Letter of intent and due diligence

In connection with our previous articles on commercial transactions, we covered letters of intent (hereinafter referred to as the “Letter” or “Letters”) (see https://endlex.ca/letter-of-intent-definition-and-purpose/) and due diligence (“DD”) (https://endlex.ca/due-diligence-dd-introduction/). The purpose of this article is to discuss the negotiation of DD at the Letter stage.   

1.  Elements of DD to be negotiated 

The Letter generally stipulates the elements of the upcoming DD: 

A. The duration of the DD and access to relevant documents; and 
B. The consequences of the DD on the other elements of the commercial transaction. 

 

A.Duration of the DD 

The Letter usually stipulates that the buyer has a defined period (usually between 30 and 90 days after receipt of the relevant documents, depending on the nature of the target company and other circumstances of the transaction) to review the target company’s business, and that the seller must provide all relevant documents requested by the buyer, including access to the target company’s offices if necessary.  

Following signature of the Letter (or concurrently with it, as the case may be), the buyer sends the seller a DD list containing all the documents to be reviewed as part of the business transaction. This list is usually prepared by the buyer’s legal advisor and must be adapted to the nature of the business and the upcoming transaction.  

It is important to note that DD periods are often extended, for several reasons. 

Firstly, the DD period in the Letter implies that the seller has all the DD documents ready for the buyer as soon as the Letter is signed, which is rarely the case. We therefore need to consider the time required to assemble the documents requested by the buyer.  

Secondly, the receipt of documents (incomplete or not) may lead to additional requests to validate certain information, and these additional requests require a considerable amount of time to respond to.  

Consequently, the parties, especially the buyer, need to be patient in the context of a DD, and understand the reasonable requests for extensions on both sides.  

B.Other terms and conditions  

The Letter also stipulates the terms and conditions under which the purchaser may accept or reject the DD’s conclusions, and it is important to negotiate these provisions carefully because of their impact on the rest of the transaction.  

First and foremost, the Letter generally stipulates that, at the end of the DD period, the buyer has the option of confirming whether he accepts or not the DD. Sometimes, the parties negotiate presumptions of acceptance or refusal at the end of the DD period, and these presumptions are negotiated according to the strategy of such parties. In fact, when the buyer wishes to purchase a business that has a lot of potential buyers, it may be wise to establish a presumption of acceptance of the DD, meaning that at the end of the DD period and in the absence of any notice to the contrary, there is a presumption that the buyer has accepted the DD for the purposes of the rest of the transaction. The seller would also like to have a presumption of acceptance as reassurance for the next steps in the transaction. In other cases, such as when the buyer has reason to believe that the business is a risky one, it may be advisable to go for a presumption of refusal, which means that in the absence of any notice to the contrary, the buyer is presumed to have refused his DD at the end of the relevant period.  

Secondly, the DD terms in the Letter influence other important steps in the transaction, including the possibility of terminating the Letter. Indeed, some Letters may stipulate that if the buyer does not accept or conclude the DD before a defined date, this may constitute unilateral termination of the Letter by the seller. By the same token, refusal by the buyer to accept the conclusions of the DD also constitutes unilateral termination of the Letter by either party. 

Finally, it is important to note that, following the DD, Letters are often amended to reflect the DD ‘s conclusions, in which case the parties (especially sellers) must understand that these are reasonable requests that may arise on either side.  

  1. Conclusion  

Negotiating good DD clauses in your Letter is in the best interests of all parties, given the consequences it may have on the rest of the business transaction. Contact us to find out more! 

Information provided in this article is intended as general introductory information only. The information provided in this article is not legal advice. It should not be construed as legal advice and should not be relied upon as such. Should you want legal advice regarding the information provided in this article, please contact one of our lawyers. 

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