To Do Due Diligence: It’s Not Just for Mergers & Acquisitions

Legal due diligence is most often discussed in the context of merger and acquisition transactions.  This makes sense; when a person or business seeks to purchase another business entity, it is prudent to know exactly what is being purchased.  However, due diligence is often overlooked in other, less obvious, contexts.

Many types of transactions between businesses, and even between individuals, might require some degree of due diligence, although not the full investigation that would occur for an M&A.  Of course, there is a spectrum of what degree of diligence is sensible for different types of transactions.

On a smaller scale, a business or homeowner might hire a contractor to do work on a home or office.  It is commonplace to ask to see the contractor’s insurance certificate and other relevant credentials.  This is one form of due diligence.  On the opposite end of the spectrum, two or more businesses may enter into a joint venture to develop a new product or offer a joint service.  Negotiations around the joint venture should include a greater degree of due diligence.  Other examples of business relationships that may call for an intermediate amount of due diligence include labor sharing arrangements, contracts with crucial vendors/suppliers, and even contracts with crucial customers.

For some of these transactions, it is sufficient to determine that the other party is a business entity validly existing under the laws of its home state.  It may be enough to ask for a current charter document (e.g., a certificate of incorporation for a corporation, or a certificate of formation for a limited liability company); or, if you know the other party’s state of domicile, this information may be publicly available on a state database.

In other instances, such as joint ventures, it is perfectly reasonable to request more documents and information from the other party.  Any business that is reluctant to share basic information with a potential partner (even though, subject to a non-disclosure agreement) might not be a business with which you want to form a symbiotic relationship that may be difficult to later unwind.  For example, joint venturers intending to jointly develop and market a new product should know about each other’s outstanding debts and obligations to avoid a situation where one side’s existing commitments distract from the joint venture’s goal or sap resources that might otherwise be useful to the joint venture.

Ultimately, the degree of diligence necessary in any given transaction is fact and circumstance specific.  But you should always consider asking a potential business relation for basic legal information, so that you have a more complete picture of that entity’s background and capabilities.  A non-disclosure agreement can protect the confidentiality of the shared information and give the relationship a greater air of formality.