DUE DILIGENCE: PART FOUR, COMMERCIAL CONTRACTS
January 31, 2017
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. Last time, we discussed the importance of corporate records and what they should include. This week, let’s take a look at commercial contracts.
Often the biggest asset of a target company is the material commercial contracts that it has signed. As a result, a business attorney must review these agreements to confirm that they will remain in effect and determine what, if any, steps are required for them to remain in effect. When there are many commercial contracts to review, and particularly if multiple people will be reviewing some or all of the contracts, it is often helpful to provide a specific diligence review chart or summary template where the key provisions are summarized.
These key provisions may include, at a minimum:
- the name of the contract;
- the other party to the contract;
- the effective date;
- the term or termination date;
- a summary of the termination provisions;
- a summary of the payment or economic terms;
- a summary of warranty, indemnification, or other obligations that continue after the contract terminates; and
- a summary of the assignment and change of control provisions.
In addition to customer contracts, a business attorney should also review vendor contracts in order to understand the target company’s obligations. With this information, the buyer is better able to decide how it would like to treat such agreements. In reviewing these contracts, it’s essential to be aware of red flags to look for. An attorney should look for anything that might impact the buyer’s ability to obtain the supplies or make the sales that it expects after the transaction is consummated, as well as any pricing surprises that could pop up post-closing. Since the number of contracts can be voluminous and difficult to gather for a data room, there is occasionally a dollar threshold that limits review to only material contracts. In addition, some relationships may not be documented, which will require interviews with representatives of the target company.
Some unusual provisions that should be identified in any type of contract include exclusivity, minimum purchase requirements, and non-compete or other restrictive covenants. A reviewer of a contract should also confirm that the copy is fully executed and review any amendments or addenda that have been signed since the date of the initial contract. Other information that should be requested, which may not be apparent from a review of a contract, is whether either party is currently in breach of a contract or if any notices have been received that indicate a contract will not be renewed.
As you can see, the review of commercial contracts in the context of due diligence requires careful analysis and nuanced judgement. If you’re looking for help with due diligence on your next strategic transaction, please feel free to contact me at the Forrest Firm.
Look for our next installment of the series, where we’ll discuss due diligence with regard to financing documents.