When a company plans to, for example, conduct a merger, acquisition, or plans to sell or purchase shares, a legal due diligence process is often required. The facts found in this process will often serve as a consideration in the company's decision-making process. But what is legal due diligence and why is it carried out?

Definition of Due Diligence

The term "due diligence" includes both financial and legal due diligences. Legal due diligence specifically, is an investigation process done by reviewing documents, and if necessary, interviewing employees, to gain an understanding of and to assess the legal risks associated with a transaction. In the legal due diligence process, risks and obligations are identified, and legal advice is provided.

The idea behind the legal due diligence is to seek information about a target company to ensure that the investment or purchase that is planned to be conducted is beneficial. Once all the important facts are collected and analyzed, then an informed decision can be made. The issues include but are not limited to company's debts, pending and potential lawsuits, leases, warranties and contracts.

Here are some other reasons for conducting legal due diligence:

  1. Evaluating the Target Company: Legal due diligence informs the investors of matters such as contingent liabilities, employee benefits, intellectual property rights and restrictions on businesses,
  2. Understanding the Target Company: Legal due diligence is needed to provide the buyer and/or investor the information necessary to learn more about their target companies and to better structure their purchases
  3. Informs the Drafting of Relevant Documentation: The information obtained is useful for both parties of a transaction in drafting and negotiating relevant agreements. This is especially helpful for risk allocation when representations and warranties, pre-closing and post-closing indemnification rights of both parties.
  4. Helps to Value the Target Company. A legal due diligence will inform the investor of some of the following: contingent liabilities, restriction on businesses, pending litigations, insurance policies, employee benefits, intellectual property rights etc.
  5. Identify Potential Closing problems: During a legal due diligence process, parties are able to identify and sometimes address impediments that might delay or hinder the success of the transaction.

Originally published 22 Apr 2022

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