- WHAT IS DUE DILIGENCE?
Due diligence has no legal definition. However, according to Merriam Webster, due diligence in a business is a research and analysis of a company or organization done in preparation for a business transaction (such as corporate merger or purchase of securities).[1] According to the Guideline, in a corporate proposal, due diligence refers to the process of enquiries and investigation to consider risk tolerance for potential investment and is carried out for the purpose of timely, sufficient and accurate disclosure of all material statements, information and/or documents.[2]
Legal due diligence on the other hand refers to due diligence that are typically done by lawyers who will draw up and submit a list of preliminary inquiries tailored according to the nature of business of the target company.
- WHAT IS THE IMPORTANCE OF LEGAL DUE DILIGENCE?
Due diligence is important due to the nature of a vendor who are not legally obliged to inform the acquirer of any defects and/or liabilities of the target company unless the acquirer request for such disclosure.
As a lawyer who draws up the preliminary inquiries, a list of questionnaire will be given to the target company or its solicitors to inquire on the company corporate information, business activities, material contracts, litigation, personnel, real property, intellectual property and compliance with law and regulations in order for the buyer to assess the risk in acquiring the target company.
Based on the list of questionnaires posed on the target company, other professionals who are involved in providing the information or documents will have a comprehensive guide in order to reduce the possibility of oversight in the due diligence process.
In Top Glove Corp Bhd & Anor v Low Chin Guan & Ors and another appeal [3], the Plaintiff applied for ancillary relief in aid of arbitration and Mareva injunction against the Defendants for fraudulent misrepresentation about the financial position and inventory of a company that the Plaintiff wanted to acquire as the Defendant has manipulated the financial statements.
The Plaintiff in this case relied on the due diligence to arrive to their valuation of the Defendant’s company in giving their initials offer and final offer. However, upon the Plaintiff finding that there were misrepresentations on the financial and inventory of the Defendant’s company, the Plaintiffs contended that the valuation should be lower than what the Plaintiff paid.
- WHAT IS THE OBLIGATION OF PARTIES CONDUCTING DUE DILIGENCE?
As due diligence is a complex process of assessing the risk and evaluating the target company, there are times when a failure to conduct proper due diligence will cause detrimental losses to a company and affect the parties conducting due diligence. Here are some of the obligation of parties conducting due diligence: –
In a public listed company, any person who can authorize or cause the issue of prospectus i.e. subscription of securities must ensure that the statement or information provided by them are not false, misleading, or consist omission on material information.
Upon findings of false or misleading information, a person can be charge under Section 246 or be liable under Section 248 of the CMSA. Section 250 of the CMSA however, provide a defence called due diligence defence which gives the person charge or sued opportunities to prove that he had done a proper due diligence and has reasonable grounds to believe the information that he provided was true and not misleading.
On the other hand, as a director of a company who wanted to acquire another company via purchase of shares, merger or acquisition, failure to conduct a proper due diligence would also be detrimental to the director as according to the Companies Act 2016, a director has a duty to exercise reasonable care, skill and diligence as expected of a director and to use his power for a proper purpose and in good faith in the best interest of the company as provided under Section 213 of the Companies Act 2016.
Law firms conducting due diligence has fiduciary relationship with their clients may also be sued for failure to exercise duty of care towards clients when lawyers has failed to act on the best interest of the client when a proper due diligence was not done which has caused the client to suffer losses.
- WHEN CAN A DUE DILIGENCE BE CONDUCTED?
Due diligence can be done before conclusive agreement is signed between the parties. It is commonly done after initial agreement or any letter of intent is signed between the parties as any due diligence conducted after the parties have signed the final agreement would defeat its purpose. Thus, in practice, due diligence is commonly done after both parties are aware of their intention which are intention to acquire the company/shares and intention to sell the company/shares and this is done via Letter of Intent or through execution of agreement with condition precedent.
As a lawyer, the first step in conducting due diligence is to review all corporate information in order to obtain a clear view to the basic corporate structure of the target company and its associated companies such as subsidiaries or any other interests held by the target company.
- CAN THE BUYER CANCEL AN ACQUISITION OF A TARGET COMPANY BASED ON THE DUE DILIGENCE REPORT OBTAINED?
The question of whether the acquirer could cancel an acquisition before any agreement is signed or after the agreement has been signed and reliance over the due diligence report depends on each facts of the case.
Commonly, in a letter of due diligence and requisition, there would be a confirmation that will be signed by the target company in good faith stating that the answers to the due diligence were true, complete, accurate and free from omission. Therefore, if any information that was answered by the target company is later found out to be untrue, the acquirer could claim for misrepresentation provided that the misrepresentation has cause losses to the acquirer.
For example, in Spacious Glory Sdn Bhd v Nexgram Land Sdn Bhd [4], the Plaintiff claimed against the Defendant for judgment of the purchase price of shares pursuant to a Share Sale Agreement (SSA) for Blue Hill Development Sdn Bhd (BH). The Defendant counterclaimed against the Plaintiff for alleged misrepresentations as to the financial condition made during the financial and legal due diligence exercised prior to the execution of the SSA and for breach of warranties and representations in the SSA.
In the SSA, the warranties in Annexure 1 was said to be represented as true and accurate in all respects. It was then signed by the Plaintiff via Confirmation Statement that the responses provided to the Questionnaire and Requisition List in respect of BH and the statements and other information provided are, to the best of its knowledge, true, and not false, not misleading and complete, clear, unambiguous and accurate, does not contain any material omission and that there was reasonable and justifiable basis for every expression of opinion contained in the statement or information.
The court held that the Plaintiff has been guilty of misrepresentation in representing the Defendant that there are no facts which may or might give rise to legal proceedings as at the date of the SSA and also when the Plaintiff represented to the Defendant that there are no matters or circumstances which may be likely to or will threaten to cause BH to be engaged in litigation. The court then awarded the Defendant with nominal damages.
In Koperasi Tanjong Keramat Kota Kinabalu Berhad v Enabling Asia Tech Sdn Bhd [5], the Plaintiff filed an action to recover against the Defendant the earnest deposit that was paid upon execution of a Memorandum of Agreement. The earnest deposit was paid to allow the Plaintiff to carry out due diligence on the Defendant’s company. Pursuant to the MoA, it was stated that if upon conducting the due diligence, the review was unsatisfactory, the Plaintiff have the right to terminate the agreement. The plaintiff applied for summary judgement to recover the earnest deposit.
The court in examining the case held that there were triable issues which warrant a full trial due to the Defendant contention that the report needs to be proved that it was unsatisfactory and the chance to challenge the said report.
- ANY RESTRICTION ON CONDUCTING DUE DILIGENCE FOR A PUBLIC LISTED COMPANY?
In conducting due diligence, the acquirer must bear in mind that there when it comes to a public listed target company, an unrestricted due diligence may not be achieved as it would trigger the possibility of an insider trading laws and the legal consequences arising.
According to the Capital Market and Services Act 2007, an insider is a person who has possess information that is not generally available to the public. Insider trading law on the other hand refers to when the acquirer obtains information which is not generally made available to the public and proceed to complete the shares acquisition and thus has committed an insider trading offence.
According to the Capital Market and Services Act 2007, person who contravenes the insider trading law shall be punished on conviction to imprisonment for a term not exceeding ten years and to a fine of not less than one million ringgits (RM 1,000,000.00).
Muhamad Aryn bin Rozali is a pupil at Yusfarizal, Aziz & Zaid and he read law at Universiti Teknologi MARA.
Nazmi Mohd Zaini is the Partner of Nazmi Zaini Chambers. He has led and completed several legal due diligence and acquisitions in Malaysia, Hong Kong and Malta.
[1] Merriam Webster, https://www.merriam-webster.com/dictionary, assessed on 22 July 2020.
[2] Securities Commission Malaysia, “Guidelines on Due Diligence Conduct for Corporate Proposals” (2008) at pg 1-1.
[3] [2018] MLJU 1608
[4] [2018] MLJU 1190
[5] [2019] MLJU 1833