Vendor due diligence is increasing in popularity in Australia after many successes in the UK, Europe and the USA, smoothing the pathways of an M&A transaction with multiple bidders while shifting the burden of due diligence to the selling party. This Legal Update explains what a vendor due diligence is all about and how the advantages outweigh the disadvantages for some transactions.
Due diligence in an M&A transaction has ordinarily been undertaken by the purchaser on the caveat emptor principle, but recent trends both here an overseas has seen that burden shifting to the vendor.
Vendor due diligence is a development which has become common in the UK, Europe and the US is now increasing in popularity in Australia. This involves the vendor undertaking a due diligence and providing a due diligence report for the transaction to each purchaser rather than multiple purchasers undertaking individual due diligence exercises.
The purchasers may then rely on the due diligence report of the vendor. The provision of a vendor due diligence report to purchasers is designed to perform the same role in discovering information as a purchaser due diligence. The terms of engagement by the vendor of its advisors would involve a full due diligence review as if acting for a purchaser, but there are differences.
A vendor due diligence is likely to be of real benefit:
- where there are multiple bidders
- where time is important
- to limit disruption to the vendor by controlling the due diligence process and avoiding the need to deal with multiple parties and requests
- the transaction is complex or substantial
- there is a desire to increase competitive tension between bidders to add value to the transaction.
The scope of work for the due diligence is established by the vendor and the due diligence advisors but may be extended by prospective purchasers before a sale agreement is entered into. New information in the form of an updated vendor due diligence report is provided to all prospective purchasers to ensure a level playing field.
The vendor due diligence report is provided initially in draft to the vendor for review prior to release to prospective purchasers. The discipline of the vendor undertaking and reviewing a due diligence pre sale has the added advantage of ensuring that the vendor knows exactly what it is selling.
The vendor usually pays the costs of the vendor due diligence (subject to negotiated contribution by prospective purchasers or the successful purchaser). Often these costs are then treated as a deduction from the purchase price. The additional cost of the vendor due diligence may be compared to the alternate cost of vendor warranty and indemnity insurance.
For the advisors involved there are potential conflicts of interest and professional liability risk issues in providing a vendor due diligence report which will be relied upon by both vendor and purchaser, particularly where those advisors are also acting for the vendor on the sale.
These conflict issues can be limited by:
- detailing the scope of work in the report and disclosing documents reviewed and tasks undertaken with any relevant disclaimers and limitations
- sticking to a factual review with a statement of facts without advice, comment or opinion
- specifying any limits on liability of the advisor in the contractual terms of engagement with the vendor which are then novated to the purchasers
- ensuring the assessment of risks, value implications, insurance issues and effect on contractual terms for the transaction are matters for the vendor and purchasers and not part of the role of the advisors in providing the vendor due diligence report
- limiting assumptions and qualifications in the report to those reasonably and usually found in transactions of the relevant kind.
Alternatively, many of these conflict risks for the vendor’s sale advisors can be avoided if third party firms of financial, accounting and legal advisors are retained separately from the vendor’s advisors on the sale.
Any perception that the vendor’s advisors may not be independant of the vendor is significantly reduced because those advisors, as providers of the vendor due diligence report, are on risk and liable for any misleading or deceptive contents or omission directly to the purchaser.
The concern of vendor management that problems will be identified by the vendor’s advisors and brought to the purchaser’s attention, must be balanced by the vendor’s ability to deal with those problems in a controlled way and the likelihood a thorough purchaser due diligence would discover the problems in any event, or that undisclosed problems carry significant risks of later warranty claims and disputes.
The vendor may be able to limit its liability on warranties in the sale and purchase agreement based on the vendor due diligence report disclosures.
The risk issues in the vendor due diligence report can be reduced by:
- setting out the risk management practices adopted in preparing the report
- maintaining a due diligence data room (actual or virtual)
- establishing and maintaining a competent due diligence committee
- setting out clearly the role of relevant advisors and participants on that committee
- ensuring there is an audit trail of documents and matters reviewed and considered
- identifying and excluding liability for things not reviewed
- obtaining and disclosing relevant expert and third party reports
- limiting assumptions and qualifications to those strictly necessary and reasonable and which could not have been tested in the ordinary course of a prudent and proper due diligence investigation
- verify or justify every statement in the report and any omissions by reference to specified materiality thresholds
- ensure no statement or omission is misleading or deceptive
- making all enquries that are reasonable in the circumstances
- ensuring the report contains all information a purchaser and their advisors would reasonably require to make an informed assessment concerning the acquisition.
The provision of a vendor due diligence report does not remove the requirement for a purchaser to make its own assessment of the value of the business or company or risks and opportunities in the acquisition for that purchaser. It does, however, shift the onus of disclosure of all factual information to the Vendor to a greater degree than pursuant to the disclosure requirements for public offers under the Corporations Act without the due diligence prospectus defences available under that Act (although there could still be some limited defences available in the Act for excluded offers).
Middletons’ M&A team undertakes vendor due diligence. We can tell you more about how our team can help you achieve your objectives in a sale or purchase.The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.