Lawyers who enter a company's data room as part of a due diligence process are in a much-envied position, as they get to see and check all relevant documents for the respective firm, usually a company targeted for acquisition. Their lips are sealed on what they find out, and so are their customers' receiving the final due diligence reports. But getting to know a company's critical information, even though the deal is not signed, offers initial potential buyers the advantage of information and a chance to estimate the surveyed company's future developments.
Due diligence was, until recently, required for privatizations; now only a few are left to happen in Romania. It is also used massively in real estate deals, before listing on the stock exchange. Sometimes, the due diligence is required by a financial institution prior to lending money to a company.
Although due diligence cases don't represent a stand-alone business line for law firms, time spent on them can cover from 20 to 40 percent of the volume of work and eventually the firm's revenues. The process requires teams of lawyers from 5 to 20 people in the case of more complex processes. Teams usually consist of a mix of junior and senior lawyers.
Several large deals on the Romanian market have required due diligences. Let's remember the BCR privatization, when lawyers representing the bidding banks have entered BCR's data room. Moreover, Electrica Muntenia Sud's takeover by Enel, KBC's takeover on Romstal Leasing and Swiss Capital, are some of the more recent deals which required a due diligence process.
Negative reports don't necessarily scupper deals
Although in most cases the due diligence report comes after the buyers have already decided to go on with the acquisition or there is a great potential for landing the deal, it is of great importance for establishing the terms.
The lawyers' final due diligence reports tell the interested buyer what to do next, what are the deal's weaknesses and in the end are meant to put the buyer in the best position to negotiate. “Investors usually want to quantify risks before investing in a business,” says Adriana Dunca, senior associate lawyer with Mazars.
The client is supplied sensitive information that can prove to be decisive in the negotiation process with its counterpart. “The main objective of a Legal Due Diligence is to assess legal risks that might hamper the future transaction in any way. […] A considerable amount of data resulting from the legal due diligence is going to be mirrored by the transaction documents, ensuring a strong bargaining position of the client and contributing to a reasonable balance of the parties' contractual interests and objectives,” explains Catalin Baiculescu, Associated lawyer with Musat & Asociatii.
Lawyers need to do detective-like work when deciphering a company's documents so as to discover legal flaws and risks, as well as to anticipate their impact on the transaction, Baiculescu adds.
“At the end of the day, it is the lawyers' responsibility to underline the risks, but at the same time propose solutions, if possible,” says Anca Parascan, partner with bpv Grigorescu.
While some believe the due diligence report won't talk the potential buyer out of the deal, but only helps the company assess the risks, others put more weight on such a report when the acquisition decision in made. Overall, 80 to 90 percent of the due diligence reports turn into acquisitions.
“The due diligence report will allow the client to decide whether or not to go forward with the transaction, give insight into how to negotiate the acquisition price and terms, allow the client to quantify the capital/investment requirements as well as to get an idea about the necessary post-transaction integration and corporate governance actions,” says Gelu Goran, partner with Biris Goran law firm.
Anca Parascan shares a similar view. “The final decision on whether to finalize the transaction or not is pendent on the due diligence report,” she says.
Failure to close a deal doesn't necessary lay in the negative findings of a due diligence report. Failed deals are usually triggered by external factors.
“In our experience, no due diligence report has resulted in the failure of an acquisition; this situation usually has other causes than the report itself,” explains Raul Mihu, senior associate with Voicu Filipescu law firm. The negative findings in the due diligence report turn into conditions in the contract, with the deal's closure contingent on achieving these conditions, for example, receiving authorization, explains Mihu. “Sometimes, the negative issues are reflected in the need for additional guarantees, like escrow hold back or a bank guarantee letter,” the Voicu Filipescu representative says.
Lawyers need to know what to ask
For an outsider of the business, the data room stage sounds like the most interesting and maybe the most important part of the due diligence process. Up to some point, it is extremely important. But there are some other steps, which come before the data room and which might determine what documents a company needs to provide for the legal team.
Getting to know what the client is interested in and where the transaction needs to end up is the first step in the process, as it lays the ground for the rest of the activity. “The first and the most important stage of a due diligence process will be the clear understanding by the lawyers of the purpose of the exercise in the context of the entire transaction,” says Corina Ionescu, partner with Bulboaca & Asociatii law firm. In other words, the lawyers need to establish the purpose of their work.
Equally important seems to be the checklist of information about the vendor which lawyers need to look at.
The checklist, meaning all the required documents about the target company's business, determines the contents of the data room.
“One needs to take into account the fact that the company ‘under investigation' offers only the requested documents, at most, so one needs to know what to ask for,” explains Anca Parascan.
In case of a market entry, the buyer will require as many documents as possible.
The checklist is not fixed, but subject to additional requests of information during the review process. “As a matter of fact, quite often checking the primary documents provided by the company leads to a large set of new questions about significant legal features,” says Catalin Baiculescu of Musat & Asociatii.
Anca Parascan from bvp Grigorescu agrees. “In practice, the time spent in the data room may increase from what was initially assessed, due to interim investigation results, which trigger the need for additional documents, to clarify situations emerging while checking the documents,” she says. The length of the due diligence process, also influenced by the time spent into the data room, is reflected in the lawyers' fee.
The fee, not disclosed by the lawyers, can be calculated per hour, in which case the clients understandably encourage their lawyers to get it done as soon as possible.
“Usually, lawyers are pressured to reduce the due diligence process by spending as little time as possible in the data room and by reducing the report delivery period,” explains Anca Parascan.
A due diligence process may take from two weeks to as much as several months, depending on the amount of documents to be checked and the complexity of the business. The privatizations of recent years needed long due diligences, mainly since they involved either companies in the oil & gas industry or banking, which are among the sectors requiring more attention due to the strict regulations. Also, in the case of privatizations, corporate control, employment issues and a historical liabilities check are needed, and this may prolong the process.
Real estate due diligences, one of the most required in the last two years, according to Goran, may also entail complex processes. “It takes time to gather the relevant documents, to fully comprehend their legal effects, in particular when it comes to the historical transfer of ownership, to spot the absences that might lead to legal risks, and finally to advise the client on the most effective approach of such data in negotiating the transactions,” explains Catalin Baiculescu.
“Usually a due diligence process would be rather more difficult when undertaken in a large corporation with several subsidiaries or where the activity of such companies is in areas where the laws have recently changed or are unclear,” adds Corina Ionescu.
Law firms are generally flexible, and they either agree on soft caps for their legal fees, provide incremental discounts, meaning a discount on those fees exceeding the initial estimate, break-fee discounts or other means of risk sharing with their clients, says Gelu Goran.
Sometimes, the final cost can exceed initial cost estimates by 20 to 50 percent, says Adriana Dunca of Haarmann Haamelrath.
In some cases, the vendor will pay for the due diligence process, and not the buyer.
“They know the longer the process takes, the higher the legal fees,” explains Gelu Goran.
Local owners understand the intrusive process less
Once into the data room, the lawyers need to review the documents rigorously, trying to concentrate on key issues, and sparing the client from unnecessary and over-detailed information. “The lawyers sometimes need to summarize documents, as once the data room is closed, the documents are no longer available,” says Raul Mihu from Voicu Filipescu.
What the lawyers find out may sometimes negatively influence the transaction, so the team of lawyers needs to discuss the findings with the seller's managers, in which case sometimes the sellers put pressure on lawyers to distort the reality to present a more favorable view for them.
“The investigated company's managers may try work with the lawyers in finding a solution, or even deny the findings and ask the lawyers not to communicate negative issues,” says Anca Parascan. Lawyers need to work with tact to persuade the surveyed management to give correct information, she goes on. Diplomacy and thoroughness are also needed, adds Goran.
The owners and managers of companies under due diligence may have trouble in understanding the due diligence process. “Let's not forget that for about 40-45 years, mergers and acquisitions did not take place in Romania. Consequently, educating the target company's shareholders and managers is also part of the due diligence process,” concludes Gelu Goran.