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1 From PLI’s Course Handbook Conducting Due Diligence #6265.

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1 1 From PLI’s Course Handbook Conducting Due Diligence #6265

2 DUE DILIGENCE ON NON-U.S. COMPANIES MARCH 2005 VALERIE FORD JACOB FRIED, FRANK, HARRIS, SHRIVER & JACOBSON Copyright ©2005 by Fried, Frank, Harris, Shriver & Jacobson LLP. All rights reserved.

3 3 Special Considerations for Due Diligence on Non-U.S. Companies Companies are often less accustomed to U.S. style due diligence procedures and tend to be more resistant to procedures considered standard in the U.S. Cultural differences in transaction and disclosure norms can lead to non-U.S. issuers becoming angry or offended at a diligence process that would be considered standard in the U.S. The local lawyers and accountants for non-U.S. issues may also be unfamiliar with U.S. standards of diligence. In many jurisdictions, lawyers have not historically been as proactive as U.S. lawyers, and companies may be unaccustomed to prolonged questioning from lawyers on issues they consider to be business risks. Non-U.S. issuers may not care about potential liability under U.S. securities laws because they have no assets in the U.S. and believe that U.S. judgments would not be enforced in local home country courts.

4 4 Practical Issues Regarding Doing Diligence on Non-U.S. Companies The legal structures differ in other countries compared to the U.S. and also differ across countries, and the legal framework may be markedly different. For example, underwriting liability standards vary by jurisdiction and range from absolute liability to limited liability for managers and underwriters. Due diligence defenses may or may not be available. Documents will often be located in other countries and will be in languages other than English. Also, management at non-U.S. companies may not speak English fluently, which can lead to inadvertent misunderstandings. Many non-U.S. companies are reluctant to ship documents and insist that the lawyers come to the company to conduct due diligence. For many items on a standard due diligence request list, such as corporate charters and bylaws (or their equivalent), board of director minutes, stockholders agreements and other documents related to a company’s outstanding securities, U.S. counsel cannot evaluate the materials without the assistance of local counsel.

5 5 Practical Issues in Doing Diligence on Non-U.S. Companies (Cont.) Corporate mechanics will be different in non-U.S. jurisdictions and will frequently require that local counsel be retained. Local counsel is necessary to determine whether an agreement has been duly authorized by necessary corporate action. Local counsel can determine if the signatory to an agreement has the authority to bind the company (many jurisdictions do not follow the U.S. doctrine of apparent authority). Local counsel can handle the mechanics of share transfers. Court approval and/or formal notarization may be required (which could affect timing). In many jurisdictions, the law is not as well developed and settled as in the U.S. and may be changing rapidly. Local counsel should be able to advise on new regulations. Regulatory regimes of each country will differ from US requirements for companies in regulated industries (e.g. health care, telecommunications). In Europe, European Union directives and rules also need to be considered.

6 6 Practical Issues in Doing Diligence on Non-U.S. Companies (Cont.) As a result, local counsel typically will be required (at least in key jurisdictions). U.S. counsel may not have all necessary resources internally. Issues to consider when hiring local counsel: Will local counsel report directly to the client, or to the U.S. lawyers who can filter the output of local counsel? Will one multi-jurisdiction law firm with capabilities in each jurisdiction in which the company operates be hired, or will separate local counsel be hired in each country? In many cases, the client will already have local counsel. Consider whether this local counsel is appropriate for the particular project. If existing local counsel’s expertise is appropriate for the project, their knowledge of the client might prove an advantage. U.S. counsel must be comfortable with local counsel, since U.S. counsel will be relying on local counsel outside of the United States and may not be in a position to evaluate the work of local counsel.

7 7 Differences in the Due Diligence Process (Securities Transactions) The due diligence focus in many non-U.S. jurisdictions is report-based. In many jurisdictions, lawyers are expected to produce a comprehensive report for use by all parties in the transactions (including financing sources). It is important to establish early in the due diligence process whether such a report is required in order to avoid later duplication of effort. This report differs from the typical U.S. report in that it is not limited to issues affecting the transaction that have been discovered during the diligence process. U.S. counsel may need the assistance of local counsel to prepare a report. U.S. counsel must be aware that the diligence report will be given to financing sources and will be relied on by financing sources in connection with the transaction.

8 8 Differences in the Due Diligence Process (Securities Transactions) (Cont.) Other parties involved in the transaction may also prepare lengthy reports. In United Kingdom securities transactions for example, the issuer’s accountants typically prepare a long-form due diligence report. U.S. counsel will need to review the long-form report in full before issuing any opinions in connection with the transaction to make certain that the accountants’ due diligence has not discovered any items of interest. Accountants are often allowed greater access to management in non-U.S. transactions and play a larger role in the diligence process. In order to avoid liability under U.K. law it is sometimes necessary in U.K. securities offerings to embark upon a lengthy verification process, the aim of which is to ensure that the prospectus is wholly accurate. As part of the verification process, issuer’s counsel breaks out each and every statement of fact in the prospectus. Counsel then requests that the company or the underwriters provide back-up for each statement.

9 9 Differences in the Due Diligence Process (M&A Transactions) As with securities transactions, the end product of the diligence may be different than in the U.S. In many cases, the purchaser’s counsel will prepare a comprehensive report on the target. Alternatively, in an auction, seller’s counsel often will prepare a report. This report will include more information than the traditional U.S. report, which is often focused on issues in the diligence that could affect the transaction or increase the risk of the transaction. If there is a financing in connection with the transaction, the report will be relied upon by the banks that are providing financing for the transaction. Often, the banks’ diligence will be limited as a result.

10 10 Differences in the Due Diligence Process (M&A Transactions) (Cont.) Similar to the securities context, the accountants will also typically prepare a long-form diligence report that will have to be considered by counsel. Separate reports are often prepared by consultants in the areas of environmental, pensions and tax. As a result, it is important to agree what form the diligence report will take as soon as possible in the diligence process. Local counsel’s assistance will often be required to produce the report.

11 11 Differences in the Due Diligence Process (M&A Transactions) (Cont.) Diligence by purchaser’s counsel is often more important than in U.S.-style transactions. Transaction norms are generally more seller-friendly. In many jurisdictions, cover provided by representations and warranties will often be less extensive than is customary for U.S.-style transactions. It is often customary to disclose a very large number of documents as exceptions to the representations and warranties. This can include, for example, the entire contents of the data room. As a result, the purchaser will not receive a great deal of comfort from the disclosure letter that specifies exceptions to the representations and warranties. Much of the diligence burden that is on seller’s counsel in a U.S. style transaction (since disclosure against an agreed bundle is not typically accepted) is shifted to purchaser’s counsel in non-U.S. transactions.

12 12 Examples of Specific Issues to Consider for non-U.S. Companies As a result of different legal structures, certain diligence items are often more important in non-U.S. companies that would be the case for domestic companies. Labor Issues. In U.S. transactions, in general employees will not have a great ability to either block or significantly delay a proposed transaction. In non-U.S. jurisdictions, labor diligence should often be performed as soon as possible. In many non-U.S. jurisdictions, employees must be consulted in varying degrees before any major transaction. A company may have to consult with the worker’s council before undertaking the transaction. Counsel should quickly determine if employees will be required to be consulted before a proposed transaction can take place. The results of this investigation may affect the form of the transaction or the timetable. Competition Issues. Competition (antitrust) issues must be considered. Potential acquirors in Europe must consider competition issues on a country basis and must also consider potential European Union competition issues.

13 13 Examples of Specific Issues to Consider for non-U.S. Companies (Cont.) Financial Assistance Rules. Financial assistance rules must be considered in many non-U.S. jurisdictions in any transactions where shares are changing hands. Financial assistance rules prevent the target company from giving any “assistance” to an acquiror that is seeking to acquire the target’s shares. Financial assistance rules differ from jurisdiction to jurisdiction, but are often arcane. Although financial assistance problems can generally be avoided with careful planning, potential penalties are severe. Local counsel with experience in financial assistance rules should be consulted. Investment Company Act. Counsel should consider in any international offering whether the non-U.S. issuer would be deemed an “investment company” under the U.S. Investment Company Act of 1940. For example, a company could be deemed an investment company if more than 40% of its assets are securities, which include items such as minority interests.

14 14 Legal Opinions It is important early on in the process to clarify among all counsel who is delivering which opinions. Particularly in securities offerings, this will impact the level of diligence performed by each law firm. It is important in particular to clarify who is giving a 10b-5 opinion. Underwriters may have preferences as to whether local or “international” counsel provide the opinion. Local counsel should understand as early as possible that they will need to deliver a disclosure opinion at least with respect to portions of the disclosure that deal with local law and regulatory matters as well as contractual matters covered by local law.

15 15 Comfort Letters As with legal opinions, it is important to negotiate the details of the comfort letter as early in the process as possible so that the company’s accountants understand what U.S. counsel expects to receive. It is critical to emphasize that the accountants will be expected to deliver a SAS 72 comfort letter which covers the audited financial statements (in compliance with Regulation S-X), unaudited financial statements (reviewed per SAS 100) and a bring down since the last reviewed period. Non-U.S. accounting firms are less accustomed to providing these letters than U.S. accounting firms. Accounting firms may expect the underwriter to enter into an engagement letter with the accounting firm which contains language limiting the liability of the accounting firm.

16 16 Conclusion Due diligencing non-U.S. companies can be very challenging. Practical issues such as: The location of documents, Documents in languages other than English (and often several different languages), and Different legal structures must be overcome. The due diligence process differs in most non-U.S. jurisdictions from the process to which U.S. lawyers (and U.S. clients) are accustomed. 537254

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