Legal due diligence in M&A transactions: risks that may affect the deal

In acquisition transactions, attention is typically focused on the value of the target company, its financial prospects and the determination of the purchase price.

However, the purchaser does not merely acquire shares and assets. It also acquires an existing business with its own corporate history, contractual arrangements, liabilities and potential legal issues that may not be immediately apparent from the financial information on which the transaction is based.

It is in this context that legal due diligence assumes particular importance.

To regard it as a mere documentary review would be to overlook a substantial part of its function. Its core purpose is to assess whether the legal position of the target is consistent with the economic and commercial assumptions underlying the transaction.

Formal compliance does not eliminate legal risk

Articles of association, corporate books and records, contracts, licences, authorisations and other corporate documentation constitute the starting point of the review, but they do not necessarily provide a complete picture of the target’s actual legal exposure.

Restrictions affecting the transfer or exercise of shareholding rights, arrangements among shareholders, change of control provisions, termination or withdrawal rights, potential disputes and commercial relationships that have not been adequately documented may become particularly significant in the context of a change of control.

Likewise, the economic stability of a business relationship does not necessarily imply that the underlying contractual framework is legally robust or capable of withstanding the transaction.

Potential liabilities are not always reflected in the financial statements

Employment matters, claims by customers or suppliers, compliance issues, intellectual property rights, regulatory authorisations and established business practices may give rise to economic consequences only after completion of the acquisition.

Particular attention must also be paid to technological and intangible assets. Software, data, licences, know-how and digital infrastructure may represent material components of the target’s value without necessarily being supported by clear, complete and enforceable rights of ownership, access or use.

When legal risk affects the deal

The identification of a legal issue does not necessarily justify abandoning the transaction.

It may, however, affect the valuation of the target, the terms of the transaction and the allocation of risk between seller and purchaser.

It is precisely in the connection between the findings of the due diligence review and the contractual structure of the transaction that the analysis acquires its full significance.

Ultimately, legal due diligence does not provide a generic certification that a company is “compliant”.

Its purpose is to assess the extent to which the target’s actual legal position is consistent with the assumptions on which the purchaser is basing its investment decision.

An acquisition does not merely involve the transfer of value. It also entails the transfer of contractual relationships, restrictions, dependencies and pre-existing liabilities or circumstances that may materially affect the overall balance of the transaction.