There are a lot of fire sales going around lately. The pandemic has forced many businesses to the brink of insolvency and forcing business owners to put up their businesses for sale. Some are lucky enough to find a white knight, perhaps a friend, a relative or an investor, willing to inject funds into the business in return for shareholdings in the company and an opportunity to participate in profits. Parties satisfied that they have worked out a win-win deal calls up their lawyers, eager to have the deal sealed. After all, the parties have already spent weeks negotiating, know and trust each other. The business owner assures the investor that he knows the operations inside out and all aspects of the business are in order.
Do Not Enter into A Deal without Having Done a Proper Due Diligence Exercise
Firstly, relying on the verbal assurance of the vendor is risky and conducting a review or audit of the business should not imply or mean a lack of trust for the other party. It is about being prudent and safeguarding your investments. It is also about uncovering issues which even the business owner himself or herself may be unaware.
The purpose of conducting a legal review or audit of the business or in legal speak – a due diligence exercise – is to ascertain if there are any legal risks or red flag issues which may be a deal breaker for the parties. The due diligence exercise also aims to uncover any approvals or notifications required to contractual partners or regulatory authorities. It also serves to highlight any change of control issues (e.g. certain business may hold supply or land concessions, financing facilities or grants which may require a percentage of Bumiputra or Malaysian participation). A change of control, without due notification may render a breach of contract on the part of the company, leading to the premature termination of such contracts.
Secondly, the business owner himself may not be aware that he is required to comply with certain laws or regulations (e.g. among others, the Environmental Quality Act 1974, Occupational Safety and Heath Act 1994, Factories and Machinery Act 1967 and others). The due diligence exercise would also look into compliance and also if there is any work-stop order issued against the company by the authorities. It certainly would not serve the new owner well, if he has bought into a business to only find out that it is unable to operate. Having said the above, it would be astute to also note that a breach of environmental or safety laws in Malaysia can attract criminal liability.
A Complete Due Diligence Exercise
Briefly, a complete due diligence exercise should, inter alia, cover the following main areas:
- Corporate Records (i.e. if the business owner is the registered owner of the company, if the shares are proper issued or transferred or if any other rights are attached to the shares to prevent them from being transferred to the investor);
- Material Contracts (i.e. restrictions of change of control, indemnity provisions and non-compete clauses);
- Licences and Regulatory Approvals (i.e. licenses and regulatory approvals relevant to the nature of the business);
- Pending Litigation (i.e. is there any pending or potential litigation that may possibly expose the business to liability and impact its financials etc.);
- Intellectual Property (i.e. that the trademarks, copyrights and other intellectual property actually belongs to the company and to uncover if any change in control would result in revocation of IP licences etc);
- Employment and Statutory Obligations (i.e. compliance with Employment Act 1955, or that all foreign workers have valid work permits etc);
- Charges and Borrowings (i.e. determine if charges are properly registered, any change of control provisions which requires notification to the creditors etc.);
- Environment, Health and Safety (i.e. compliance with applicable laws and regulations relevant to the business etc.); and
- Real Estate and Tenancies (i.e. ensure that the tenancies haven’t expired etc.)
Summary
A final due diligence report would enable the parties to avoid any unpleasant surprises and clarify any pertinent issues affecting the company. It would minimise any risk which may be connected to the transaction and reduce the risk of potential disputes arising from the transaction. Further, it would also help the parties make informed decisions as well as agree on the essential terms of the sale and purchase agreement.