The legal investigation of a target company in M&A transactions, i.e. a "legal due diligence", has traditionally been performed on behalf of the potential purchaser. The trend over recent years has however been that the investigation is increasingly performed by the vendor’s legal advisors. The procedure is called a (legal) Vendor Due Diligence (VDD), and the product, a Vendor Due Diligence report, is often offered to potential purchasers as a supplement to an Information Memorandum containing the vendor’s risk analysis of the target company. The VDD report thus forms the (sole) basis for the assessment of the legal circumstances of the target and the transaction. The knowledge of risks, linked to the target, obtained by the purchaser in a traditional due diligence may have given the purchaser a strong position when negotiating the deal. A VDD balances the positions of the parties and also serves the purpose of speeding up the sale process.
To fulfill its purpose, a VDD report must be a reliable source of information and, hence, give the purchaser a fair and adequate view of what has been reported. Indemnities for damages in relation to a defect of the VDD report, i.e. any substantial deficiency of the advice presented by the vendor’s counsel, must be able to be claimed by the purchaser as would be the case if the purchaser’s own advisor had performed the due diligence. Thus, the VDD procedure has given rise to a number of issues and questions related to a lawyer’s position and the weighing against each other of, on the one hand, the interests of the vendor (i.e. the client) and, on the other hand, possible liability for damages towards the purchaser.
In the UK, legal advisors have developed a certain practice as to the disclosure of a VDD report to the vendors’ counterparts. In order to avoid or limit liability or a conflict of interests, two documents are central: a "release letter" and a "reliance letter". Upon receipt of the VDD report, by signing a release letter, the bidder commits not to disclose any information contained in the VDD report to third parties and to use the report solely for the purpose of assessing the relevant transaction. The bidder is also required to confirm that no client or contractual relationship has been established between themselves and the law firm issuing the report (the vendor’s counsel). Shortly before signing the acquisition agreement, the purchaser receives a reliance letter from the vendor’s counsel. Hereby, the purchaser is conferred a right to rely on the facts presented in the VDD report, notwithstanding the vendor’s counsel’s repeated statement that no client or contractual relationship has been established between themselves and the purchaser. Further, such letter often includes statements intended to limit the extent of liability of the vendor's counsel, inter alia (1) that they have acted solely for the benefit of the vendor; (2) that they only accept liability for damages incurred as a result of their own negligence; (3) that the character and scope of the VDD has been limited to certain matters agreed with the vendor; and (4) that a number of specified areas or aspects have not been reviewed. This will, and should, affect the recipients assessment of the extent to which the VDD report can be relied upon.
As a general rule in Sweden set forth in the Torts Act, there is no obligation outside the scope of a contractual relationship to pay damages for a "pure economic loss" (i.e. damages to compensate damage having no relation to physical or personal damage) unless the damage is a result of a criminal act. This means that as a general rule a Swedish lawyer may not be held liable for damage caused to their client’s counterpart unless the damage is a result of a criminal act of the lawyer. There are some exceptions to this general rule. The most important relates to the so called "reliability doctrine". Liability hereunder would require negligence and further that the party who has suffered the damage justifiably relied on information negligently provided or reported to them. Pursuant to the reliability doctrine it is perfectly possible to limit the liability by limiting the scope and by means of assumptions and qualifications. Unlike what would be the case in a contractual relationship such limitations can be made unilaterally.
This means that a VDD report should be instructive in terms of the scope of the performed investigation and the instructions and principles according to which the report has been prepared. It is good practice that the vendor’s counsel and the vendor at an early stage agree on the guidelines and principles for how the VDD shall be conducted, specified, documented and disclosed to the counterpart. The law firm issuing a VDD report must ensure that the recipient of the VDD-report is not misled.
The Guiding Rules on Legal Ethics for members of the Swedish Bar Association (Sw: Vägledande regler för god advokatsed) ("VRGA"), do not as such restrain a lawyer from restricting their liability towards their client provided that the client’s prior consent is obtained. Also a restriction of liability in relation to a third party, such as in the context of liability under the reliability doctrine is perfectly acceptable. Under such circumstances the justifiable reliance is limited accordingly.
Unless a vendor’s counsel limits their liability for damages linked to their findings in a VDD, if such damages are incurred by the purchaser as a result of justifiable reliance on the VDD report, the vendor’s counsel could be held liable for damages to a third party provided this is due to negligence on part of the vendor’s counsel. In case a vendor’s counsel does accept liability towards a purchaser, such liability must however be outside the scope of the vendor’s own liability under the acquisition agreement otherwise the liability for the Vendor’s counsel could be construed as a warranty to the client, and would as such be contrary to a provision set out in the Guiding Rules on Legal Ethics for members of the Swedish Bar Association (Article 22).
For further information please contact Axel Calissendorff, Partner at Roschier in Stockholm.
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.