Liability Due Diligence in M&A: What to Expect, What to Know

Any company can be sued at any time, for almost any reason. It’s something every business has to grapple with. But in the world of mergers and acquisitions, the potential for a lawsuit poses a serious threat to selling a business. This is doubly true if there is the possibility of a lawsuit that is either very expensive to defend, or that yields a big loss (or settlement). As a result, liability due diligence is usually a part of the due diligence process. Moreover, sellers often must agree to indemnify buyers against lawsuits arising from the seller’s negligence, or from any information the seller omitted from due diligence. So what can sellers expect as part of the due diligence process? And what should buyers look for as part of due diligence M&A. Here are some key topics. 

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Ongoing Litigation

Sellers must tell buyers about all ongoing litigation. This includes lawsuits that have been filed, as well as suits currently in mediation. If a seller has recently settled a lawsuit that will obligate payouts or other changes, they must inform the buyer. 

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Threatened Litigation

If a person has threatened to sue, sent a spoliation letter, notified a seller they are represented by counsel, or otherwise given a seller reason to believe that litigation is possible or likely, the seller must disclose this fact to the buyer. 

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Intellectual Property

Intellectual property poses an area of potentially significant exposure for many businesses. Some common issues include: 

• IP created by third parties: Who owns it, and what does the contract say? 
• IP used publicly: Photos a person uses online are not public property. Consider whether the seller has paid for all IP it uses. For example, has the seller hired a blogger to gather images for blog posts? Has it paid for those images? 
• Licensing: Does the seller owe licensing fees for any intellectual property it currently uses? 
• Value of IP: In many companies, valuable IP is a key selling point. Sellers must ensure they fully own the IP and all of its components. 

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Contracts

Well-written contracts provide significant protection against lawsuits. Poorly written or nonexistent contracts can give rise to lawsuits. Every seller should consult with their lawyer to review all contracts, including: 

• contracts with contractors and other third parties
• IP contracts
• employment contracts
• settlement agreements 
• service and product agreements, especially for subscriptions or enrollments 

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Where appropriate contracts are not in place, the expense and time involved in rewriting them is often significantly less than the potential expense and time of a lawsuit. 

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Areas of Exposure

Even if there’s no current litigation or threat of litigation, many companies have glaring and obvious areas of potential exposure: chronic copyright infringement, for example, or a history of sweeping sexual harassment under the rug. Buyers should seek out this information early. If sellers know they have a problem—or should know—they need to reveal it. And if they don’t, they could be liable for an eventual lawsuit, even after the sale of the company.