Merger and acquisition activity has started to rebound from the credit crisis, which inhibited the merger and acquisition market a few years ago. As the volume of deals continues to increase, buyers and sellers, now more than ever, need to carefully allocate risk and the assumption and retention of liabilities when structuring a transaction.

When negotiating and structuring a purchase agreement, each party should understand the risks the transaction poses, how such risks are being allocated between the parties and what each party is doing to protect against the risks. One of the best ways a buyer can get a comprehensive understanding of the risk they face, and the target company’s (the “Target”) operations, is to thoroughly review and investigate the Target through the process of due diligence.

A properly conducted due diligence process can reveal the Target’s current or potential risks and liabilities. Once identified, the buyer and seller can then attempt to allocate and protect themselves against these risks (and other unknown risks) through the use of representations and warranties and indemnification in the purchase agreement.

Additionally, the structure of the transaction can influence the buyer’s due diligence review. For example, if the transaction is a stock purchase, the buyer will automatically assume all of the Target’s liabilities, while if it is an asset purchase, the buyer can negotiate with the seller only to assume certain risks and liabilities.

When negotiating a purchase agreement, it is very important to make the purchase agreement contingent on the completion of due diligence that is satisfactory in the opinion of the buyer. Assuming there is an effective due diligence contingency in place, if the due diligence process reveals risks and liabilities the buyer is unwilling to assume, it may exercise its due diligence contingency and walk away from the transaction. Alternatively, if the buyer wishes to continue to work towards the consummation of the transaction, the knowledge and information the buyer obtained during the due diligence process will hopefully be valuable information in negotiating the transaction.

To conduct an effective due diligence review, the following items should be analyzed and identified:

• The Target’s organizational documents
• Corporate proceedings (e.g. minutes of meetings of the board of directors, board committees and shareholders)
• The Target’s capital structure and agreements relating thereto
• Material agreements with third parties
• Business information (e.g. business plans, operating budgets, sales and marketing studies, and customer and supplier lists)
• Indebtedness
• Financial Statements
• Employment matters (e.g. employment agreements, consulting agreements, change-of control agreements, and employee benefit plans)
• Real property
• Intellectual property information
• Regulatory matters (e.g. required permits and approvals from governmental authorities)
• Pending or threatened litigation
• Environmental matters

If you have questions, please contact Anthony R. Taglia and Richard M. Wallace.