This is an investigative process where the buyer will seek information about the business and the seller to ensure that what he believes he is purchasing in the transaction is actually the case.

Throughout this process, the buyer will have access to information and documentation from the seller relating to their business.

It is essentially an exercise for the buyer to investigate the key aspects of the business. Generally the due diligence exercise commences with the seller filling out a questionnaire supplied by the buyer which will request documents and focus on the areas of the business. The seller’s answers will start to form the basis of the buyer’s warranties and indemnities.

The due diligence exercise can be fairly lengthy and should not be left until too late in the transaction. The Heads of Agreement should be signed before due diligence is commenced and, ideally, the seller should not provide the buyer with any documentation until a confidentiality agreement is in place.

Prospective buyers should take the advice of investigating accounts to help determine whether their valuation of the company is correct. The due diligence process will generally place either the buyer or seller in a strong bargaining position depending on what is discovered.

Below is a non-exhaustive list of what information is required in a due diligence exercise:

Property

It is necessary for the buyer to undergo diligent investigations of the property involved in the transaction. This will entail property searches and a review of the official titles of the property. These investigations may uncover issues such as easements and covenants which may have to be dealt with.

Planning

Planning permission will have to be reviewed on the properties involved in the transaction.

Survey

As with any property transaction it is good practice to instruct surveyors to investigate and place a value on the property. It is common for a property to be the largest asset owned by a Company which makes it good practice to ensure that it is in good condition as the value of the property may greatly affect the potential value of the transaction.

Lease

If the property is leasehold, the lease should be investigated to ensure that the terms will be favourable to the buyer.

Customers

It will be crucial to investigate the customers of the business. Especially important for the buyer will be to uncover who the main customers who make up the core of the revenue coming into the company are. It is common for contracts to include a clause which deals with a situation in which the Company changes ownership; this will need to be investigated as it may force a change to the structure of the deal or an approach to the customer.

 Employees

A thorough report will need to be compiled on the employees of the Company and their respective employment contracts. If the structure of the deal is to be an asset sale then TUPE regulations may come into force which will be something to consider for the prospective buyer.

Contracts of Employment

It is unlikely that the prospective buyer will want to hand new long term contracts to employees before entering the business and having a chance to evaluate their skills.

Redundancies

It is fairly common when a Company is purchased for the new buyers to want to streamline and make the Company more efficient. One of the main ways in which buyers will look to do this will be by restructuring the staff of the Company. All redundancy costs should be figured into calculations before the transaction is completed. Buyers will also have to abide by the strict redundancy procedures which are necessary for the Company to undertake.

Intellectual Property

One of the most important assets of a Company is their intellectual property rights, which can take the form of copyright, trademark, design rights and/or patents.

Their validity and any doubts as to their ownership must be investigated, particularly if any such rights have been registered. Increasingly, the wealth of a business is reflected in such “intangibles”.

Pension Scheme

It is recommended that prior to purchasing a business; a valuation of any pension funds which may be held by the business is undertaken. A pension fund may become a big liability to a purchaser once the transaction is complete.

Litigation

It is pertinent that any potential buyer investigates whether the business is subject to any litigation. The buyer will not want to purchase a business and then be tied up in lengthy litigation which could end up being a big liability to the business.

The due diligence exercise will investigate all aspects of the business including any litigation disputes or claims which may arise. A thorough due diligence exercise will limit the amount of liabilities which could surprise a potential purchaser of a business on completion.

In a recent survey of businesses with in-house legal, the following findings arose :-

• Commercial skills rather than pure legal skills were considered the biggest important factor in senior management’s perception of the value of the legal team
• A significant proportion of those asked classified  the legal function as adding value but not significant value.
• The cost effectiveness of the legal advice was seen as a big driver for having an in-house team
•  Only 21% of the businesses surveyed seek to measure the performance of their in-house legal function.
• Less tan 50% of the businesses asked consider that external lawyers provide financial value.

As with any survey, mush of course depends on the questions asked. The term “adding value” can be looked at in many ways – does it mean improving profitability or does it mean saving money or reducing risk ? This is always the difficulty for lawyers in that most legal advice is inherently of a defensive, cautionary and risk management nature. Only if the risks materialise does the value sometimes show itself clearly.

Some savvy and progressive lawyers, particularly in the current economic conditions are finding ways to make their clients money by tasks such as contract reviews, looking for ways to renegotiate contracts or extricate from contracts. As these can directly impact profit in a positive way, this is smart thinking.

What do you think about the value proposition debate ?

Pre-emption rights are often defined as those rights that shareholders may have to be offered shares in a company before they are made available to anyone else. Pre-emption rights can arise on allotment of shares, transfer of shares and/or transmission of shares. Pre-emption rights is one way to ensure that existing shareholder’s proportion of voting and other rights in a company are not diluted.

Pre-emption rights on allotment

The Companies Act 2006 provides that a company proposing to allot shares may only do so provided that it has previously offered these shares on the same or more favourable terms to its existing shareholders.

It is common practice to find pre-emption rights on allotment in a company’s articles of association or in a shareholders’ agreement.

Provided that a company follows the correct procedure, these pre-emption rights can be disapplied

Pre-emption rights under the Companies Act 2006

These arise under the Companies Act 2006 which state that shares must be offered to existing shareholder in such proportion to their current share holdings, in writing, before they are offered or issued a new shareholder. The company must allow the shareholder at least 21 days to take up the offer.

These pre-emptive rights do not apply if:

(a) the memorandum or articles of a private company exclude them; or

(b) the company passes a special resolution to exclude them; or

(c) the shares are issued for non-cash consideration;

Many articles of association contain provisions on the allotment of shares which either exclude the statutory rights or impose different provisions on share allotment. No issue of shares should be made without being sure what pre-emptive rights apply under the articles, and how the provisions in the articles relate to the current statutory provisions.

Pre-emption provisions on transfer or transmission

There are no statutory provisions relating to share transfers or transmissions, but they are quite commonly included in the articles of private companies as amendments to the Model Articles or Table A (in the case of older companies). Such provisions will also usually apply also to the transmission of shares (i.e. when a shareholder dies or is made bankrupt).

The Data Protection Act 1998 is a piece of legislation which regulates how individuals and organisations process information, especially information which can be used to identify an individual.

In order to comply with the Act, individuals or organisations must only process personal information when they have a fair and lawful reason to do so. The definition of processing under the Act includes almost anything that can be done with information, such as:

• Obtaining it;
• Collecting it;
• Storing it;
• Analysing it;
• Discussing it;
• Destroying it;
• Or even filing it.

The purpose of the Act is for individuals or organisations to only collect the information they need and to use it for specified purposes; they are supposed to delete it when they no longer need it. They are further restrictions within the Act on individuals or organisations seeking to send the information abroad and they also have to ensure that the data which they have lawfully processed is held securely.

Individuals whose data has been lawfully processed by an individual or organisation have the right to see the information to which an individual or organisation are holding on them. They are able to ask for mistakes to be rectified and that the individual or organisation do not use their data for the purposes of direct marketing amongst other things.

The Information Commissioner is the watchdog to which individuals or organisations are responsible to for any breaches of data protection law. They are obliged to report to the Information Commissioner with a report of the types of information they are holding and on what grounds. Once the Information Commissioner has been notified, the information should be placed onto a public register so in theory individuals will be able to see what information is being held about them and by whom.

Under the Data Protection Act 1998 it is seen as a criminal offence for a business not to have notified the Information Commissioner that they are holding certain information. If the Information Commissioner has not received notification from a business that they are holding certain information and conducts an investigation this may lead to an enforcement notice being placed against the business. The Data Protection Act 1998 will require that a business has to enter into a written agreement with anyone to process personal information on their behalf. It is recommended that the business obtains written guarantees from the third party that they will keep the information secure and will not disseminate or use the information unlawfully.

The Data Protection Act 1998 covers the way in which employers can monitor their employees. The Information Commissioner code of practice states that as a general principle the employees must be told how they will be monitored within the workplace and the employer should use the least intrusive method of monitoring available to achieve their goal. This has recently been confirmed by the European Court of Human Rights.

Employers will also have to provide employees with copies of information that they hold on them. Employees will have to make a ‘subject access request’ which must be in writing and the employer has to be convinced that the person making the request for the information is the person entitled to see it. Employers are able to charge the employee a fee of up to £10 for their requested information.

The Data Protection Act 1998 contains a number of enforcement mechanisms, the Information Commissioner has the ability to follow up an enforcement notice with penalties including a criminal offence and a fine of up to £5,000.

Business disputes in family companies are more common than meets the eye.

A case involving celebrity chef Gordon Ramsey (GR) has all the usual elements of such disputes and more, and clearly demonstrates that such disputes can get very bitter very quickly.

Like any other type of legal dispute, there is no failsafe method of preventing a dispute, but a clear shareholders or partnership agreement which sets out control and conduct issues certainly helps.

Mr Ramsay is reported to have started a High Court claim suing his wife’s father, mother, sister, brother, brother’s wife, and their father’s alleged mistress !

The case apparently may  involve many other highly topical issues including :-

• Allegations that the father-in-law repeatedly hacked into GR’s personal and company files

• Allegations that the father-in-law withdrew £1.42 million from GR’s businesses for funding a double life with a secret second family.

Should be an interesting case worth following !

VAT fraud typically has occurred relating to electronic goods such as mobile phones which are imported to the UK from another EU country without having to pay VAT. The fraudster then charges VAT to it’s customers in the UK but does not pay the VAT to the HMRC and folds the trading entity and disappears. Part of the problem with this is that the buyer of the goods in the UK, who has paid VAT and if VAT registered themselves, would then offset this payment against it’s own VAT receipts in the normal way, but the HMRC does not allow this, so it is the innocent buyer that truly suffers as a result of these types of frauds..

What steps can be taken to avoid being defrauded ?

The best method of prevention is to thoroughly vet any suppliers and to watch for warning signs, such as the following :-

• The deal seems suspiciously cheap
• Any new company
• Recent change of directors or owners
• People involved are not known in the industry
• The seller does not have an established business address
• company trades from residential or short-term lease property.
• You are asked to make payments to third parties or offshore bank accounts.

A breach of contract takes place when one of the parties to the contract fails to perform part or all of his/her/it’s obligations in the contract or performs an obligation in a defective manner. Any breach of contract entitles the aggrieved party to claim damages for losses suffered. A repudiatory breach of contract entitles the aggrieved party to treat himself as discharged from further obligations under the contract, instead of or as well as claiming damages.

A repudiatory breach does not end the contract automatically. It is for the aggrieved party to choose, in addition to its right to claim damages, one of these alternatives:

• Termination. The aggrieved party may accept the repudiation, bringing to an end both parties’ obligations under the contract. The decision to terminate the contract has no effect until communicated clearly to the other party. An unclear or equivocal notice will not end the contract.  A party that waits too long to communicate its decision may lose the right to.
• Affirmation. The aggrieved party may affirm the contract, keeping it in existence. This affirmation does not need to be express and can be implied where the aggrieved party does something indicating that it intends to proceed despite the breach. Affirmation can only take place if the aggrieved party knows of the breach and of its right to end the contract.

The most simple way of differentiating between different types of possible bonus in employment is on the basis of either being contractual or non-contractual. However, it is vital that both employer and employee, but particularly employer, are aware that employment law and employment contracts are an area where, due to the inherent inequality in bargaining position between employer and employee, the Tribunal or court will often “open up” a contract or imply a certain meaning to it based on reality, notwithstanding the strict legal terms agreed and incorporated.

As an example if the above, there is a growing tendency for courts to decide that bonus schemes stated as being-contractual or discretionary do in fact, in reality, create contractual or quasi-contractual rights..

Absolute discretion

If the employment contract is very clear in stating that any bonus is subject to total discretion and the employer can show a rational and documented history of discretionary bonuses it makes it harder for an employee to claim a right to a bonus.

Conditions

Based on the fact that whatever is stated in an employment contract will possibly be subject to scrutiny thereafter as regards practical implementation, it is important that a bonus clause is as clear as possible from the outset. Consequently, with most discretionary bonus schemes, the employer will be well advised top clearly set out criteria which will be used in exercising discretion and to comply with these criteria and document the position clearly.

Custom and practice

A common argument, notwithstanding what may be a clear discretionary clause in a contract of employment, is that the employee should have received a bonus based on prior behaviour by the employer. This is known as the “custom and practice” argument, which equates to an implied contractual right rather than an express contractual right. Employers should be aware that a court or tribunal is likely to consider all relevant circumstances, including past practices, particularly if over a number of years, in assessing the possible entitlement .

Repayable bonuses/clawbacks

Examples of common uses of repayment clauses are perhaps most often found when it comes to senior employees offered significant loyalty inducements at the time of joining the employer. These are often called “golden hellos” or signing-on bonuses. If the employee leaves within a set period or perhaps based on other trigger events, the employer will want to claw back payments made. Care and caution is required in drafting any such clauses, because they are capable of being legally attacked in a number of ways :-

• As being penalty clauses
• As being an unlawful restraint of trade