An Overview of the Due Diligence Process
Dallas Parker
713.238.2700 dparker@mayerbrown.com

September 2010

William S. Moss III

Mayer Brown is a global legal services organization comprising legal practices that are separate entities ("Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP, a limited liability partnership established in the United States; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales; Mayer Brown JSM, a Hong Kong partnership, and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.

Review of M&A Basics: Due Diligence Objectives

• Due Diligence is:
– Investigation of the target business or assets – Evaluation of factors that may have a future impact on the business or assets – Confirmation of information provided by the seller and its advisors

• Objective is to identify:
– Factors that affect acquisition decision and/or valuation
– Risks associated with ownership of the Target/target assets – Obstacles to effecting the transaction or realizing the investment objectives

Identify Risks and Confirm Assumptions

• The due diligence process should:
– Confirm the Seller/Target has title/rights to key assets – Identify potential liabilities and risks

– Determine or confirm valuation
– Identify any obstacles to effecting the transaction (third party consents, regulatory approvals, etc.) – Identify issues that will affect the reps and warranties

– Identify steps necessary to integrate the business/assets into the Buyer’s operations
– Confirm that the acquisition will meet the Buyer’s investment objective

scope and timing • Transaction details – Valuation – Purchase agreement • Structure and timing of payments • Representations and warranties • Pre-closing covenants • Closing conditions • Indemnification • Deal terms (including representations and warranties and indemnification provisions) and purchase price can be materially affected by issues identified during due diligence review 4 .Impact on Transaction • Viability • Structure.

expense and risk of litigation 5 . baskets and deductibles • Limits on consequential damages/lost profits • Time.Importance of Effective Due Diligence • Reduces Risk (and Related Costs) of a Failed Deal • Contractual Protections May Be Insufficient – The Seller may not be willing (or able) to provide sufficient post-closing indemnification to cover all losses – Certain issues cannot be cured with dollars – Acquisition agreement may limit recovery • Survival of representations and warranties • Caps.

g. “political” implications of disclosure or sensitive terms (e. customers.Seller’s Due Diligence Responsibilities • Data Room Preparation – Gather. margins) – May be appropriate to withhold certain documents until later in the process • Prepare Management Presentation 6 .. pricing. organize and index documents obtained from appropriate business units and specialty teams – May be necessary to redact documents due to contractual confidentiality restrictions.

the Seller will need to conduct a more thorough due diligence investigation – not materially different that Buyer’s due diligence investigation. Other schedules will be based on information obtained from inquiries of the relevant individuals who are responsible for the business being sold • If Seller is receiving stock as consideration. 7 .Seller’s Due Diligence Responsibilities • Preparation of Disclosure Schedules – Seller will prepare schedules to the definitive agreement based on its own due diligence review – Some of the schedules will be based on information contained in the data room.

if requested • Review of financial information and other corporate-type documents (e. letters from outside legal counsel to auditors. non-compete. correspondence with outside legal counsel to auditors.Buyer’s Due Diligence Responsibilities • Prepare due diligence checklist • General legal contract review – Assignment/change of control provisions that might be triggered as a result of contemplated transaction – Exclusivity. most favored nation provisions – Parties’ ability to terminate contract before end of term • Prepare summary of key commercial terms of contracts. correspondence with government agencies..g. correspondence with auditors regarding issues or disputes) 8 .

IP and benefits related documents • Attend management presentation. environmental. ask follow-up questions as appropriate • Due diligence report may be prepared – Summarize documents reviewed and discussions with Seller and its representatives – Identify and quantify any problems or opportunities and propose solutions/alternatives • Identify areas where further due diligence may be warranted or desirable • Confirm information contained in disclosure schedules 9 .Buyer’s Due Diligence Responsibilities • Specialists should review tax.

Key Sources of Information • External — helps corroborate information received from the Target – Public documents – Lien searches – Litigation searches • Seller/Target – Data room materials – Management presentations and site tours – Offering memoranda and other marketing materials – Press releases and other information from the Target’s website 10 .

Organizing the Due Diligence Process – Goals • Defining Goals and Setting Expectations – Deliverables – Key Considerations – Process – Timing – Budget 11 .

12 .Organizing the Due Diligence Process – Scope • Factors affecting the appropriate scope of review include: – Deal structure and size – what is material to the deal? – Industry of the Target business/assets – Location of operations – Value drivers – Cost and time constraints – Identity of the Target – Competition – Financing • Generally want to be covered either by due diligence review or reps and warranties. • Extensive reps and warranties may reduce scope of due diligence review.

employment.Managing the Due Diligence Process • The Due Diligence Team – Legal – Business/Subject matter experts • Tax. IP. etc. – Financial – Regulatory – Insurance/Risk management – Foreign counsel 13 . litigation. environmental. labor.

Managing the Due Diligence Process • Organization – Team Leader/Point Person – Allocation of responsibilities • Distribution and Tracking Plan • Communication Plan – Extremely important aspect of due diligence process – Confidentiality requirements – Process and Timing • Up the chain • Between due diligence team and drafting team • Between the Buyer and the Seller/Target • Often different teams handling due diligence and negotiations 14 .

g.) – Clean Team 15 . customer information. etc.Special Issues – Competitors • Legal Restrictions – Antitrust laws may prohibit competitors from exchanging certain information prior to consummation of the transaction (e. pricing) • Seller/Target Imposed Limits • Solutions – Redact (pricing..

updated records checks by landmen / title counsel • Is “check stub” title good enough? • What does the lender require? • How good is “Exhibit A” – the list of material O&G properties? 16 .Upstream • Proven Developed Reserves (PDPs) only? Other proven categories? Any value given to Probables / Possibles? • Comparison to independent engineering report • “As of” date? • File review only vs.Due Diligence .

Due Diligence – Midstream/Pipeline • A good system map? • Schedules of easements / rights of way • Compressor / pump station / terminal sites • What sort of real property title diligence currently exists & can be built upon? How extensive should additional real property title diligence be? • How to conduct a practical environmental assessment project? 17 .

inputs – Transmission lines .Due Diligence – Power • Title insurance on plant sites • Easements / Rights of way for – – General / Vehicular Access – Fuel (gas) pipelines .outputs – Water supply lines / storage – Stations / substations – Interconnection facilities – Any shared facilities? 18 .

DUE DILIGENCE FROM A BUYER’S PERSPECTIVE: FCPA Due Diligence Mayer Brown is a global legal services organization comprising legal practices that are separate entities ("Mayer Brown Practices"). a Hong Kong partnership. and Tauil & Chequer Advogados. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions. and its associated entities in Asia. a limited liability partnership incorporated in England and Wales. The Mayer Brown Practices are: Mayer Brown LLP. . Mayer Brown JSM. a limited liability partnership established in the United States. a Brazilian law partnership with which Mayer Brown is associated. Mayer Brown International LLP.

FCPA Overview • US law passed in 1977 to prohibit bribery of foreign officials/ first aggressive anti-bribery statute among developed nations • Two main components: – Anti-Bribery Provisions Prohibits bribes (or offers to bribe) made to foreign officials. fines. including imprisonment. political parties. loss of export licenses and suspension from competing on government contracts 20 . candidate for public office whether made directly or through a third party for the purpose of obtaining or retaining business – Accounting Provisions Requires companies to maintain accurate books and records and adequate accounting and financial controls. No allegations of bribery are required – Joint Jurisdiction US Department of Justice (bribery & corruption-criminal) and US Securities & Exchange Commission (books and records-civil) – Violations Include both criminal and civil penalties.

Who is liable under the FCPA? • Domestic – All US “issuers” and private companies (“domestic concerns”) using instrumentalities of interstate commerce – Any US corporation or national engaging in any foreign bribery-related conduct – US citizens or foreign nationals operating in the US or using instrumentalities • Foreign – Foreign corporations subject to SEC regulation (e. officers.. whether or not they use instrumentalities of interstate commerce • Includes directors. and agents of entities subject to the statute 21 . via ADRs) and using instrumentalities – All foreign corporations when in US territory.g. employees.

FCPA Penalties: Criminal and Civil Corporate Sanctions • Fines of up to $2 million for each violation of the anti-bribery prohibition • Fines of up to $25 million for violation of accounting provision • Record $800 million in monetary sanctions in Siemens • Disgorgement of proceeds associated with improper payments • Injunction to prevent future violations • Suspension and debarment • Compliance Monitor 22 .

6 months • Equitable Remedies: Injunction.FCPA Penalties: Criminal and Civil Individual Sanctions • Up to $250. bar from serving as director or officer 23 . 18 months.000 per criminal violation – Government prohibits indemnification for fines • Up to 5 years imprisonment – Recent sentences: 36 months.

00.com/dtt/whitepaper/0.deloitte.FCPA and M&A Transactions Deloitte Survey on International Business Transactions • 87% always or frequently conduct background checks before international M&A activity. 70% have pulled out of a deal Source: “Look Before You Leap: Investigative Due Diligence in International Business Relationships.” (available at http://www.sid%253D2007%2526cid%253D150086.html) 24 . 49% always do so • 57% have restructured or renegotiated potential deal based on information uncovered during background checks. 67% always do so • 67% always or frequently conduct background check before international joint venture activity.1017.

Potential FCPA Exposures in M&A Transactions • Acquisition involving government owned or controlled entity or where the government has an ownership interest • Need for government authorization of private entity acquisition • Inherit liability for past FCPA violations when acquiring private entity (“successor liability”) 25 .

Thailand and Philippines. the Buyer forced the Target to make a voluntary disclosure • Latin Node (2009) First FCPA action filed based entirely on pre-acquisition conduct unknown to the Buyer when the transaction closed 26 .FCPA in the M&A Context Enforcement Actions • Lockheed/Titan (2005) While conducting pre-acquisition due diligence of Titan. Deal failed to close because of FCPA problems. Lockheed discovered payments to obtain telephone contract in Republic of Benin. Deal closed. Titan prosecuted • GE/InVision (2005) While conducting pre-acquisition due diligence of InVision. The Target had enlisted consultants to obtain contracts for equipment in China. GE discovered FCPA concerns.

customs. 08-02 • Halliburton sought advice from the DOJ concerning its potential FCPA liability in connection with a proposed acquisition of a UK oil field services company • UK law prevented access to the information necessary to complete appropriate FCPA due diligence prior to closing • Halliburton informed the DOJ it would impose an FCPA policy on the UK company and implement a post-closing FCPA due diligence work plan on third parties. etc. • Halliburton would report the results of any risks found to DOJ • DOJ recognized the insufficient time and inadequate access to complete the pre-acquisition FCPA due diligence • DOJ determined not to take any enforcement action against Halliburton 27 . joint ventures.FCPA in the M&A Context: DOJ Opinion Procedure Release No.

document.Factors to Consider in Designing Pre-Merger Due Diligence Process • Education of diligence team on FCPA issues • Factor in necessary time for FCPA review • Follow up on identified Red Flags and risk areas • Document. document due diligence steps 28 .

including how those representatives vetted • “The Department has seen each of these areas as fraught with challenging FCPA issues. an acquiring company should be comfortable that it has assessed those risks before closing a deal. identified five questions Buyers should ask Targets during due diligence • Interaction with foreign governments as customers • Interaction with foreign governments as JV partners • Government licenses and approvals required to operate abroad • Requirements relating to customs in foreign countries • Relationship with 3rd-party representatives. November 2007) 29 .DOJ View on Due Diligence Questions Alice Fisher. if possible. Former Assistant Attorney General. and.” (Alice Fisher.

Protection Through FCPA Reps and Warranties • Overview of typical FCPA representation and warranty – No corrupt payments were made by the Target to foreign officials. for the purpose of obtaining or retaining business. either directly or indirectly. or to otherwise securing an improper advantage – Absence of government officials as owners or in other relevant provisions – Books and records are accurate and complete 30 .

FCPA Due Diligence Assess the existence and awareness of systems and controls over the following areas: • Expense claims. payments and petty cash disbursements • Use of agents and outside consultants • Entertainment and gifts provided to third parties • Contracting with government bodies • Fraud response mechanisms • Identification and monitoring of relationship development and maintenance with state-owned enterprises and their employees • Accurate recording of transactions within the target’s books and records • Record keeping protocols in respect of transactions recorded in the books and records 31 .

third-party processes. hot line reporting • Request information on prior FCPA problems • Analyze existing internal controls and perform financial audits on the Target’s books and records • Include in the acquisition agreement FCPA compliance and resolution of FCPA issues as a condition of closing • Voluntarily disclose to DOJ and SEC past unlawful activity before closing 32 . training.FCPA in the M&A Context Buyer Due Diligence Checklist • Assess corruption levels of the Target’s country and industry (Transparency International Index) • Evaluate the Target’s compliance program – Clear policies and procedures. senior management oversight.

Q&A Thank you 33 .

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