Canada: Due Diligence – Assembling The Stones To Be Overturned

Last Updated: February 25 2017

Introduction

This Practice Guide discusses the process of due diligence that is typically undertaken in connection with an M+A transaction and some practical tips in relation thereto. 

What is Due Diligence?

Due diligence refers to the process undertaken, most typically by a proposed Purchaser under an Acquisition transaction, to obtain and confirm pertinent information regarding the other party (e.g. the target company). In most cases it involves a detailed financial, operational and legal review of information that is either publicly available or otherwise obtained on a confidential basis, relating to the business, assets, liabilities, obligations, condition and results of the operations of the other party. Often, this is broken down into a number of distinct areas: financial, operations, environmental, intellectual property, human resources, and legal. This typically includes review by business personnel of the Purchaser, as well as accountants, lawyers, tax advisors and other professionals, of financial statements, contracts and other material information. For example, legal counsel may review corporate records of the target company, and certain contracts, licenses, permits and executive or employment compensation arrangements, and business people and accounting and financial advisors may review financial statements, records, tax returns and reports and other information.

Due Diligence Period

Letters of Intent entered into in relation to a proposed Acquisition transaction (see the Letters of Intent Practice Guides) often expressly contemplate a specified period for due diligence, typically between the signing of the Letter of Intent and the parties entering into a definitive agreement.  However, where a Confidentiality Agreement has already been executed by the prospective Purchaser, due diligence may commence prior to the Letter of Intent being signed.

Purchasers often continue to conduct due diligence after entering into a definitive agreement, to attempt to confirm that there has been no breach of any representations and warranties and, in some cases, may do so to satisfy any “due diligence out” condition that may be included in the Acquisition Agreement.

Purpose of Due Diligence

Due diligence may be largely “confirmatory” in nature, intended to permit the Purchaser to confirm (i) information (e.g. summary information) provided by the Vendor or target company or its agent (e.g. a financial adviser), (ii) the truth and accuracy of the representations and warranties, or (iii) whether any issues identified in prior phases of due diligence have been addressed or are properly reflected in the Acquisition Agreement. In other cases the Purchaser may use the due diligence process to obtain additional information regarding a target company and to confirm the suitability of the Acquisition and that is it comfortable committing to complete the purchase.

In general, due diligence conducted prior to signing of an Acquisition Agreement is not intended to permit a prospective Acquiror to ‘sandbag’ the Vendor by “keeping quiet” about any inaccuracies in the Vendor’s proposed representations and warranties, and then sue for a breach following Closing (although, depending on the terms of the Acquisition Agreement, it can sometimes be used for that purpose).  Instead, in most cases, Acquirors share the results of deficiencies that they uncover with the target company and its legal counsel, and may, if the deficiency is material and significant, seek to negotiate a reduction in the purchase price before the Acquisition Agreement is signed. Similarly, if due diligence discovers deficiencies after signing, but before Closing, Acquirors typically share the information with the target company. In that case, depending upon whether the Acquisition Agreement includes or does not include “Sandbagging” or “Anti-Sandbagging” provisions, if the Vendor is not willing to renegotiate the purchase price the Acquiror may have to make a decision regarding whether to rely on a condition precedent permitting it not to complete the Acquisition, or complete the purchase.  If the Acquiror elects to complete, depending on whether the Agreement contains Sandbagging or Anti-sandbagging provisions, the Acquiror may or may not have the right to close and then seek indemnification for the breach (See the Sandbagging and Anti-Sandbagging Practice Guide).

Due Diligence Checklists, Confidentiality Agreements and Data Rooms

Experienced buyers will often provide a target company with extensive due diligence checklists or questionnaires or requests that many target companies find overwhelming.

In negotiated transactions (e.g. private M+A transactions and friendly public M+A transactions), it is common for a target company to create a “data room” (usually a virtual data room on a hosted website) containing materials assembled in response to the requests (or anticipated requests) of a prospective Acquiror (or more than one) to review information, including confidential information, regarding the target company. Typically, access to the due diligence materials assembled in the data room is only granted after the prospective Acquiror agrees to confidentiality restrictions, which may be included as part of the Letter of Intent, or may be in a Confidentiality Agreement or Non Disclosure Agreement executed by the prospective Acquiror.

For public target companies, the Confidentiality or Non Disclosure Agreements often include “standstill” restrictions restricting the prospective Acquiror from acquiring shares of the target company or commencing a hostile take over bid.

Vendor Due Diligence

Where the proposed consideration for the acquisition of the target company shares or assets includes securities of the Acquiror, the Vendor may also need to conduct due diligence on the Acquiror prior to entering into a definitive agreement or completing the transaction.  However, if an Acquiror is a public entity, the Vendor may conduct less extensive due diligence and instead be more willing to rely on information publicly available in relation to the Purchaser.

Prepare in Advance

In many cases, where a target company is anticipating potentially ‘shopping’ itself around  or entering into discussions with one or more prospective Acquirors, it is advisable for the target company to conduct its own internal due diligence to attempt to identify (i) matters that may give rise to issues as part of prospective Acquiror’s due diligence requests, (ii) deficiencies that may need to be rectified, or (iii) items that may require disclosure, and try to assemble the materials in advance in a data room, rather than only doing so in response to requests by a prospective Acquiror. 

As a general comment, if a target company is disorganized, has not assembled materials in a data room in advance, and only does so in response to requests from a prospective Acquiror, this can often affect the way the prospective Acquiror negotiates various provisions.  The Acquiror may be less likely to (i) accept risks regarding potentially undisclosed items, (ii) accept knowledge or materiality qualifications to representations and warranties, (iii) agree to seller friendly or even middle of the road indemnification provisions, or (iv) waive conditions precedent to Closing and close on a more expedited basis.

How Much Is Too Much?

The level of due diligence information that needs to be provided can be the subject of negotiation. For example, in a transaction structured as an Asset Purchase, where the Purchaser only intends to assume specified “Material Contracts” or agreements or liabilities that they expressly agree to assume, and other contracts, agreements or obligations will remain with the target company, Vendors may resist having to go through the exercise of making available copies of contracts or documents that are not to be assumed. But Purchasers typically insist that they be provided with as much information as possible in order to decide what they wish to assume, and to more fully understand the business and protect against unforeseen surprises. For example, a Purchaser needs to determine whether and to what extent any contract not intended to be assigned or assumed may be necessary or material to the conduct of the business or generate revenue intended to be generated post Closing.

Publicly Available Information

If a target company is a public company  and is a “reporting issuer” in Canada, material information regarding that party will be publicly available, which can reduce the information or documents that need to be separately made available in the data room, or otherwise under the due diligence process.

Lender Due Diligence

In some cases, e.g. where a Purchaser is obtaining financing from a third party for the transaction (for example, from an institutional lender, or private equity firm) those parties may have due diligence requirements which supplement those of the Purchaser.

Should a Purchaser Prepare a Vendor’s Response?

If a target company does not have a large staff, assembling the due diligence information, responding to due diligence requests, and preparing required disclosure schedules can be overwhelming. In such cases Vendors might argue that the Purchaser, and its representatives, have greater familiarity than the target company regarding the required disclosure as a result of all of the due diligence they are conducting. However, Purchasers will generally resist having their representatives prepare disclosure required from the Vendors, on the basis that this may potentially prejudice their right to seek indemnification in the event the disclosure is not correct.

Conclusions

Due diligence by a Purchaser in an M+A transaction is an unavoidable necessity. The process is unfortunately time consuming, can involve a significant amount of effort and may require significant time and attention of representatives of the target company. However, not being properly prepared for due diligence, or being unable to promptly and properly respond to due diligence requests can potentially delay Closing, adversely impact negotiation of certain provisions in the Acquisition Agreement and increase risks of the target company not uncovering any of its own ‘skeletons” on a timely basis (increasing the risk of claims for breach of representations and warranties or indemnification claims).  

This document is not intended to create an attorney-client relationship. You should not act or rely on any information in this document without first seeking legal advice. This material is intended for general information purposes only and does not constitute legal advice. If you have any specific questions on any legal matter, you should consult a professional legal services provider.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Contact the Author?
Click here to email the Author
In Association with
In Partnership with
Other Canada Advice Centres
Competition and Antitrust
Labour and Employment
Intellectual Property
More Advice Centers
Useful Resources
An Act to provide for the general regulation of trade and commerce in respect of conspiracies, trade practices and mergers affecting competition.
Regulations Respecting Notifiable Transactions Pursuant to Part VIII of the Competition Act.
The Regulations Respecting Anti-Competitive Acts of Persons Operating a Domestic Service.
An Act respecting investment in Canada.
The Competition Bureau, as an independent law enforcement agency, ensures that Canadian businesses and consumers prosper in a competitive and innovative marketplace.
The Competition Tribunal is a specialized tribunal that combines expertise in economics and business with expertise in law.
Our Mergers, Acquisitions + Financing team draws upon their Canadian M&A legal experience and shares legal insights, from the essentials for novices to more advanced concepts for seasoned dealmakers.
Tools
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.