What Is Legal Due Diligence?

Legal due diligence is a discovery process initiated by a company that is interested in acquiring another company. Lawyers are hired by the buyer to review documents and conduct interviews of key officers and directors to arrive at a legal conclusion regarding the validity of the transaction and the overall value of the company. The process typically results in a written memorandum that presents the lawyer’s legal findings to the buyer.

Due diligence is a standard of care that must be exercised by a buyer to prove he made every effort to ascertain the legitimacy and value of what was being purchased. The term refers to the thorough investigation of all parts of a sale. In the context of business acquisitions due diligence has multiple components, including legal, financial, and operational reviews, that are carried out by various professional consultants.

A licensed lawyer or a law firm ordinarily handles the legal due diligence part of a business acquisition, particularly for major corporate transactions. The investigation starts right after the deal is announced and can take as long as 18 months or more to complete. Lawyers hired by the buyer will typically set up an area in the offices of the company that is the subject of the purchase and will request documents to review and people to interview on-site to make the investigation as convenient as possible.

There is a process for conducting legal due diligence that has developed as a best practice for corporate transactions. The lawyers will generally follow that process, supplementing the industry standard due diligence checklist with additional requests that follow up on unique circumstances. Many items, including financial records, audits, organizational documentation, major contracts, employment records, evidence of pending lawsuits, and permits and licenses will form the main part of the document production.

Lawyers will also interview key officers and directors to determine if there is anything the buyer should know about the company that will affect its value. This part of the investigation can delve into the personal background of owners and employees to determine if there are any conflicts, areas of concern regarding reputation or integrity, or past legal trouble that can have future implications. Although this may seem intrusive, it is as important to determine the legitimacy of the people involved in the transaction as it is to evaluate the company itself.

Legal due diligence enables lawyers to reach a professional conclusion about the condition of the company and provide an estimation of its value that takes into account any legal issue that might arise in the future. That professional opinion is often provided in a findings memorandum. In smaller transactions, the lawyer’s findings can be presented verbally. The buyer will rely on the conclusions presented either written or verbally and has recourse against the lawyers if the investigation did not meet the appropriate standard of care.