Legal Due Diligence: Debunking 7 Common Myths

Legal due diligence plays a crucial role in M&A transactions, serving to assist both the buyer and seller to identify and understand the potential risks and opportunities in a transaction. Too often, particularly in smaller transactions, legal due diligence is rushed or overlooked completely. In this article, we debunk seven common myths surrounding legal due diligence and hope to emphasise its importance in a deal.

Reality

Legal due diligence should not be approached as a mere formality or a check-the-box exercise. It requires careful analysis, critical thinking and proactive risk management to uncover potential liabilities and leverage those to negotiate favourable deal terms. Failing to undertake thorough legal due diligence can expose parties to significant legal and financial risks.

Reality

Legal due diligence is essential for all M&A transactions, regardless of size or complexity. Even seemingly straightforward deals can harbour legal risks that may impact the success of a transaction or lead to costly consequences for the buyer after completion. Key areas where due diligence will be critical regardless of the deal size and complexity includes customer/supply agreements, property rights, employee and superannuation obligations and intellectual property rights.

Reality

Legal due diligence can also be beneficial to the seller. A properly run vendor due diligence process (prior to selecting a buyer) will enable a seller to prepare its business for sale and to identify and rectify any issues before a buyer or investor gets involved. This often leads to a more streamlined transaction process and a higher value deal.

Reality

Legal due diligence provides an opportunity for the buyer to understand the target business and its operations, and to determine a fair purchase price. For a buyer, conducting due diligence on areas such as intellectual property rights, plant and equipment, contracts and licences and approvals can reveal areas for optimisation and value creation post transaction.

Reality

While legal due diligence requires time and resources, it is a crucial step that can prevent delays and complications during and after the transaction. Early engagement of legal and other advisors, clear communication and efficient project management can streamline the due diligence process without unduly prolonging successful completion of the transaction.

Reality

If due diligence identifies significant risks, this can impact the deal significantly. It may result in a reduction of the purchase price, or part of the purchase price being deferred on the condition that the risk is adequately mitigated or resolved post completion. It may also prompt the seller to offer a warranty in the transaction documents in respect of the risk, allowing the buyer to sue the seller if it incurs losses due to the risk crystallising. In the most extreme circumstances, the identification of a risk during due diligence may prompt the buyer to not proceed with the deal.

Reality

As the saying goes, “buyer beware”. Risks related to current liabilities may be uncovered after the deal completes if proper due diligence is not undertaken. The buyer cannot then sue the seller for any losses which follow unless the losses are the subject of warranties provided by the buyer in the transaction documents.


This article provides general commentary only. It is not legal advice. Before acting on the basis of any material contained in this article, seek professional advice.


Co-author

Name: Stephanie Maurangi

Position: Lawyer

Practice: Transactions

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