In the life cycle of a company, the moment of buying/selling the company is a special event. Such a sale is not one act at one specific moment, but consists of an intensive process which follows a recognizable pattern. Within that process, the due diligence takes a special role. The potential buyer has already received information from the seller about the company to be acquired (the 'target'). This is done first through a teaser (a concise brochure), followed by an information memorandum (a detailed description). Based on this information, the buyer and seller have negotiated, made outline agreements, and recorded the agreements in a letter of intent.
The signing of a letter of intent often marks the start of a tightly defined period during which the buyer is given the opportunity to vet the target through a due diligence. When conducting a due diligence, the buyer has a duty to investigate and the seller has a duty to disclose. If defects come to light after the acquisition, the question arises as to which party is liable for damages suffered at that time.
The exchange of information between buyer and seller plays a major role in a business acquisition, where buyer and seller have different interests. Logically, the seller will not want to hang out all his proverbial dirty laundry, as this could, for example, affect the amount of the purchase price or the purchase decision in general. For the buyer, however, it is important to be aware of all relevant information in order to identify risks and avoid damage afterwards.
A main rule with exceptions
The main rule was established in a 1990 Supreme Court ruling: in principle, the seller's obligation to disclose outweighs the buyer's obligation to investigate. The idea behind this is that the buyer should be protected for a situation in which the seller has concealed a circumstance that he should have disclosed. This was also confirmed some time ago in a 2014 ruling by the Rotterdam District Court, which held that the deliberate withholding of information relevant to the purchase decision does not become less culpable merely because of the fact that a book examination has taken place. The liability for the defects that come to light then lies with the seller.
It follows from further case law on the subject that the allocation of liability depends heavily on the facts and circumstances of each specific case. In 2009, for example, the Amsterdam Court of Appeal made a nuance to the main rule described above. In doing so, the court ruled that the seller's duty of disclosure does not include that information, the inquiry of which by the buyer in the context of its bookkeeping investigation was obvious but failed to request. The liability for the defects (the bodies in the closet) that come to light then lies with the buyer.
The due diligence beyond the data room
Due diligence will focus on several aspects of the target. One sub-area is the commercial, operational and logistical aspects, which are often handled by people from the buying company itself. The same applies to personnel matters. Sub-areas such as legal, financial and tax aspects lend themselves well to being outsourced to consultants.
Over the years, we have seen an interesting development in this regard. The jurisprudence on liability for the corpses in the closet, and the balancing of the duty to disclose versus the duty to investigate, has led to the investigation of the books being done on the basis of structured data rooms. These were first physical rooms with files full of documents such as articles of association, agreements, financial information, etc.Subsequently, the datarooms became Internet applications, with controlled access to websites containing electronic documents. Unfortunately, experience shows that data rooms are increasingly filled to a large extent with unimportant documents, while the really relevant information is absent or limited.
Especially in SMEs, it is important that due diligence is not limited to perusal of the contents of the data room, but is followed by a visit to the company itself. With the opportunity to interview key people, asking about the issues that really matter. It is our experience that in this way the chances of having to litigate afterwards about the corpses in the closet are reduced to an acceptable level. The buyer can then use the knowledge and insights gained to conclude the negotiations and draft a well-founded purchase agreement.