“Due Diligence and the Fiduciary Duties of Buyer’s Management Team”
Middle Market Legal Toolbox Blog 04/11/13 Kevin Slaughter
In the context of a merger or acquisition, management of the acquiring entity may bring lawsuits and potential liability upon itself for failing to conduct due diligence in a thorough and careful manner. For example, and as has been widely reported, Hewlett-Packard Co. and its current and former senior executives and board members are facing multiple shareholder actions—and investigations by the Department of Justice and the UK Serious Fraud Office—after an $8.8 billion write-down following HP’s October 2011 acquisition of British software maker Autonomy Corp., plc. HP, relying in part on a clean 2010 audit of Autonomy by Deloitte LLP, continues to claim that Autonomy actively manipulated its financials to bolster its bottom line, which prevented HP management from fairly valuing Autonomy at the time of the deal. But shareholders wonder if HP management was just asleep at the wheel. The complaints allege that HP executives issued false and misleading statements about HP’s financial health in connection with the acquisition and concealed the fact that the deal was based on unreliable financial statements. And, facing pressure from shareholders over the Autonomy debacle (although narrowly surviving a recent reelection), three board members have stepped down, including HP’s Chairman, Raymond L. Lane.
While the due diligence process includes the general review of legal contracts and other documentation, one of the most important goals is the confirmation of the information provided by the seller and its advisors, including the information contained in the seller’s disclosure schedules. The buyer’s diligence team should specifically seek to confirm that the seller/target has title/rights to essential assets; that the valuation of the target and/or its assets is sound; and, most importantly, that the acquisition will meet the buyer’s investment objectives. The due diligence process should be driven by a team comprised of business people, lawyers, financial professionals, and, where appropriate, subject matter experts (e.g., regulatory, tax, labor, intellectual property, environmental). As demonstrated by the HP case, the process should include a thorough review of financial information, including correspondence between the target’s auditors, outside counsel, and/or the target relating to issues or disputes. Areas where further due diligence may be warranted or desirable should be indentified and follow-up questions should asked as appropriate.
Though extensive representations and warranties may limit the scope needed for the due diligence review, contractual protections alone may be insufficient due to limitations such as survival periods, caps, baskets and limits on damages. Not to mention the time, expense and risk associated with litigation, which is often required to seek redress under contractual remedies.
Due diligence is an indispensable investigation and evaluation of the target, but the due diligence team cannot just merely record the information provided by the target/seller. The fiduciary duties of buyer’s management team require that due diligence be conducted with a view to actively confirming that the buyer is getting what it desires and is paying an appropriate price.
And what if an acquisition proves to be less beneficial than expected? In our experience, the risks of fiduciary duty litigation following a troubled acquisition can be greatly reduced through a careful internal investigation and public communications plan.