By Jeff Wolfe
At the Forrest Firm, we often represent clients as they negotiate and enter into strategic transactions with other companies, such as mergers and acquisitions, strategic alliances, and joint ventures, and licensing. One of our most important jobs as corporate attorneys is guiding our clients through the process of due diligence associated with these types of transactions, especially with regard to the mergers and acquisitions that occur between companies on a regular basis.
Recently, we began a series of articles focusing on due diligence from our legal perspective. In the first installment of the series, we discussed the big picture of due diligence, taking an overall view of the process of due diligence and its proper execution in the context of a strategic transaction. Next, we looked at due diligence with specific regard to assignment and change of control provisions.
In this post, we’ll outline due diligence with concern to corporate records.
Legal counsel for the buyer will want to review the principal formation documents of a target company, including the articles or certificate of incorporation and bylaws if the target company is a corporation, or the articles or certificate of organization and operating agreement if the target company is a limited liability company, including all amendments. In addition to the initial charter document filed with the Secretary of State in the target company’s state of formation, a business attorney should review all documents on file with the Secretary of State and obtain a certificate of good standing (both at the beginning of the due diligence review and one that is dated closer to the closing date).
Besides the bylaws and operating agreement, companies may also have agreements among the owners (e.g., stockholders’ agreement, voting agreement) that provide additional rights to the owners (or transaction restrictions).
These corporate records will collectively provide important information regarding the target company (e.g., its official legal name, rights of existing equity owners, and any restrictions on the target company’s business or ability to consummate the proposed transaction). Reviewing these documents alongside the state of formation’s statutes will also help you determine whether approval by the owners of the company is required (and the requisite approval threshold). Besides basic approvals, there may also be rights of first refusal or pre-emptive rights that would impact the proposed transaction.
Since these types of records tend to be standardized or plain vanilla, any unusual provisions should be noted (e.g., a poison pill).
Reviewing the minutes and all materials distributed in connection with all meetings of the target company (ownership and board level) will also give the business attorney an opportunity to learn the history of the target company and identify key agreements that should be reviewed at some point during the diligence process (either initially or in a subsequent due diligence request if not provided). For instance, if the board and shareholders approved an acquisition, you should expect to find the acquisition documents among the diligence materials provided by the target company. It’s also a red flag if the target company does not maintain adequate corporate records, including board minutes, which can sometimes be cleaned up with the board of directors or shareholders ratifying prior actions.
In reviewing minutes of ownership and board meetings, it’s also important to look for any red flags, which may include actions that were taken in violation of the target company’s formation documents or applicable law; written consents signed in lieu of meetings not containing sufficient signatures; or litigation (or threats of litigation) or other negative business developments mentioned at board meetings.
Actions classified as in violation of the target company’s formation documents may include the elections of directors, appointment of officers, issuances of equity and debt securities, and related-party transactions.
Lastly, the corporate records of a target company should include capitalization charts, stock ledgers and other stock records; certificates of authority to conduct business in states where it conducts business (other than the state of formation); and organizational charts describing subsidiaries, divisions, and branches and the management structure (i.e., titles and reporting levels).
In our next installment of the series, we’ll discuss due diligence with regard to commercial contracts.