Due diligence

Question 1

“caveat emptor”?

Answer 1

let the buyer beware”

Question 2

How does caveat emptor apply to private acquisitions?

Answer 2

Yes It is the buyer’s responsibility to ensure that it obtains sufficiently detailed information relating to the company or business that it is going to purchase before completion. This process of gathering information is called due diligence.

Question 3

· The key purposes of due diligence include the following:

Answer 3

 to ascertain whether the proposed acquisition is a good commercial investment;
 to identify potential risks which may affect the structure of the transaction (for example, the discovery of unexpected large-scale liabilities may make an asset sale the only viable option);
 to provide the buyer with knowledge that will assist it in negotiations, in particular with regard to the price;
 to help the buyer identify where it may require contractual protections such as warranties and indemnities;
 to establish whether shareholder consents/ contractual consents/ approvals from regulatory authorities are required before the acquisition can proceed; and
 to assist the buyer to understand the target’s business which will help the buyer to integrate the target within its existing activities post-completion.

Question 4

What will due diligence extend to depending on the sale?

Answer 4

· On a share sale, the buyer will acquire the target company with all its assets and liabilities. Extensive investigation will therefore usually be required in relation to all aspects of the target company.
· On an asset sale, the due diligence can be limited to those specific assets and liabilities that the buyer will be acquiring.

Question 5

· A complete due diligence exercise covers 3 main aspects:

Answer 5

 Legal due diligence
 Financial due diligence
 Commercial due diligence

Question 6

Due diligence process in a Bilateral sale:

Answer 6

· Seller will prepare due diligence materials for review which will often be placed in a data room. This is sometimes, but not always, in response to a due diligence questionnaire prepared by the Buyer’s solicitors.
· Buyer’s solicitors will submit requests for further information (through the Q&A function in a virtual data room if there is one) as it learns more about the target.
· Buyer’s solicitors will review the information supplied and produce a due diligence report for their client.
 Buyer needs this to see whether they want to proceed with the purchase.

Question 7

Due diligence process in an auction sale:

Answer 7

· Seller sets up a data room of information about the target.
· Selected bidders will then be permitted to review the information.
· Buyer’s solicitors will review the information supplied and produce a due diligence report for their client.

Question 8

What does legal due diligence focus on?

Answer 8

· Legal due diligence focuses on establishing the key legal issues affecting the target, including the legal obligations and liabilities which the buyer will be acquiring.

Question 9

· A data room has several benefits:

Answer 9

• it ensures that equal access to information is given to all potential buyers;
• the distribution of information is centralised and more easily controlled;
• it limits the potential buyers’ access to the target’s management team.

Question 10

Most common type of data room?

Answer 10

· Virtual data rooms are the most common option. Virtual data rooms may be accessed remotely or on site and are often provided on a separate platform. A seller can opt for a physical data room, which would normally be located at the offices of either the seller’s accountants’ or the seller’s solicitors , but this is unusual in practice.
· Data rooms will often be segregated to ensure that only “clean teams” review competitively sensitive information and only HR professionals review employee data (which will be anonymised for data protection reasons).

Question 11

How can a due diligence report be presented?

Answer 11

· How the due diligence report is presented will depend on the buyer’s needs.
* A ‘full form’ report sets out detailed information about all aspects of the target and its business. It will also include an executive summary which sets out the key findings of the due diligence review. Most expensive report.
- E.g. a standard form report on all contracts.
* An ‘exceptions only’ or ‘red flag’ report is a shorter, more targeted report focusing only on matters material to the transaction.
- Level of work may be not less than a ‘full form’ report because you still need to review all the docs.
* An oral report takes the form of a presentation to the buyer’s board.
- In addition to a written report.
* Should be proactive to give solutions in the due diligence report.

Question 12

Outcome of due diligence report?

Answer 12

The due diligence report should help the buyer to make an informed assessment of the potential risks and rewards of the proposed acquisition.

Question 13

Buyer options after due diligence report?

Answer 13

• Proceed with the transaction on the terms that have been negotiated;
• Seek contractual protections from the seller, such as warranties, indemnities (compensation if an identified risk arises in practice) and conditions precedent.
• Seeking a reduction in the price (not worth as much as the buyer thought)
• Try to (1) renegotiate the terms of the acquisition or (2) restructure the acquisition to reflect any issues or liabilities identified during the due diligence process;
• Restructuring the deal
• Withdraw from the transaction.

Question 14

• Transitional services agreement?

Answer 14

· Group companies often rely on each other for services. There might, for example, be ‘group’ IT support or payroll services. One of the problems that can come to light during the due diligence process is what the target company will do post-completion – in other words, when the target will no longer be part of the seller’s group.
· The issue is usually resolved by a transitional services agreement. This is an agreement between the relevant parties to provide services for a specified period following completion to facilitate the handover and to provide the target company with sufficient time to put alternative arrangements in place.

Question 15

Key issues to be covered in transactional agreement?

Answer 15

the nature of the services to be provided;
 the required standard of the services;
 the level of fees; and termination provisions.
* This agreement is entered into at the same time as the acquisition agreement.
· Notwithstanding the above: If there is an intra-group supply of goods or services to the target which is key to the target’s business - and which the buyer would like to continue post-completion - a separate supply or services agreement will be negotiated.
 Note that it may be necessary to deal with services provided by the target to the retained seller group in addition to or instead of services provided to the target

Question 16

What is Vendor due diligence?

Answer 16

· This is where the seller provides a due diligence report to the bidders and the potential bidders’ aim is to rely on this report, in addition to carrying out their own due diligence (they will usually still have access to the data room).

Question 17

Benefits of vendor due diligence?

Answer 17

· One of the main benefits of using vendor due diligence is that it can speed up the process by giving the bidders’ advisers an idea of where to focus their investigation of the target. Vendor due diligence is also useful as it enables the seller to identify issues that may need to be resolved prior to the sale.

Question 18

• Legal due diligence covers a number of key areas including general corporate areas as well as more specialist areas including:

Answer 18

• Insolvency checks;
• Compliance;
• Issues in past transactions;
• Material contracts;
• Litigation.

Question 19

• The level of due diligence and the areas included in the due diligence will depend on a number of factors such as:

Answer 19

• The buyer’s approach to risk;
• The deal structure; and
• The type of company, business or assets being acquired.

Question 20

• Key corporate areas typically addressed in legal due diligence:

Answer 20

· Constitution of the target
* Title to shares and/or assets
* Companies House filings and wider corporate governance
* Acquisitions and Disposals
* Separation Issues
* Insolvency Searches
* Regulatory/General Compliance
* Material contacts e.g. supplier contracts; customer contracts
* Material Litigation

Question 21

 The buyer will need to check the constitution of the target for a range of reasons. Examples include:

Answer 21

• Checking the target is validly incorporated.
• Checking for any restrictions on the directors’ powers (e.g. restricted objects) or other unusual governance arrangements which could impact the validity of past transactions.
• Establishing whether there are any restrictions (for example, pre emption rights) on or consents required for the proposed acquisition.
  · The buyer may want to check other areas, examples of which are below, however any problematic provisions can usually be removed or amended post completion. The target company will often adopt new articles to remove problematic provisions or to bring them in line with other buyer group companies.
• Considering the different classes of shares and their associated rights.
• Considering whether there are any restrictions in the target’s constitution which would affect the buyer’s plans for the target company.

Question 22

· The buyer will want to ensure that the seller has good title to:

Answer 22

• the shares in the target company, (on a share purchase). For example have all previous share transfers been properly registered in the statutory books of the target company and have any company buy backs or other changes to the share capital been carried out properly?; and
• the assets being acquired (on an asset sale). For example is the seller the registered owner of any real estate or registered IP being transferred?
  · The buyer will also want to check if there are any charges over the shares or assets being acquired.

Question 23

What will the buyer want to check at Companies House?

Answer 23

• As well as searching public filings at Companies House to understand more about the target, for example who the PSCs are and details of its share capital, a buyer will want to check that required filings have been made and records are up to date.
• Depending on the transaction, the buyer’s advisers may want to look at previous board or shareholder resolutions to ensure that key historic transactions have been validly entered into.
• A buyer would also want to know if there is a pattern of smaller issues. For example repeated late or poor filings which may indicate wider issues with processes.

Question 24

· In relation to any acquisitions or disposals, the buyer would want to check whether the target has any ongoing obligations or liabilities under contracts pursuant to which it acquired or disposed of subsidiary companies and/or businesses. Typical examples of points to look out for are:

Answer 24

• outstanding warranty or indemnity periods (including for tax);
• non-compete and other restrictive covenants;
• any conditions still to be satisfied;
• other “live” obligations such as deferred or additional consideration;
• confidentiality obligations; and
• any post-closing undertakings (e.g. to provide services/products or support after completion) which are still live.
  · In the event that the target or any subsidiary is not a wholly owned subsidiary, the buyer will want to investigate the shareholder dynamics and rights including the terms of any shareholders’ agreement.

Question 25

· The buyer will need to investigate the relationship between the target group/business and the seller’s group. It will also want to ensure that the assets subject to the transaction sit in the right place at completion such that the target group/business can cleanly detach from the seller’s group. Examples of key point to look out for include:

Answer 25

• Assets that are not owned by the target group;
• Contractual relationships or operational dependence on the seller’s group. If the target group/business is reliant on services or supplies provided by the seller’s group, for example, the buyer will need to consider if it can replicate or replace these post completion; and
• Guarantees given by the target group in respect of seller group obligations.

Question 26

Why would a buyer carry out insolvency searches?

Answer 26

· A buyer would want to ensure that neither the target company nor any seller is subject to any kind of insolvency proceedings. Necessary searches would therefore need to be carried out to ensure that the seller, in the case of an individual hasn’t been declared bankrupt and, in the case of a company, hasn’t been put into administration for example or that there are no pending petitions. Obviously, a buyer doesn’t want to acquire a target that is in this position but neither would it want to transact with a seller in this situation: In some cases a transaction entered into with such a seller could be considered void.

Question 27

What would a buyer want to check regulatory and general compliance?

Answer 27

· A buyer will want to ensure that the target or seller has adequate policies and procedures in place to ensure compliance with their regulatory obligations. Key areas include data protection, anti-bribery and corruption and modern slavery.

Question 28

· There will be a number of key issues that a buyer’s advisers will look for in their review of material contracts. Examples include:

Answer 28

• Are there any contractual restrictions on transfer, for example, change of control provisions (in the case of a share sale) or assignment provisions (in the case of an asset sale).
• Under what circumstances are the parties entitled to terminate the contract?
• When are the contracts due to expire and does any party have renewal rights?
• Are there any negotiations in relation to those contracts that are currently in progress?
• Are there any particularly unusual or onerous terms?
• What are the payment obligations under the contract, are there penalties for late payment or any price review provisions?
• Are there any non-compete/exclusive dealing obligations?
• Have key contracts been documented/properly documented and executed and what is the governing law?
  · The input of a commercial lawyer may be required in relation to any material contracts that are identified.

Question 29

Why would the buyer want to check if there is material litigation?

Answer 29

· In the case of a share sale, the buyer will want to know whether the target is affected by any material existing or threatened litigation and if so the relevant details, the most obvious being details of the litigation itself along with the amounts involved.
· The input of a litigation lawyer may be required in relation to any material litigation that is identified.

Question 30

When does data protection apply?

Answer 30

· Where the transfer of information or data as part of a due diligence exercise is made by a UK entity, and where it includes personal data relating to a data subject, it will amount to processing by a controller and will be subject to the legislative framework which protects the rights of that data subject.

Question 31

· Giving personal data to prospective buyers during due diligence will amount to ‘processing’ as ‘controllers’ by both:

Answer 31

• (1) the seller processing the information by providing it as due diligence; and
• (2) the prospective buyer(s) who receive such information and use it to carry out their due diligence investigation.

Question 32

Lawful and fair processing principle?

Answer 32

· Both seller and each prospective buyer(s) involved in a share or business sale need to be aware of the principles relating to processing of personal data (Art. 5 UK GDPR), as they will be directly responsible for their own compliance with these principles.

Question 33

· Principle 1 is that personal data must be processed lawfully, fairly and in a transparent manner.
 In order to process data lawfully, it must satisfy one of the legal processing grounds in Art. 6 UK GDPR.
 These grounds include:

Answer 33

• (i) where the data subject has given consent to the processing (Arts. 6(1)(a)); and
• (ii) where the processing is necessary for the purposes of the legitimate interests pursued by the controller (Arts. 6(1)(f)).

Question 34

· In considering which of these grounds they might rely on to share personal data during due diligence on a corporate transaction, the parties need to consider the following:

Answer 34

 Obtaining consent from all employees/individual customers before completion of a confidential commercial transaction is impractical. The GDPR sets strict rules on what will constitute valid consent, including the need to show that consent has been freely given. This may also be difficult to show – particularly where there is an imbalance of power, as there will be in an employment relationship. It might be practicable in relation to senior employees/directors.
 The legitimate interest condition allows for disclosures which are in the legitimate interest of a controller or third party, providing that such interests are not overridden by the interests and fundamental rights and freedoms of the data subject which would require protection of that personal data. This is the ground that is usually relied on in a corporate transaction – but the parties must actually carry out and document an assessment of (i) the purpose and necessity of the disclosure, and (ii) the balance of this against the individuals’ interests (ICO Guidance) - so it cannot just be assumed.

Question 35

· The second principle of processing data is the ‘purpose limitation’ principle (Art 5(b) UK GDPR). What does this require?

Answer 35

This requires that data must be collected for specified, explicit and legitimate purposes and not further processed in a manner that is incompatible with those purposes. The parties must therefore consider if the sharing of data during due diligence is incompatible with the purpose for which it was collected: if the seller uses a well drafted privacy notice for employees/customers, this should refer to processing in respect of a potential sale.

Question 36

· The third principle of processing data is the ‘data minimisation’ principle (Art 5(c) UK GDPR). What does this include?

Answer 36

This requires that the minimum of personal data necessary for the purpose should be shared. For example, during due diligence, it is generally not necessary to share employee data in such a way that individuals (other than senior individuals) can be identified.

Question 37

· The sixth principle of processing data is the ‘integrity and confidentiality’ principle (Art 5(f) UK GDPR). What does this require?

Answer 37

This requires that data must be processed in a manner that ensures appropriate security of the personal data. So due diligence information should be shared in a secure manner, and the seller should place obligations on the buyer(s) as to its security and confidentiality.

Question 38

• Anonymisation?

Answer 38

· If data is amended so that all personal identifying details are removed and the recipient cannot re-identify the data subjects from what they are given (for example, this would include deleting office location and/or department if there are fewer than 5 employees who would fall into that category), then the ICO’s current position is that this information is anonymous in the buyer’s hands – so it would no longer be personal data and would fall outside the provisions of UK GDPR – SO the principles considered above would cease to be directly relevant.

Question 39

• Pseudonymisation?

Answer 39

· Instead of removing all identifying details, data could instead just be amended to remove the obvious details (such as names and job titles). Although UK GDPR would still apply to the information, this would act as a security measure, helping the parties demonstrate that they are ensuring data minimisation and also appropriate security for the data.
· The approach taken to data when seeking to anonymise it is to ‘redact’ (i.e. cover up or remove) identifiers including names and/or to provide data in a composite format.

Question 40

• Information Notices?

Answer 40

· To comply with UK GDPR, controllers must also provide the data subjects with certain prescribed fair processing information. The required information is often provided by way of a privacy notice.

Question 41

What should the data subject be informed of in an information notice?

Answer 41

 of the fact that their data will be processed, and of the purpose for which their data will be processed.
* This obligation will apply to both the seller (who will be processing data for a new purpose) and the buyer(s), and has obvious issues for maintaining the confidentiality of the transaction.
· If the seller uses a well drafted privacy notice for use when collecting data from employees/customers, this should already refer to processing in respect of a potential sale: in which case the data subject would already have the information (see Art. 13(4) UK GDPR).
· As the buyer(s) will have obtained the data indirectly, they have up to a month to give the notification – or they may postpone notification until the transaction becomes public, relying on Art 14(5) UK GDPR, which applies where a notification would ‘render impossible or seriously impair’ the objectives of the data processing.

Question 42

Data protection at the completion of a transaction?

Answer 42

• On a share sale, only the shares will transfer and so the identity of the data controller (the target company) will not change. Therefore, no additional processing of personal data will occur.
• On an asset sale, however, the Transfer of Undertakings (Protection of Employment) Regulations 2006 (‘TUPE’) which govern the transfer of employees ALSO require personal data about the employees to be transferred from the seller to the buyer at completion. Both the provision and the receipt of this information will amount to processing, so both parties will be under a duty to inform the employees that a new controller is now holding the personal data.
• In practice, it is enough for one party to inform the data subjects. It is normally the buyer who will do this. The seller will, however, want some assurance that this will be done - so the acquisition agreement will often include an undertaking that the buyer will inform all relevant data subjects of the transfer.

Question 43

· The buyer will want to carry out enquiries and investigations in relation to the target’s compliance with UK data protection legislation as part of its due diligence exercise. Key actions points include:

Answer 43

• Checking the records of the target’s processing activities.
• Requesting details of any material breaches of UK data protection legislation by the target.
• Seeking details of the target’s dedicated data protection officers.
• Seeking confirmation that all consents have been obtained in respect of personal data used by the target.
• Requesting details of how personal data is collected.
• Requesting details of all data protection policies, systems and processes.

Question 44

• Key action points in relation to registered IP rights:

Answer 44

· Seek confirmation that all registrations and applications for registration are in the right name and that key brands and patents are registered in the relevant markets by carrying out searches of intellectual property registers in the important jurisdictions.
· Seek confirmation that any and all renewal fees have been paid.
· Check when IP rights will expire. Seek confirmation that the validity of the IP rights has not been challenged by third parties and that the seller is not aware that any such rights have been infringed by third parties.
· Check whether there are any claims or disputes with third parties concerning any of the IP rights.

Question 45

• Key action points in relation to unregistered IP rights:

Answer 45

· If an unregistered trademark is considered especially important, the buyer may ask the seller to apply for registration of the trademark prior to the acquisition.
· Try to identify all important copyright works owned and used by the target.
· Review the employment contracts of any technical staff and any consultancy agreements to establish who owns the copyright in any works created by the target’s employees and consultants. Copyright in any work created by an employee in the course of their employment is owned by the employer unless the contract of employment states otherwise. On the other hand, copyright in any work created by a consultant will usually belong to the consultant unless otherwise agreed in the relevant consultancy agreement.
· Enquire about the target’s documentation and record-keeping procedures; such information is vital to establishing not only the existence and ownership of any unregistered rights but it will also indicate the likely ease of asserting or defending such rights.

Question 46

• Key action points in relation to IP licences granted by third parties:

Answer 46

· Obtain copies and check when the licences expire.
· (a) If the transaction is an asset sale: Are there any restrictions on assignment? Would the sale trigger termination of the licence?
· (b) If the transaction is a share sale: Does the licence contain a change of control clause and, if so, what will the consequences be?
· Check the terms of the licences for any unusual or particularly onerous terms.
· If any licences have been granted to third parties to use IP rights:
· Seek confirmation that the target actually owns these rights.
· What are the terms of these licences? Will the terms prevent the target from using the IP rights?
· If the target has been indiscriminate in allowing third parties to use its IP rights, this may affect the value or even the validity of those rights.

Question 47

• Key action points in relation to software:

Answer 47

· Confirm who owns the copyright in any important software.
 Ownership can be determined by reviewing the relevant contracts. Have the relevant contracts been disclosed by the seller? Identify what open-source software is used by the target, where it originates from and the terms of the open source software licences.
 Confirm how much of the software is licensed from third parties. If any software is licensed, find out the fees payable by the licensees, review the termination provisions of the licences and establish whether such licences can be assigned or novated (for an asset sale) or whether they may be affected by a change of control (for a share sale). Seek confirmation, also, that the target’s use of any licensed software is compliant with the terms of the licence.
 If software is licensed, confirm the target’s access rights to the source code in order to update the software and any rights it has if the licensor enters into an insolvency procedure or does not comply with its obligations under the licence.
 Under what circumstances and on what notice may the licence be terminated?

Question 48

exclusive licence?

Answer 48

a licence where the licensee is the only authorised user of the IP right. The licensor may not use the rights nor may the licensor grant any further licences.

Question 49

sole licence?

Answer 49

a licence where the licensor and the licensee may use the rights but the licensor may not grant any further licences.

Question 50

non-exclusive licence?

Answer 50

allows the licensor and the licensee to use the rights and allows the licensor to grant further licences.

Question 51

· All registered IP rights and key unregistered IP rights owned by the target will be set out in a schedule to the acquisition agreement. It is likely that the buyer will seek reassurances from the seller regarding the accuracy of the schedule. These assurances will generally be as follows:

Answer 51

• the target owns or is authorised to use all such IP rights;
• there are no encumbrances (such as security interests or charges) over the IP rights;
• all registrations have been maintained and relevant fees paid;
• the IP rights have not been challenged and that no IP licences have been breached;
• the target has done nothing to infringe the IP rights of any third party and that there are no claims by a third party that the IP rights have been infringed or are invalid; and
• the transaction itself will not give rise to a termination right under any of the licences.
• These reassurances are usually given by way of warranties.

Question 52

Employment - PAs

· In the context of an acquisition, the buyer will want to ensure that

Answer 52

 (1) it retains all of the key employees it needs to carry on the business and
 (2) the contracts of employment do not contain onerous conditions or allow key employees to leave and set up in competition.

· The buyer may also, following completion, plan to make changes to the employment structure. These could include:
 making redundancies;
 implementing re-organisations;
 and/or harmonising terms and conditions of employment.

Question 53

• Effect of an acquisition on the employment contract

Answer 53

· On a share sale, the target - as a separate legal entity - remains the same pre- and post-completion. There is, therefore, no change of employer - only a change in who owns that employer.
· Given the above, there is no direct effect on the employment contracts – the employees continue as before, on the same terms and conditions that operated before ownership of the shares in the target changed hands.
· When the buyer becomes the new owner of the shares in the target, it will indirectly assume any liabilities in relation to the employees.
· On an asset sale, meanwhile, the buyer becomes the new employer of the employees pursuant to TUPE.
· Whilst the legal employer will change on a business sale, the buyer inherits all transferring employees on, broadly, the same terms and conditions as those under which they were employed by the seller.
· From a practical perspective, employees and their contracts of employment are unaffected by the choice of deal structure; they pass either way, either with the target (on a share sale) or by virtue of TUPE (on an asset sale).

Question 54

· The buyer (whether on a share sale or an asset sale) would expect to receive information from the seller in relation to key employment issues, in particular

Answer 54

• Full anonymised details of all employees and directors and, in particular, details of any key employees.
• Notice periods. For example, are there any unduly long periods or other onerous termination provisions?
• Full details of salaries, bonuses and any commission arrangements (if applicable) and other fringe benefits, (such as company cars, medical insurance or pensions).
• Details of any employees who are on long term sick leave or other leave of absence.
• Details of any employees who only work partly for the business being transferred. For example, where the employee works in the division being sold, and the division being retained by the seller.
• Copy contracts, directors’ service agreements, consultancy agreements and other agreements for services and staff handbooks.
• Details of any active or pending litigation or disciplinary proceedings.

Question 55

· The following are examples of warranties you would generally expect to find in relation to employment issues in the acquisition agreement:

Answer 55

• All employment contracts can be terminated at any time on 3 months’ notice or less.
• The company has not given notice terminating the employment of any employee or made any offers of employment to new recruits.
• No employee is able to terminate his/her contract as a result of the acquisition agreement.
• There are no outstanding or potential claims or litigation against the company.
• All salaries and other benefits have been paid to all directors and employees, to the extent due and payable, in full up to completion.
• Full particulars of all directors and employees are provided (in the early stages of a transaction, details such as name and date of birth would generally be anonymised in order to comply data protection legislation).

Question 56

· After completion, the buyer may want to make changes to the terms and conditions of employment of some or all of the employees. This may be because the buyer wants to:

Answer 56

 cut costs; and / or
 put the new workforce on similar terms and conditions to its existing workforce (often referred to as ‘harmonisation’);and / or
 ensure that key employees are bound by new restrictive covenants and / or confidentiality provisions.

Question 57

· Where individuals are surplus to the buyer’s requirements, the following should be considered:

Answer 57

• Compensation will be payable to a director who is midway through a fixed term contract with no notice provisions.
• Do service contracts contain effective restrictive covenants following termination? Remember that even enforceable restrictive covenants will not survive a breach of contract by the employer.
• Consider the danger of an automatically unfair dismissal claim under TUPE (in the context of an asset sale) or any other potential claim of unfair dismissal.
• Check whether the company’s articles of association contain a Bushell v Faith clause - this would give weighted voting rights to the director on a resolution to remove them as a director, or to change the article conferring those rights, therefore preventing removal of a director under s.168 CA 2006.

Question 58

· If there are certain people that a buyer is keen should stay, at least for a short period post-completion, the following should be considered:

Answer 58

• The buyer will want to ensure that the notice periods of key individuals are long enough and that there are appropriate restrictive covenants in the service contracts to stop them competing with the target for a reasonable period post-completion.
• On a share sale: Check for any ‘golden parachute’ clauses during due diligence. These allow individuals to treat themselves as dismissed, without notice, on a change of control. The clause will also entitle such individuals to receive a specified (and often very generous) payment from the company in these circumstances.
• It may be that the buyer needs to offer a whole new package of incentives to the key individuals it wishes to retain on completion. Although a buyer would want to open negotiations on this front sooner rather than later, particularly where the buyer views the individuals as key to its business operating post completion, a seller is likely to resist this. A seller is likely to want to control, or at least have oversight, over any such negotiations and will only want such negotiations to happen (if at all) very late in the process.

Question 59

What is an occupational pension scheme?

Answer 59

· An occupational pension scheme is a scheme set up and operated by an employer under a trust arrangement in order to provide benefits for employees on retirement or death.

Question 60

What are the two main types of occupational pension schemes?

Answer 60

defined contribution (DC) schemes and defined benefit (DB) schemes.

Question 61

What is a defined contribution scheme?

Answer 61

· A defined contribution scheme is also known as a money purchase scheme. The employer will agree in advance the level of contributions it will make on behalf of the employees who join the scheme, and its liability will be fixed to this amount. This is usually expressed as a percentage of each member employee’s annual salary. The employees are usually required to make contributions into the scheme as well, set at a fixed percentage of salary.
· Defined contribution schemes are often cheaper for an employer to provide. They also give the employer greater certainty as to its pension costs.

Question 62

What is a defined benefit scheme?

Answer 62

· The most common type of defined benefit scheme is a final salary scheme. The purpose of a defined benefit scheme is to provide a pension for life on retirement, from a specified age calculated as a percentage (more often fraction) of the employee’s salary at or close to retirement (for a final salary scheme) or as earned during their membership of the scheme (career average scheme). The relevant percentage is usually dependent on the number of years’ service whilst in the scheme.

Question 63

· Occupational pension schemes are structured using a trust to hold the pension assets, so the key parties to an occupational scheme are:

Answer 63

 The Employing Company/Companies that sponsor and contribute to the scheme - and have responsibility for funding a DB scheme
 The Trustee(s) of the scheme who safeguard the pension assets and manage funding/investment requirements
 The Members of the scheme who pay into the scheme and receive pension benefits
· Some occupational schemes will have a single sponsoring employer; but in a corporate group, a pension scheme is likely to be a ‘multi-employer’ scheme, providing pensions for employees from a number of companies within the group.
· Many corporate groups have both DB and DC schemes for their employees: many defined benefit schemes have been closed to new members and/or to future accruals by the existing members (which means that the members will not be able to build up further rights to an additional proportion of their salary on retirement) - new occupational schemes will generally be defined contribution schemes.

Question 64

What is a personal pension scheme?

Answer 64

· A personal pension scheme is a contractual arrangement between an individual member and an authorised provider, such as an insurance company. Contributions can be made by the member alone or the member’s employer or both.
· All personal pensions work on a defined contribution basis.

Question 65

What is a group personal pension scheme?

Answer 65

· A group personal pension scheme is where an employer arranges with an authorised provider for employees to set up personal pension schemes.
· The employer makes contributions to the group personal pension scheme and pays across any employee contributions deducted from salary (contribution terms will be part of the employment contract, not the pension scheme terms).

Question 66

• Auto-enrolment obligations?

Answer 66

· The Pensions Act 2008 introduced obligations on employers requiring them to automatically enrol eligible employees into qualifying workplace pension arrangements.
· Under the auto-enrolment provisions, an employer is required to enrol each ‘eligible jobholder’ as an active member of a ‘qualifying scheme’ and to make certain minimum contributions to the scheme on the employee’s behalf.
· The employee may also be required to make contributions to their own scheme, which will be deducted from his salary. The employee will be able to opt out of the scheme but if they do so then the employer must automatically re-enrol them once every three years (at which time the employee may opt out again).

Question 67

What is an eligible jobholder?

Answer 67

a person aged between 22 and the state pension retirement age who works in the UK under a contract of employment and whose ‘qualifying earnings’ payable by the employer are more than £10,000 a year (as at 2022/23).

Question 68

· A qualifying scheme?

Answer 68

can be an occupational or a personal pension scheme. It must be registered with HMRC, and it must meet certain quality requirements.

Question 69

Schemes associated with statutory obligations?

Answer 69

· National Employment Savings Trust (NEST)
· Stakeholder pension schemes

Question 70

Issues relating to defined benefit schemes?

Answer 70

· Defined benefit schemes often require additional finance from the sponsoring employer(s), but if an employer becomes insolvent and cannot meet its funding obligations (and certain other conditions are met), the scheme will instead ‘fall in’ to the Pension Protection Fund (a government created scheme), which will partially cover the pension obligations. In order to protect against this, defined benefit schemes are subject to additional statutory provisions.
· The key legislative source is the Pensions Act 2004 (‘2004 Act’), amended by the Pension Schemes Act 2021.
· There are also important provisions in the Pensions Act 1995 (‘1995 Act’).
· The oversight of these statutory protections (and of the funding requirements on the employer) is vested in: The Pensions Regulator (TPR).

Question 71

• Statutory Basis for Funding DB Schemes?

Answer 71

· Pursuant to section 222(1) of the Pensions Act 2004:
 “Every [DB] scheme is subject to a requirement….. that it must have sufficient and appropriate assets to cover its technical provisions [i.e. the amount required to provide for its liabilities, based on actuarial calculations]”
· At least every three years, the scheme’s actuary must conduct a ‘funding valuation’ - used to inform a ‘schedule of contributions’ from the sponsoring employer(s) and a ‘recovery plan’ if the scheme is in deficit.
· If the sponsoring employer’s solvency or its long-term ability to fund any shortfalls in the scheme is in doubt (meaning that the scheme has a ‘weak employer covenant’), the employer may be required to pay more into the scheme through its recovery plan because a more conservative funding basis may be used.

Question 72

· There are additional statutory protections for defined benefit schemes:

Answer 72

 Notifications to the Pensions Regulator are required on the occurrence of significant ‘notifiable events’ that might have an impact on a DB scheme.
 Funding of the scheme is required when an employer ceases to participate in a DB scheme (known as a ‘s. 75 Debt’).
 Where there has been some act/failure to act that has materially damaged the scheme (‘moral hazard’), the Pensions Regulator has the power to issue a ‘Contribution Notice’ (CN) on certain parties.
 Where there is otherwise an under-resourcing of the scheme, the Pensions Regulator has the power to issue a ‘Financial Support Direction’ (FSD) on certain parties.
 Contribution Notices and Financial Support Directions can potentially be served on any of the wholly owned companies in a corporate group, even if they are not themselves sponsoring employers of the DB pension scheme in question.
 TPR operates a clearance procedure under which it can be asked to confirm in advance that it will not use its powers to issue CNs or FSDs in relation to a particular DB Scheme and a particular event (such as a proposed transaction).
 Under the Pensions Schemes Act 2021, TPR can bring criminal prosecutions alongside use of its civil powers.

Question 73

· As part of the due diligence process, it is essential to obtain full details of the pension arrangements for the employees of the target business or company. This will generally include:

Answer 73

• details of, and copy of the governing documentation relating to, each pension scheme;
• confirmation that each scheme is registered with HMRC and whether any defined benefit scheme is open or closed to future accruals;
• confirmation that the target has complied with its auto-enrolment obligations;
• confirmation that all the contributions to each scheme are up to date;
• the identities of the participating employers and the names of the current trustees of each scheme;
• copies of the latest trustee annual reports and audited accounts for each scheme;
• full details of any claims against any of the trustees of any of the schemes;
• copies of all contracting out certificates (This is where a pension scheme has contracted out of the additional State pension);
• confirmation that any defined benefit scheme is sufficiently funded, with copies of the latest statutory funding documentation; and
• details of any contributions which the target has agreed to pay to personal pension schemes.

Question 74

What are the key issues to investigate when conducting due diligence for Defined contribution schemes?

Answer 74

• Cost to employer of the scheme – monthly contributions.
• Whether the target is up to date with auto-enrollment obligations.

Question 75

What are the key issues to investigate when conducting due diligence for occupational schemes where there is an asset sale?

Answer 75

• Obligations that might transfer across to the buyer under TUPE.
  o These would comprise ‘Beckmann’ liabilities relating to benefits other than old age, invalidity or survivors (for example, a right to enhanced early retirement on redundancy).

Question 76

What are the key issues to investigate when conducting due diligence for Defined benefit schemes?

Answer 76

• The funding level of the scheme – and in particular any deficit.
• The likely impact of the transaction on the funding obligations of the target company to the scheme.
• Any notifications of the transaction required to be made to the Pensions Regulator.
• Any risk of a Contribution Notice or Financial Support Direction being served on the target company (NB: This risk might arise even if the target itself is not an employer in the scheme – the parties might wish to guard against any risk by seeking a clearance from TPR).

Question 77

• Effect of an asset sale on pension arrangements

Answer 77

· Where the target operates a single employer occupational pension scheme (operated for the benefit of the employees of the target only):
 Target: No change: the Occupational pension scheme remains with the target after completion.
· Where the target participates in a group occupational pension scheme (operated for the benefit of the employees of a group of companies):
 Seller group: The target will leave the seller group’s pension scheme on completion, so employees will no longer participate in the scheme. Employment terms do not change so the target must provide the same pension benefits to employees. If the scheme is a defined benefit scheme and it is in deficit (assets less than liabilities) at the time that the target leaves the group, then under s. 75 of the 1995 Act, the target may be liable for a proportion of the deficit (a s. 75 liability, as already referenced). The buyer will seek warranties or indemnities from the seller in relation to such liability.

Question 78

• Effect of an asset sale on pension arrangements

Answer 78

· Where the seller operates an occupational pension scheme (OPS):
 Employees transfer under TUPE.
 Seller: The OPS remains with the seller. Enhanced benefits (‘Beckmann’ liabilities) may pass to the buyer, so the buyer may seek an indemnity from the seller. If the OPS is a defined benefit scheme in deficit, the seller may end up with a s. 75 liability to the scheme.
 Buyer: The buyer must provide a scheme to employees who were members of the OPS pre-sale, but is not obliged to match the seller’s scheme and the buyer can decide on the type of scheme orthe buyer can agree to take on the seller’s OPS.
 Where the seller operates a personal pension scheme (PPS)
* Seller -> Employees AND rights under the PPS transfer under TUPE -> Buyer

Question 79

· In a share sale, there is no implied duty to gurantee good and marketable title. This means that it is essential to establish that:

Answer 79

 the seller or the target has good title to the properties and that the properties have the benefit of all necessary rights required for their beneficial use and enjoyment;
 the properties are not subject to any onerous condition or third-party rights which may affect their marketability or valuation; and
 the properties may be used for the purposes intended by the buyer.
* It is usual for the buyer to instruct a valuation of any significant sites, which the solicitor should compare with the valuation made by the seller or the target.
* It is unlikely that normal conveyancing precedents will be used, therefore the contracts may not incorporate Standard Commercial Property Conditions.
* Consider also if the Economic Crime (Transparency and Enforcement) Act 2022 applies - broadly, overseas entities that own, or wish to acquire or dispose of, UK property must be registered on the Register of Overseas Entities.

Question 80

· There are three ways in which the buyer can obtain protection in respect of property issues on a share purchase:

Answer 80

 Investigation of title Certificate of Title Property
 Warranties and
 Indemnities.
· Note: It could still be necessary to get a landlord’s consent if the target holds a lease of land as the lease may contain a change of control clause.

Question 81

When investigating title there should be a focus on:

Answer 81

• Restrictive covenants affecting the title;
• Access issues;
• Provisions in leases such as service charge caps, rent reviews and pre-emptions rights;
• Forfeiture clauses in leases (e.g. due to insolvency).

Question 82

Certificate of title

· The seller’s solicitors will usually seek to limit their potential liability in a number of ways:

Answer 82

 They may qualify the certificate by way of a disclaimer stating that they will not accept responsibility in respect of information supplied by the seller.
 The certificate will be expressed to be for the benefit of the specified addressee(s) only and only in respect of the particular transaction.
 It is likely to include a financial limit on any potential liability. Often liability may be capped to loan value which some lenders may accept.

Question 83

· The property warranties will confirm

Answer 83

 that the seller and the target has good title to the properties;
 that the land is free from charges and encumbrances;
 that all planning legislation and permissions have been complied with, that all covenants have been complied with;
 that the property is in a good state of repair and is fit for the proposed use by the buyer and that there are no outstanding disputes.
· this list is not definitive and is given purely as a sample of the types of matters that the property warranties would cover. Any liability for breach of warranty will, of course, lie against the seller for breach of contract. The seller will want the benefit of the warranties to be restricted to the buyer and the warranties will be qualified by the disclosures in the disclosure letter.

Question 84

Criteria for competition law to bite and consequence of this?

Answer 84

· There must be an agreement between undertakings, a decision by associations of undertakings or a concerted practice between undertakings; which
 may affect trade within the UK; and
 has as its object or effect the prevention, restriction or distortion of competition within the UK.

· An agreement that meets these three criteria is prohibited (and therefore void) unless it comes within an exemption.

Question 85

· Exemptions from Chapter 1 prohibition
 In assessing whether an agreement is prohibited under s. 2 CA, the following decision tree should be followed:

Answer 85

• Step 1: Does a ‘block exemption’ apply?
  o Each ‘block exemption’ exempts from the Chapter I prohibition a particular category of agreement that complies with the conditions set out in that block exemption. Each category of agreement will be a commercial arrangement that the competition authorities consider should be encouraged: examples include research and development agreements, technology transfer agreements and distribution agreements – see further below.
• Step 2: Could the agreement be exempt under s. 9 CA?
  o An agreement that does not come within a block exemption may still be exempt if it satisfies the conditions set out in s. 9(1) CA, BY:
• Contributing to improvements in production/distribution or promoting technical or economic progress – while allowing consumers a fair share of the resulting benefit BUT
• Only imposing restrictions that are indispensable to the attainment of these objectives AND
• Not affording the parties the possibility of eliminating competition.
• Further question: Does the conduct of minor significance regime apply?
  o The Chapter I prohibition applies only where an agreement has an appreciable effect on trade within the UK – agreements between competitors with up to a 10% combined market share OR agreements between non-competitors with a maximum market share of 15% each may benefit from a‘de minimis’ threshold.

Question 86

Competition law

What is a horizontal agreements?

Answer 86

operate at the same level of the supply chain

Question 87

What are vertical agreements?

Answer 87

Agreements are classified as vertical if for the purposes of the agreement the parties operate at different levels of the supply chain.

Question 88

· Most vertical agreements will be drafted so as to benefit from the exemption of the Chapter I prohibition set out in Competition Act 1998 (Vertical Agreements Block Exemption) Order 2022 (VABEO) - which will apply unless:

Answer 88

• Either party has a market share of over 30% in their market; or
• The agreement contains any of the so-called ‘hardcore restrictions’: which include price fixing and restrictions on passive selling – inclusion of any of these provisions would also mean that the parties could not rely on the de minimis limit.
  · Even where VABEO does not apply, e.g. because the market share thresholds are exceeded, the agreement will not necessarily fall foul of the Chapter I prohibition, however, the parties will need to consider the extent to which the agreement might have the effect of restricting competition.

Question 89

Abuse of a dominant position?

Answer 89

· Abuse of a dominant position regulates business entities that are so powerful on the market that they are capable of operating independently of customers and competitors (and hence are ‘dominant’ within one or more of the markets on which they operate).

Question 90

When is a merger relevant?

Answer 90

· A merger will be a relevant merger for review by the CMA if it meets either a turnover test or a share of supply/acquisition test. If the CMA considers that the merger may lead to an SLC, then it has the power either to block the merger or to clear it subject to conditions.
· Other merger control authorities, e.g. the European Commission and national authorities, may also have a role on cross border mergers.

Question 91

Models for taking goods and services to market:

Answer 91

 Direct sales
 Agency
 Distribution
 Licensing
 Franchising

Question 92

Direct sales?

Answer 92

· This involves the client marketing directly to customers, possibly through a subsidiary and often online.
· While directly would generally be seen as the ‘default’ option, a business might ask itself whether it has sufficient internal resources and expertise in marketing to make this the sensible choice. A particularly clear example would be where the business decides to break into a new market, for example by selling its goods in a different country.

Question 93

A public company is selling all the shares in its wholly owned subsidiary company (‘Target’) to a competitor. The Target has a number of offices in England and Wales with approximately 150 full time and part time staff. The Target offers its employees access to a defined contribution occupational pension scheme or a defined contribution personal pension scheme dependant on their seniority within the company.

Which of the following statements correctly explains the position in relation to the pension schemes offered by the Target?

Occupational pension schemes are always defined contribution schemes as employers do not want to be responsible for any deficit that might arise from a defined benefit scheme.

Employers generally prefer defined contribution pension schemes as it means that the pension to which the employee is entitled is dependent on the value of the contributions made to the pension at the time of retirement.

Employees generally prefer defined contribution pension schemes as it means that the pension that they are entitled to on retirement is certain from the outset of their employment

An occupational pension scheme is between an employee and a pension provider whilst a personal pension scheme is between an employee and an employer.

Answer 93

Employers generally prefer defined contribution pension schemes as it means that the pension to which the employee is entitled is dependent on the value of the contributions made to the pension at the time of retirement.

Question 94

Your firm is acting for a corporate client in connection with its purchase of all the shares in a private limited company (‘Target’).

The Target participates in a group final salary pension scheme (the ‘Scheme’) for the benefit of its directors, managers and staff. The Target has just received the actuarial report which has revealed that the Scheme is seriously in deficit.

Which of the following statements is the correct advice in relation to the deficit?

If the transaction is restructured as a business sale, the Target may, be required to pay a proportion of the deficit in the Scheme existing at the date on which the Target leaves the Scheme.

If the transaction is restructured as a business sale, all rights and liabilities under the Scheme will transfer to your client under TUPE. Therefore your client may be liable in relation to the deficit.

If the transaction is structured as a share sale, the Target will leave the group of companies and therefore will have no liability in relation to the deficit.

If the transaction is structured as a share sale, the Target may, be required to pay a proportion of the deficit in the Scheme existing at the date on which the Target leaves the Scheme.

Answer 94

If the transaction is structured as a share sale, the Target may, be required to pay a proportion of the deficit in the Scheme existing at the date on which the Target leaves the Scheme.

Question 95

Your firm is acting for a corporate client in connection with its purchase of all the shares in a private limited company (‘Target’) from a plc.

The Target uses a software under licence from a third-party developer (‘Developer’). Your client is keen to ensure that the Target can continue to use the software following completion.

Which of the following statements is the best advice for your client in relation to the Target’s continued use of the software following completion?

As this is a share sale the Target will be entitled to continue using the software under licence from the Developer following completion. Your client does not need to take any action.

The licence should be checked for a change of control clause. If there is such a clause, your client should seek confirmation from the Developer that it does not intend to terminate the licence.

The licence should be checked for a restriction on assignment. If there is such a restriction, then your client should negotiate with the Developer for a new licence following completion.

As this is a share sale the licence will automatically terminate on a change of control and your client will have to negotiate with the Developer for a new licence following completion.

Answer 95

The licence should be checked for a change of control clause. If there is such a clause, your client should seek confirmation from the Developer that it does not intend to terminate the licence.