Due Diligence In Business Acquisitions

(republished from daily.nb.org)

In previous articles, we discussed confidentiality clauses (NDA/CA) and Memoranda of Understanding (MOUs) in business acquisitions (see here and here). Today, we examine the next step in the acquisition process: the pre-contractual investigation of the business, commonly referred to as due diligence (DD).

Due diligence is one of the most crucial stages of the acquisition. It is where the prospective buyer gains deeper insight into what they intend to purchase, uncovering potential issues, defects, or weaknesses. Due diligence typically follows the signing of the MOU and lasts anywhere from 1 to 6 months, depending on the volume of data and the size of the review team.

Due diligence usually includes an investigation of: (a) corporate documents (formation, representation, and governance records), (b) affiliated companies, (c) customer base, (d) branch offices, (e) pending lawsuits and potential disputes, (f) capital structure and changes, (g) the company's assets (real estate, equipment, cash, etc.), (h) intellectual property rights, (i) loan agreements, (j) security interests (pledges, pre-notations, mortgages, etc.), (k) tax and social security compliance, (l) contracts, (m) employment relationships, and more.

The findings from DD are critical for two main reasons:

1. They influence the purchase price. If issues are uncovered during the investigation, the offered price may be reduced or become conditional. When significant risks are identified, the buyer may negotiate a price that factors in performance-based clauses or conditional pricing. (See Decision No. 493/2021, Athens Court of Appeal: "To determine the share purchase price, the buyer conducted a pre-contractual financial audit (due diligence) through a specialized firm, which assessed the target company's financial status, including assets and liabilities toward suppliers, creditors, tax and insurance agencies." Also, Decision No. 344/2021, Athens Court of Appeal: "Due to uncertainty in inventory value, the parties agreed to adjust the final purchase price based on a final confirmation within 20 days.")
2. They shape the contractual terms of the SPA (Share Purchase Agreement). The buyer's concerns, based on the DD findings, are typically addressed by shifting certain risks to the seller through specific contract provisions.

Furthermore, DD significantly influences the seller's liability post-acquisition. Under Greek Civil Code (Article 539), if the buyer was aware of certain issues before the purchase, the seller is generally not liable for them. This is logical—if you knew about a problem before signing, you can't later use it to seek a price reduction or compensation. By knowingly buying a business with flaws, the buyer assumes the corresponding risk, which should be reflected in the agreed price.

To formalize this, sellers often provide a disclosure letter listing all documents shared with the buyer, or agree that everything uploaded to the Virtual Data Room is deemed disclosed and known to the buyer.

(See Decision No. 6285/2013, Athens Court of First Instance:

"Despite the tight timeline, the buyer had been informed of a liability to a Dutch company and was aware that the balance sheet was inaccurate."

Also, Decision No. 6119/2011:

"Before signing the SPA, the buyer had full knowledge of the target company's poor financial condition and project delays, having participated in the verification process with financial and legal advisors.")

Within an SPA, parties can define how DD findings affect liability in different ways:

A. Pro-sandbagging clause:

It may be agreed that DD findings do not exempt the seller from liability. Even if the buyer became aware of a defect during DD, the seller remains liable if they warranted a defect-free company. This protects the buyer in cases of late disclosures or when the implications of a risk cannot be assessed in time.

B. Specific knowledge requirement:

Alternatively, the agreement may specify that the buyer must have obtained explicit knowledge of an issue to relieve the seller of liability. That is, a defect must be clearly evident in the disclosed documents—not inferred.

For example, if a supplier contract contains an invalid clause that could lead to legal claims, the mere presence of that contract in the data room might not suffice. The seller would typically only be protected if a legal notice or claim from the supplier had also been disclosed.

In conclusion, the purpose of due diligence is to provide the buyer with a comprehensive view of material risks and help shape:

• the final purchase price, and
• the allocation of liabilities in the share purchase agreement (SPA).

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.