Proper Due Diligence Investigations

Reinier W.L. Russell, LL.M.
Russell Advocaten, B.V.
Amsterdam, Netherlands

Directors may be held liable if they don’t conduct or have not commissioned proper due diligence investigations before taking over a company. How can you prevent this?

Before the takeover of a company the board of the buyer usually commissions due diligence investigations (also known as audits) of the company they intend to take over. Is the board required to do so or not? And in the event of investigations - how do they have to be conducted?

Conducting Investigations?

It is up to the management of the buyer to opt for due diligence investigations and to ensure proper investigations. By this, risks can be assessed that may lead to a reduction of the sales price or the inclusion of warranties in the sales contract. To take a responsible takeover decision it is important to be up to date regarding the risks of the target company and the transaction.

Apart from due diligence investigations, there is of course another way to identify the risks. However, directors will then be on a slippery slope. Opting for not conducting due diligence investigations may result in personal liability. However, this is not always the case.

The Enterprise Chamber has listed a number of conditions that together could lead to the result the option not to conduct due diligence investigations does not result in liability:

The management of the buyer has known the group which the target company belongs to and the target company itself for some time.
The management of the buyer has not just based its decision on the information received from the seller.
The management of the buyer has based its decision on a (critical) report of a third party.

Actually, this implies that the management does not have to conduct due diligence investigations if it already has all information such investigations might disclose. Without this kind of information not performing due diligence investigations might result in liability of the board.

Proper Investigations?

Directors’ liability may also arise if due diligence investigations were performed improperly. Which standards does the board have to take into consideration?

The Enterprise Chamber has indicated that due diligence investigations have to cover the financial condition, the reliability of the administration, and the internal provision of information in the financial field of the company to be taken over.

The following conditions may lead to the conclusion that due diligence investigations were conducted improperly:

The order confirmation for the due diligence investigations is sent to a person active within the sphere of the seller. This shows that the seller does in fact conduct the investigations of the buyer.
The commissioned work is rather limited.
The buyer’s accountant has no part in the investigations.
The investigations are conducted on the basis of information provided by the seller.
Important consolidated financial statements are missing, for instance regarding years with unclear results.
The affluence of the seller was not investigated.
“Key contracts” (contracts of the company to be taken over that are of importance for the decision whether the transaction is desirable) were not consulted.

Our Advice

As board, you are well advised to conduct investigations regarding the target company before, for instance, a share transaction or any other form of takeover. Though it may not always be required to conduct proper due diligence investigations to justify a transaction, the possibility to be held liable will be significantly lower.

When conducting due diligence investigations, make sure to check not only the current state of the company’s affairs, but also the obligations you will take over in the future. Go through important contracts and investigate the financial state of the company, the reliability of the administration, and the internal information provision in the financial field.

More Information

Would you like to learn more about due diligence investigations? Or would you like to commission due diligence investigations? Please contact Russell Advocaten.