Corporate Due Diligence: Identifying Risk before Deals Close

Legal corporate due diligence encompasses review of the target's organizational documents, capitalization table, board resolutions and minutes, material contracts, litigation history, regulatory licenses and permits, and any pending or threatened government investigations, and legal due diligence counsel conducting corporate due diligence should confirm whether the target's charter documents and shareholder agreements contain transfer restrictions, rights of first refusal, or anti-dilution provisions that affect the buyer's ability to acquire full ownership without obtaining consents from existing shareholders.

Corporate due diligence in technology and product company acquisitions requires particular attention to the target's intellectual property ownership chain, including whether all IP was properly assigned by founders, employees, and contractors who created it and whether any open source code use creates license contamination risks, and compliance audit counsel conducting corporate due diligence on employment and environmental matters should assess whether the target's workforce classification practices, wage and hour compliance records, and any pending EEOC charges create contingent liabilities not reflected in the target's financial statements.

A material adverse change clause allows the buyer to terminate the transaction if the target's business suffers a significant negative development between signing and closing, and the adequacy of the MAC definition depends on whether the corporate due diligence process identified the specific risks that the buyer needs the MAC clause to address, and business acquisition transactions counsel reviewing MAC provisions in light of corporate due diligence findings should confirm whether the MAC definition's exclusions for general economic conditions and industry-wide trends are balanced against specific carve-ins for target-specific adverse developments that the diligence revealed as plausible risks.

The seller's representations and warranties are only as protective as the corporate due diligence process that verifies them, because a buyer who did not review the documents underlying a representation cannot establish that the seller's breach caused damages rather than that the buyer simply failed to investigate, and indemnification claims counsel advising on corporate due diligence warranty coverage should assess whether the disclosure schedules that modify the seller's representations are complete and whether representations and warranties insurance is available to provide coverage for breaches that the seller cannot indemnify due to financial condition.

The virtual data room that houses corporate due diligence materials must be organized to allow the buyer's legal, financial, tax, and operational advisors to work simultaneously without duplicating requests or missing connections between related documents, and internal investigation services counsel managing corporate due diligence investigations should confirm whether the data room index corresponds to the due diligence request list in a manner that makes it possible to identify documents that have not been produced and whether the target's management team is prepared to respond to follow-up questions within the timeline the transaction schedule requires.

Corporate due diligence must assess whether the proposed transaction requires premerger notification under the Hart-Scott-Rodino Act, whether foreign antitrust filings are required in jurisdictions where both parties operate, and whether the transaction's competitive effects in any relevant product or geographic market are likely to attract a government second request that would substantially extend the signing-to-closing timeline, and Hart-Scott-Rodino filing counsel advising on corporate due diligence antitrust risk should assess whether the combined company's market share in any identifiable product market is likely to exceed the concentration thresholds that the DOJ and FTC use to trigger a more searching competitive effects analysis.

The connection between corporate due diligence findings and deal terms requires that counsel present each significant finding in terms of its potential financial impact, its probability of materializing into an actual loss, and the specific contractual mechanism that would best address it, and mergers by acquisition counsel translating corporate due diligence findings into transaction agreement protections should confirm whether each identified regulatory compliance gap is addressed by a specific representation, a closing condition requiring the seller to remediate the issue before closing.

Even the most thorough corporate due diligence process does not eliminate the possibility that the target's post-closing financial or legal condition will differ materially from what the seller represented, and the post-closing indemnification regime, including its survival periods, caps, baskets, and seller escrow amounts, is the buyer's primary remedy for undisclosed liabilities that surface after closing, and contract drafting and corporate due diligence counsel negotiating post-closing indemnification terms should assess whether the survival periods proposed by the seller are long enough for the buyer to discover and assert breaches in the liability categories that the due diligence identified as highest risk.