MA 2 - Due Diligence PDF

Andrew Yip (00:01.548) Hi there. I hope you\'ve been enjoying your other lectures. My name is Zee Min and in this session, I\'ll be covering the basics of legal due diligence and sharing with you how I think you should approach the endeavor of conducting due diligence. Due diligence is a vital proc...

Andrew Yip (00:01.548) Hi there. I hope you\'ve been enjoying your other lectures. My name is Zee Min and in this session, I\'ll be covering the basics of legal due diligence and sharing with you how I think you should approach the endeavor of conducting due diligence. Due diligence is a vital process in many forms of corporate transactions, be it in mergers and acquisitions, bank financings or IPOs. Therefore, to be a competent and reliable corporate practitioner, you must first understand the process of due diligence well. I will address four key areas of due diligence in this session. In part A, I\'ll explain what is due diligence and the purpose of the due diligence exercise. In part B, I will outline the usual due diligence process for a Singapore corporate transaction. Here, we will discuss common issues for due diligence review. In part C, I\'ll discuss the preparation of a due diligence report. And finally, in part D, I\'ll address dealing with negative findings arising from a due diligence review. Starting with part A, what is due diligence? It is the gathering, organizing, analyzing, and verifying of relevant or appropriate information relating to a particular corporate transaction. Now, this is a technical definition and is quite a mouthful. But broken down to its very core, due diligence is fact -finding and fact -finding for a corporate purpose. It stems from the principles of freedom of contract and caveat emptor. Now the extent and approach of due diligence also varies depending on the nature of transaction, the parties involved, and the quality and quantity of data supplied. Your focus and due diligence will change depending on whether it\'s a mergers and acquisitions transaction, a capital markets transaction, or a banking transaction. It also varies depending on the parties involved. For example, if you\'re acting for a purchaser in an &A transaction, The focus of due diligence to be undertaken will be very different compared to if you were acting for the seller in the same &A transaction. Due diligence also varies depending on the quality and quantity of data supplied. By quality, I mean the type and nature of documents to be reviewed. If the crown jewel of a target company is a building in Singapore, then you will need to bring in real estate experts to investigate land title and lease agreements. If the target company\'s Andrew Yip (02:26.306) business is in harnessing IP technology and code that it authors, then you will need to bring in IP experts to investigate IP registrations, software development, et cetera. By quantity of data supplied, I mean the volume of documents. This will dictate if you need a large team or a small team to undertake the review and how critical it is that you should utilize available due diligence software to assist in a due diligence review. Next, I\'ll move on to talk about the types of due diligence. As lawyers, we focus on legal matters and in this case, legal due diligence. But legal due diligence is not the only type of diligence that should be undertaken in any corporate transaction. Let\'s talk about the different types. First, legal. Legal due diligence investigates the legal affairs of a target business or the target company. Another type of diligence would be business and operational due diligence. And this examines broader issues such as the industry in which the business operates, competitors, and the business strengths and weaknesses, research and development. Next, the client would also involve financial and tax advisors to conduct financial due diligence and tax due diligence. Such diligence will focus on financial affairs that are material to the buyer\'s investment decision and is usually undertaken by the big four or other public accounting firms. There is also environmental due diligence. Environmental due diligence is usually relevant where the business involves manufacturing sites. In such instances, Environmental due diligence seeks to identify if there is any contamination or pollution on the sites or other environmental risks and issues. Environmental specialists do so by boring holes in agreed areas within a manufacturing facility to extract, among other things, groundwater to test for contaminants. But the four types of diligence that I\'ve mentioned aren\'t the only types of diligence. Going back to an earlier point raised, Andrew Yip (04:31.769) that due diligence is heavily dependent on the nature of the business of the target being acquired, where a target is a technology company, for example, technology specialists may be required to review its tech stack or its source codes. Now that you have an overview of what due diligence is and the more common types of due diligence, let\'s move on to discuss the purpose of legal due diligence. As alluded to earlier, the purpose of legal due diligence can differ depending on the nature of transaction in the party\'s perspectives. In the case of an acquisition, the seller\'s purpose will be different from a buyer\'s purpose. Let me elaborate. From a seller\'s perspective, there are four key purposes. First, to groom the target business or the target company for sale. And by grooming, I mean making the target more attractive to buyers. For example, if there is an unprofitable part of the business, grooming may mean hiving off such unprofitable part through an internal restructuring process to another subsidiary of the seller that\'s not part of the transaction. Grooming could also mean that whether there are complaints or disputes against target, then these are settled before the process begins. A second objective would be to prepare an information memorandum, which is a document common where the seller intends to sell the target company or the business through a competitive auction process. This is where the seller invites more than one bidder to take part in the sale process. Think about the information memorandum as being akin to a marketing brochure. where the prospective buyer obtains a high -level overview of the underlying business and what it entails. So the due diligence exercise undertaken for a seller will help populate this information memorandum. The third objective of undertaking a seller due diligence would be to assist in the process of disclosure against warranties in the sale agreement. This is important and we\'ll cover this in greater detail in a later part of the session. The last objective of undertaking a seller Andrew Yip (06:33.88) due diligence is to ensure that commercially sensitive or confidential documents are not released to potential bidders and buyers, at least not until it\'s intended to. Now there is a difference between the two terms, commercially sensitive and confidential. Commercially sensitive information may mean price margins, key client or suppliers list or other trade secrets, whereas confidential documents are documents protected by confidential obligation not to disclose. So if you think about it, a key client list is something that\'s internal, generated internally by the business, and it may not be covered by confidentiality obligations not to disclose. So we\'ve talked about due diligence from a seller\'s perspective. What about from the buyer\'s perspective? Here, there are six key objectives. The first is to check what the buyer is buying. This is critical. If the buyer is buying shares in a company, you must check that the seller in fact owns those shares. If the seller says the company owns a factory, then you must check that the company in fact owns that factory. The second would be to structure and negotiate the transaction. Will the buyer need to impose conditions precedent in the sale and purchase agreement? For example, the target company is occupying land on which a manufacturing plant sits pursuant to a 30 -year lease from the Jurong Town Corporation. The lease agreement contains a change control provision which gives JTC the right to terminate and re -enter the premises if there is a change in shareholding or ownership of the company without JTC prior consent. You can imagine how disruptive it will be for the business if JTC were to exercise its right to re -enter, and it certainly will not make any commercial sense for the buyer to buy the target if JTC does not consent. In that case, Buyers Council would recommend to the buyer to include as condition precedent the consent of JTC to the transaction. Take another example. If the company is settled with material liabilities, you may need to advise the buyer Andrew Yip (08:36.802) to consider an asset deal which allows the client to acquire assets and perhaps certain liabilities that you must take on and leave behind unwanted material liabilities. If the material liabilities are so significant that it destroys commercial value in the acquisition, the buyer may walk away. Third, and as a subset to the second purpose, to ascertain the need for indemnity or warranty protection. We\'ll talk about these important aspects later. Fourth, to ascertain if any ancillary documents need to be signed. As an example, if important software that the company relies on is authored by its employees and it\'s not clear whether a proper assignment of copyright and IP has been signed by such employees, then you may want to advise the client to have such employees sign agreements to assign all IP created in the course of their employment to the target company. And this can be either in the form of a condition precedent to the sale and purchase agreement or as a completion deliverable. The fifth purpose of due diligence from a buyer\'s perspective is to plan integration steps after the deal is completed. As an example, if during the course of commercial and operational due diligence, the buyer discovers that the management team is weak or is overstaffed, then one of the steps post -deal might be to replace or streamline the management team. Another example would be if the employment benefits of the target company are very different from those of the buyer\'s group. Then post -closing, the BIAS HR department may wish to take steps to harmonise the benefits with the consent of the employees for easier management. Last but not least, and this is the sixth purpose, it is really to narrow down issues between the parties and have all issues raised during diligence examined, discussed, and if they are material, addressed in the Facilient Purchase Agreement. I\'ll spend some time now discussing warranties and indemnities. First of all, what are warranties? Warranties are contractual statements of fact. For example, the seller says the target is not subject to any litigation. That\'s a warranty. The seller may warrant that the shares being sold are not encumbered. That\'s another warranty. Now, warranties do not act as substitute for diligence, and the two are complementary. Andrew Yip (10:56.748) Warranties are not a substitute for due diligence for five key reasons. The first, warranties and indemnities are often subject to extensive negotiations and so it will not be certain what warranties and indemnities the buyer will get until the transaction documents are signed. It is very rare for the first suite of warranties proposed by either the seller or the buyer to remain intact throughout the negotiation process. Second, warranties are often qualified. They can be qualified as to materiality, and knowledge. Third, warranties are often subject to disclosure. Often a seller will deliver a disclosure letter to the buyer, disclosing information or documents, explaining why certain warranties are not true. The effect of such disclosure is that if disclosures are fairly made, then there is no breach of the warranties against which such disclosures were made, and no liability will then accrue to the seller. A matter of contention between the buyers and sellers is whether the contents of the data room can be deemed disclosed against the warranties. Sellers will of course want the data room to be deemed disclosed against the warranties, and a well -organised data room would give the buyers one less reason to reject such a deemed disclosure. The fourth reason why warranties do not act as substitute for delusions is that warranties are subject to limitations of liability, and these limitations can take the form of single claims limit. a monetary cap and also time limitation. A single claims limit means no claims can be made against the seller unless a claim exceeds a certain agreed amount. A monetary cap means the seller\'s maximum liability for breaches of warranties shall not exceed the agreed monetary amount. This is usually a percentage of the purchase consideration and may be tiered depending on the importance of the warranties. For example, Parties may agree that breaches of business warranties would be kept at say 50 % of purchase consideration, whereas breaches of fundamental warranties, example warranties on share title, would be kept at say 100 % of purchase consideration. Time limits would require the buyer to submit a claim for breach of warranty within an agreed period of time post -closing, failing which the buyer is time -barred from submitting any claims. The statutory limitation period for breach of contract is six years. Andrew Yip (13:20.59) The sellers will course typically negotiate for a shorter period, for example, 18 to 24 months on the basis that most matters would surface within one to two audit cycles, whereas the purchaser may settle for 18 to 24 months for business warranties, but ask for longer limitation periods, such as up to six years for tax warranties and fundamental warranties. Now, the final reason why warranties do not act as a substitute for due diligence is that the warranties are only as good as the creditworthiness of the warrantor. If the warrantor has distributed all the proceeds of the sale to its shareholders, leaving behind minimal assets, this means that any claim for breach of warranties would be at best a paper victory. So it would, as a general rule, be more prudent to execute a deal where purchaser has a high level of confidence that there are no material issues with the target\'s business or the target company. Now we\'ve discussed what warranties are. We\'ve also discussed why warranties do not constitute a substitute for diligence. Now let\'s talk about indemnities. Indemnities address specific negative findings and due diligence. And this can arise whether seller discloses that a particular warranty cannot be given or is untrue. Andrew Yip (14:45.518) Let\'s take this example. The seller warrants that the target company is not subject to any ongoing litigation. The biased due diligence shows that there is, in fact, a claim for \$100 million, which is disputed by the target. The seller discloses the \$100 million claim in the disclosure letter. And because the seller has made the disclosure, there is no breach of the litigation warranty. To protect the buyer from the risk of an adverse finding under the suit, the buyer then says it will not proceed with the deal unless, 1. There is a specific indemnity given by the seller in relation to the \$100 million claim or 2. The deal is changed from a share deal to an asset deal where the litigation liability is left behind. I hope this example reinforces the reason why warranties are not a substitute for due diligence and the two are complementary and how due diligence is critical in the shaping of a structure for a transaction. Let\'s move on to talk about the usual due diligence process in the context of an &A transaction in Singapore. There are eight key steps in such due diligence process. First, if you\'re acting for the seller, you\'ll need to protect data to be disclosed. You do so by ensuring that third parties execute appropriate non -disclosure agreements. The second, you need to acquire data. Now, in the case of bilateral transactions being where there is only one buyer and one seller, The buyer will typically provide a legal due diligence questionnaire to the seller and require the seller to populate the data room accordingly. In the case of a competitive auction process where there is one seller and multiple potential bidders, then the seller and his counsel will set up the data room and gather information that the seller thinks will be material from a buyer\'s or bidder\'s perspective and populate the data room accordingly. After you\'ve acquired the data, you will need to vet and review the data acquired. you need to consider whether it is subject to any confidentiality restrictions and whether the data contains commercially sensitive information. From a seller\'s perspective, it should only include in the data room information that will be key to the potential buyer\'s due diligence while guarding against phishing expeditions, especially by competitors of the target company or the target business. Additionally, when deciding what information to include, you should also bear in mind two key factors. The first is the current stage of negotiations. Andrew Yip (17:11.32) For example, in a competitive auction process, the seller may hold back commercially sensitive information such as key customer or key supplier contracts until a later stage when there is greater certainty that a deal is imminent. A second factor to note is that delivery of adverse data at the wrong time could potentially prejudice the seller\'s negotiating position. So if certain contracts or information are particularly sensitive or confidential, then how should we advise the sellers on the disclosure of such documents or information. There are to my mind four key methods. The first, you could summarize material contracts and provide only the summaries instead of the full contract. The second is to provide contracts with sensitive or confidential information redacted. The third would be to provide these contracts only to the legal counsel of the bidder or counterparty with instructions that sensitive or confidential information be anonymized or aggregated. And finally, to consider a tiered release of data. So we leave the most sensitive and confidential documents to be disclosed only when a deal is likely to be struck imminently. Now coming back to the slide, on the fourth step, documents collected will need to be indexed, stored, and organized. And this will be housed in a data room. The fifth step is that you\'ll need to distribute the data. Now what does that mean? It means having to consider who should obtain access, how many people should access the documents, and for how long. The sixth step would be the data collected should not be analyzed in isolation, and there should always be collaboration between teams. The diligence manager should have a good overview of the scope of work for each team. It\'s not just the legal workstream that we need to coordinate within. Very often, we will also need to coordinate with advisors handling the financial due diligence, commercial due diligence, environmental due diligence and so on. The seventh step is that once the data is collected, council should analyze the data. In the case of an acquisition, it should be analyzed in order to meet the buyer\'s or seller\'s objective, depending on who you\'re acting for. And finally, the eighth step, data should be reported in a manner that is concise and clear with recommendations on protective provisions to be included in the sales agreement. Andrew Yip (19:39.244) Let\'s now turn to the key considerations when preparing a due diligence report. Andrew Yip (19:47.032) When preparing a due diligence report, we must always start with considering the profile of the target, what industry does it engage in, and whether there are any particular concerns. If the target is an IP company, then we will need to focus on IP or patent rights and ensuring that the source codes authored by its employees have in fact been properly assigned to the company. If the target is a manufacturing concern, then the focus of the delusions will be on land, environmental issues, as well as HR issues. Andrew Yip (20:21.654) In addition to the profile of the target, we will also need to consider typical areas of risk and liability, which we will discuss in later part of this session. We will also need to consider the deal structure. And here we\'ll need to think about whether it\'s a business sale or a share sale. In a business sale, because contracts and assets are being transferred from the seller to the buyer, we will need to highlight any provisions in the documents that prohibit the assignment or innovation of contracts from the seller to the buyer. In a share deal, however, you will need to look out for change in control provisions which will allow the counterparty to terminate or amend the terms of contract upon the change in the shareholding of the target company. Andrew Yip (21:04.494) Another factor we need to consider is the relative importance of jurisdictions covered by the target\'s business. Now where a target business has multiple jurisdictions, operates in multiple jurisdictions, and have a turnover of say a hundred million dollars, then you should pay attention to the relative importance of each jurisdiction versus the entire target business. For example, if in Singapore operations account for only 5 % of total revenue, then it is likely that Both the buyer and the seller would view Singapore as being an immaterial jurisdiction in the context of transaction. And so the scope of your due diligence may be reduced. Another consideration is available time. Now this is self -explanatory. If timelines are very compressed, then you will either need to get more hands on deck or have a discussion with a client to focus on only key areas of investigation having regard to the compressed timelines. And next important consideration is budget. due diligence is time consuming and can be very expensive. So if the client is running on a tight budget, then it\'s important for you to have discussion with the client to take a call together on what you can realistically deliver within the budget constraints. You may together with the client take a view that given say a \$100 million transaction, you will not review any document that has an impact of less than \$1 million in value, for example. Andrew Yip (22:32.372) Lastly, an important consideration would be the role of other advisors. Now, when preparing your due diligence report, you must understand the role of other advisors as well. This will enable you to prevent a duplication of effort such that in the event that the folders of a virtual data room allocated to you contain documents that should be reviewed by other advisors, you can ensure that those documents that you come across can be efficiently brought to the attention of other advisors for review. We\'ve talked about the key considerations of preparing a due diligence report. Now let\'s turn our attention to discussing the different categories of documents in a due diligence exercise and the matters that you should focus on in each category of document that you need to report on in your due diligence report. The first category of documents is corporate secretarial records of the target. When we\'re considering corporate secretarial records, especially in the context of a share acquisition, We need to first and foremost consider and confirm the validity and chain of title of shares. By that I mean, have the shares been properly issued? And in the issuance of those shares, have resolutions being bought and shareholder resolutions been properly passed? Has there been a transfer of shares in the past? And if so, have the steps giving effect to the historical transfers been properly undertaken? The second item that we need to look at relates to restrictions on transfer of shares. Here, we\'ll need to consider whether there are any moratorium of transfers and any preemption rights that are set out in the constitution of the target company. Moratorium of transfer refers to a situation where, for example, shareholders have agreed with each other that each shareholder will not transfer their shares for period of, say, five years from the execution of the shareholders agreement. Preemption rights refer to a right given to the other shareholders that require the selling shareholder to first give the other shareholders an option to purchase the shares of the selling shareholder before it can sell its shares to a third party. Now, if the Constitutional Shareholders Agreement contains restrictions on transfer, then before the sellers can sell the shares to the purchaser, the purchaser needs to ensure that the seller obtains the relevant waivers of these moratorium or transfers or preemption rights. Andrew Yip (24:48.822) or ensure that the preemption process has in fact already been carried out. The third point that we need to consider relates to minority shareholder protections. If the purchaser is purchasing a majority stake, it will need to understand what rights and obligations are vis -a -vis the remaining minority. You may want to make sure that the client understands the rights and obligations of the minority and consider whether the minority has veto rights. as that could potentially make the carrying on of the business of the company more difficult because consent of certain important matters relating to perhaps changes in constitution, incorporation of subsidiary or expansion of plans into other jurisdictions more difficult because that requires consent of the minority shareholder. The fourth item on the table relates to whether there are encumbrances over shares and the assets of the hugger company. If the shares of the seller are encumbered, then clearly as condition precedent to completion of the purchase by the purchaser, those encumbrances need to be lifted. If there are encumbrances over the assets of the company, then perhaps the purchaser could continue to live with these encumbrances, likely because these are pursuant to an existing financial facility agreement that a target is bound by. But if there\'s going to be acquisition financing, meaning that the purchaser will require financing from a bank in order to acquire the seller\'s shares, then it may be that the assets downstream, being the assets belonging to the company, will need to be discharged in order for new financing to be put in place. And this brings me to the last point on the table that is restriction against granting security. In the event that acquisition financing is required to help the purchaser fund the purchase price, then the purchaser\'s counsel will need to ensure that those restrictions are lifted or the Constitution is amended in order to allow the granting of security by the target company over its assets or by the purchaser over the shares to the bank that will finance acquisition financing. Andrew Yip (27:09.078) Another category of documents you will review in the course of due diligence is material contracts. And these can be key customer contracts, key suppliers contracts, IP license agreements and lease agreements. Depending on the nature or structure of the transaction, the focus of your diligence may be different. Take for example, in a share sale, the focus of your diligence may be to ascertain whether there are any change control provisions or change of shareholding provisions in the material contracts. A change of control provision includes, for example, giving the third party or counterparty an ability to terminate the contract in the event of a change of control or change of shareholding of the target. Contrast that with a business sale where the focus of your diligence will be on whether there are any prohibitions in a contract against assignment or novation of such contract to the buyer of the business. Another key area that you need to focus on when reviewing material contracts is term and duration. The purchaser will want to know if a long -term revenue -generating contract that grants the company exclusivity has expired or is expiring soon. In this case, the purchaser may either ask the seller to secure a renewal of the contract as a condition precedent to closing, or consider how this expired or expiring contract could impact the valuation of the business. The inability to terminate a contract with notice may also be important. A key customer contract which can be terminated with, say, three months notice may not be as valuable as a contract which cannot be terminated until the expiry of a term. because the revenue stream of that customer contract has more permanence. When considering material contracts, you should also look for onerous or unusual terms, and these include warranties, indemnities and guarantees. Essentially, these are provisions which impose liabilities on the target company. A last matter that you should also consider is governing law. If a material contract is governed by laws of a jurisdiction other than Singapore, Andrew Yip (29:15.618) Then you may want to advise the client to consider appointing local counsel to review the contract to ensure enforceability under local laws. Another category of contracts that you will need to look out for are contracts relating to acquisitions and disposals. So these are in essence &A contracts. And here I\'m not referring to the sale and purchase agreement that the seller and purchaser will enter into following the due diligence process, but rather any sale and purchase agreements that the target may have entered into to acquire or dispose of assets it currently holds. The key matter to look out for in this case is whether there are any outstanding financial obligations such as deferred consideration due. If the target company had paid \$50 million out of a purchase consideration of \$100 million, for example, for the acquisition of assets, and a further \$50 million is due from the target company, then this will be important from the purchaser\'s perspective, as the \$50 million owing will sit as a liability on the company\'s books and the purchaser will be inheriting that post -closing by virtue of the acquisition of shares in the company. Another key area that we need to look out for and review would be whether there are any unexpired warranty or indemnity obligations on the target company because again, these impose liabilities on the target company which will then be inherited by the purchaser by virtue of the share sale. Now &A contracts typically have restrictive covenants and these are important. If the target company has disposed of its assets and had undertaken with the purchaser of those assets that it will not conduct a particular line of business which your client wishes to conduct or intend to, then this could be problematic from a client\'s perspective because it restricts the target\'s operations and therefore the viability or profitability of the target moving forward. Andrew Yip (31:11.286) A next category of documents that you\'ll need to review or will be important in due diligence would be joint venture and shelter agreements. And these could be joint ventures or shelter agreements that the target company has entered into in respect of its subsidiary or associated companies. First off, you must consider the target company\'s stake in the joint venture company, short for JV Cole, and whether the target has the right to appoint directors in the JV Cole\'s board of directors. Similar to the constitutional documents of the target company that we discussed earlier, you should also consider whether there are restrictions on transfer of shares because that will impact the ability of the target company to exit investment in the JVCo if it wanted. You should also consider whether there are any financing obligations on the target company in respect of its obligations to the JVCo. For example, if the JVCo shareholders are bound to finance the JVCo for up to, say, \$30 million, and each joint venture party has financed only 20 million thus far, then the purchaser would have an indirect exposure to fund a further \$10 million post -closing. Andrew Yip (32:21.432) The next category of documents that you commonly see in a due diligence exercise is finance documents. And by this we mean facility agreements where the target company is a borrower or any security that the target company may have granted to its bankers. Where your client is the purchaser of shares in the target company, you\'ll need to look out for change of control or change of shareholding provisions because very often facility agreements will require the target to repay the loan where there is a change of control or change of shareholding. You should also report whether there are any prohibitions against prepayment or early repayment. If so, then whether there are any penalties involved. Now, this is important where, for example, the purchaser requires acquisition financing and wants to prepay or pay down the loan prior to completion or immediately upon completion. If there are prepayment penalties involved, then that needs to be taken into account in the purchaser\'s financial modelling. Again, with other material contracts, You will also need to consider whether there are any onerous provisions such as outstanding indemnities or unusual events of default insecurity. Andrew Yip (33:34.508) The next category of documents that\'s common in due diligence exercises relates to real estate. Whether Tugger Company owns land or buildings, will be important to involve real estate experts to check title, zoning, planning permissions, etc. You will also need to conduct legal requisitions and review the line plans and ascertain whether the land or building is subject to any compulsory acquisition orders. Most industrial land in Singapore is owned by JTC, so land or buildings sitting on industrial land is likely to be subject to 30 or 60 year leases from the JTC. In this case then, lease agreements will be no different than the material contracts that we\'ve discussed earlier. Now in the case of a share sale, we\'ll need to check the lease agreements for prohibitions against changing control. In the case of a business sale, then we\'ll need to check whether there are any prohibitions against assignment or novation that will require the consent of JTC. The next category of documents you\'ll commonly see in due diligence relate to licenses and permits. Now there are a few regulated industries in Singapore which require business permit to operate. Some exceptions include financial institutions such as bank and insurance companies which are regulated by the MAS. Another example is telecommunications and these companies are regulated by the IMDA. With the target is manufacturing concern, then even if it doesn\'t require a permit for its business operations, it may still need to obtain certain environmental and health and safety licenses. In all of these cases, is important to check the licenses and permits, number one, to ensure compliance with conditions, number two, to determine if there are any restrictions against changing control. Now, in the case of a business sale, it is unlikely that the licenses and permits issued to the seller can be assigned or transferred to the buyer because these are personal to the seller. So what this means is that the buyer will then need to apply for such licenses and permits afresh, effective, closing. Andrew Yip (35:36.834) The next category of documents that you\'ll commonly come across during due diligence exercise are insurance documents. And here you should consider whether essential assets are covered by insurance and whether there are any gaps in insurance coverage. You should also consider whether there are any outstanding claims made against insurance policies and history of claims made as well. Now, the history of claims made is important because if there many claims made, for example, accidents in manufacturing facility, then this might be a signal that there might be systemic problems with the operations of target business that need to be fixed either before completion or as post -completion matter. The next category of documents to review are employment documents. Here you\'ll need to understand the benefits provided, particularly whether retrenchment benefits are provided. You\'ll also need to understand termination provisions and consider whether the employees are bound by restrictive covenants. If they are, assess whether those restrictive covenants are likely to be enforceable. If the target company hires foreign workers, you\'ll also need to check that the target is compliant with its foreign employee quotas. Another important matter for employment is to check whether there are collective agreements. If there are, then you\'ll need to understand the impact of the transaction on those collective agreements. Specifically, query whether the transaction would trigger any obligation to consult with the union or obtain the union\'s consent. Another category of documents you\'ll need to review are litigation documents, and these are important for clear reasons. You\'ll need to understand whether there are any litigation claims pending or in progress. the nature of those claims and whether those claims are covered by insurance. Now you can conduct independent litigation, bankruptcy and winding up searches with Singapore courts to determine whether any such proceedings are pending by or threatened against the target company. This means that you can independently verify the data that the target company or the seller may give you in this respect. The final category of documents you should review is audited accounts of the target company. Andrew Yip (37:48.744) This may not strike you as a document that lawyers should review, but my recommendation is that you do so before you commence your due diligence proper. This is because the audited accounts give you a bird\'s eye view of the affairs of the company, its assets and liabilities, and you\'ll be able to tell quickly the key assets that the target company owns, be it real estate, intellectual property or shares and subsidies. You\'ll also be able to tell whether the company is subject to any adverse litigation as those need to be reflected as contingent liabilities of the company. Andrew Yip (38:23.542) Now that you have analyzed the data and information provided to you in the data room, you\'ll have to synthesize it and report the same. There are two main types of due diligence reports, the long form and the short form. In a long form, you will describe the business in detail and summarize each and every document. This is relatively rare because, as you can imagine, the report will be very thick and this will likely be an expensive endeavor. A short form or an exceptions only report is more common because it covers material issues only. It doesn\'t require the author to describe or summarise each and every document and really focuses the reader\'s attention on the key material issues that have an impact on the transaction at hand. When drafting the report, it is important that you state the scope of your review. You should also state clearly any exclusions. For example, as a legal advisor, you will not be covering financial, accounting, actual, environmental, or tax matters. You should also include assumptions upon which you had undertaken your due diligence exercise. For example, you may mention that you\'ve assumed that the documents provided for review are true and complete. Another example would be that if the data room contains documents governed by foreign law, you have reviewed those documents assuming simple law applied and from a plain English perspective. Andrew Yip (39:53.558) In the previous sections, we talked about what is due diligence, the purpose of a due diligence exercise, the usual due diligence process for a Singapore corporate transaction, and preparing a due diligence report. In the next section, we\'ll discuss how we can deal with negative findings arising from a due diligence exercise. There are nine principal ways of dealing with negative findings in the context of an acquisition, and the first is to adjust price. This is suitable where parties can quantify the actual and contingent cost of an adverse finding. For example, the target owns a building with an unlawful structure which may take about three months to dismantle, and parties want to close the transaction in a month\'s time. Now, having received quotes from contractors, the seller and purchaser agree that it will cost the target company around \$500 ,000 to dismantle and reinstate the building to its previous condition. In this case, the purchaser could simply ask to knock off \$500 ,000 from the purchase price and take care of the dismantling of the unlawful structure itself post -closing because the cost of the adverse finding is easily quantifiable. The next method would be to restructure the transaction. We discussed this in earlier parts of this session. Assume that a target company is subject to a material litigation and the plaintiff\'s claim is for at least \$100 million. but it is not clear the extent of the damages that the plaintiff will be awarded ultimately. The seller thinks that the company has a good defence and the plaintiff\'s claim will be thrown out. In this case, the seller may not be prepared to agree to an outright reduction in price. Andrew Yip (41:35.296) Assume further that the seller is a private equity fund and will need to repatriate the sale proceeds to his limiter partners post -closing. So even if the buyer accepted an indemnity, it is questionable whether it will be able to recover its losses fully in the event that the material litigation turns out with a diverse finding against the target company. From the buyer\'s perspective, this would be a significant risk. So where the liability cannot be quantifiable, it may be necessary in this case to consider structuring the transaction as a business sale rather than a share sale where we carve out the material litigation and take only the assets and liabilities that are quantifiable and that are acceptable to the purchaser. A third method of dealing with negative findings will be to obtain concessions in other areas. This is particularly relevant where the cost cannot be easily quantifiable. And it could be that the purchaser could ask for a higher monetary cap for breaches warranties, a lower single claims threshold, or a longer period of time to bring claims. A fourth matter of dealing with negative findings is to impose conditions for closing. As a starting point, material adverse findings should be remedied by the seller before closing. So for example, if it is discovered that the shares being sold by the seller were not properly issued because, for example, of a failure to obtain a quorum at a shareholders meeting approving the issuance of shares, then a condition precedent may be for the seller to obtain a court order to rectify the allotment of shares. A fifth method of dealing with negative findings might be to impose performance -related payments. And these are typically called earnouts. They are useful where accuracy of financial information or projections or projected performance of the target company is in doubt. Earnouts are typically structured such that perhaps 80 % of the purchase price is paid on closing and the remainder 20 % of the purchase price is paid upon the target meeting its financial targets. Andrew Yip (43:44.546) within a prescribed period of time as agreed between the parties. Andrew Yip (43:51.726) The sixth way of dealing with negative findings is through indemnities, and we\'ve discussed this at length earlier. Specific indemnities can be sought for problem areas arising from due diligence, where for example, disclosures have negated the effectiveness of warranty claims. The seventh method would be to place a portion of purchase price in escrow to meet warranty claims. What this entails is that the purchaser will, instead of paying 100 % of the purchase price to the seller on closing, hold back 20 % of the purchase price and place it in an escrow account for say 18 to 24 months to meet potential warranty claims by the purchaser. If at the end of the escrow period there are no claims, then the escrow agent will release the remaining 20 % of the purchase price to the seller. The eighth method of dealing with negative findings is to deal with them post -closing. This is appropriate for adverse findings which are not deal -breakers but are instead more administrative or low -risk in nature. For example, if the company has not obtained a license or a certification that is good to have, but not material for the business, the purchaser may procure that the company obtains such license or certification after closing. And final method would be to walk away. This would be suitable where the averse findings cannot be remedied or adequately remedied or addressed by any of the above methods that we have just discussed. These are termed as deal breakers and are of significant importance that destroy deal rationale or would otherwise pose significant reputational or financial risk to the purchaser. Mergers and Acquisition - Due Diligence - What is due diligence? - Part A: What is Due Diligence? - Part B: Purpose of a due diligence exercise - **[Differences between disclosure, warranties and indemnities]** 1. Warranties are contractual statements of fact and are subject to disclosures 2. Warranties are not a substitute for due diligence 3. Indemnities address negative disclosures (i.e. non-compliance) in due diligence - Part C: Preparing the due diligence report - **[8 Steps in DD]** - **[Key considerations]**