could request a warranty regarding the state of a company’s pension scheme.

Other contractual protections

There are various other contractual protections available that can pre-empt and mitigate, or help to determine the outcome of, potential issues that could arise post-acquisition. Notable examples include non-compete and entire agreement clauses.

Non-compete agreement: these usually contain restrictions on the extent to which an individual or organisation can engage in work that “competes” with the activities of another contractual party during the course of the agreement and/or after the agreement terminates or expires. For example, non-compete provisions may exist in employment contracts to prevent an individual from working with a competitor organisation if/when they resign. In a transactional context, non-compete agreements may contain various contractual promises from the seller to ensure that if the sale goes ahead, the seller cannot subsequently set up a similar business and emerge as a competitor of the business they are selling. However, such restrictions cannot be perpetual and will usually be limited in time and scope.

Entire agreement clause: a clause stating that only the terms contained within the contract will apply to the agreement, meaning that the parties will not be bound by any previous negotiations, representations or oral statements that have not been recorded in the contract. 

The parties to a transaction will also usually subject the Sale and Purchase Agreement to conditions precedent. 

Conditions precedent: conditions that must be fulfilled before full performance under a contract becomes due. Notable examples of conditions precedent include the verification (through due diligence) of all the key promises made by the seller prior to the transaction and the receipt of clearance from the relevant competition authorities.