Due diligence allows the parties and their advisors to confirm the current state of affairs of a business and to learn as much as possible about a target business before committing funds to buy it. Sometimes clients have done considerable due diligence through their own efforts and come to you anxious to close the deal as quickly as possible. Others have never given the topic of due diligence a moment’s consideration. Ideally the purchase agreement will provide for a reasonable due diligence period during which the purchaser can get out of the deal if it discovers that all is not as represented.
Ensure that you confirm, in writing, your advice regarding the need for due diligence. Don’t forget to list the possible pitfalls to what, at first glance, appears to be a “clean” purchase, such as:
- the corporate vendor’s legal right to sell (to be confirmed by a review of the company minute book, Registrar of Companies search, Bankruptcy office search);
- liens on the assets by government agencies (to be confirmed by requesting clearance certificates from those various agencies);
- liens on, or other potential claims to, the assets by other creditors (to be confirmed by land searches, PPSA searches and court registry searches for litigation proceedings and judgments); and
- issues affecting the goodwill of the business – an important factor if your client is purchasing the shares of a company or hoping to continue to operate the business under the same name (to be confirmed by searches at Better Business Bureau and civic/municipal/provincial offices, among others).
If the nature of the business is such that its operations extend to other provinces, it may be necessary to engage local counsel to conduct some or all of these searches in those other provinces as well.
This list is simply a sample of the types of problems that your client may encounter and the possible places to conduct searches. An invaluable resource is the Due Diligence Deskbook (looseleaf, The Continuing Legal Education Society of BC), which contains a comprehensive description of the potential searches that can be done in asset and share transactions, as well as sample precedent search letters and contact information.
Discuss with the client the searches that you recommend, given the nature of the business and the structure of the transaction (whether assets or shares). Remember that several provincial statutes provide for liens for unpaid wages, assessments, and taxes that follow the assets and take priority over other charges or interests. Arrive at a practical list, bearing in mind the limitations of time and the client’s budget. Confirm your instructions in writing, particularly any instructions you may receive not to perform particular searches. Beware of excuses for not conducting searches before the anticipated closing of a transaction – a business may seem too attractive to delay closing because of price or a perceived lack of blemishes before searches. If the client wants you to omit or limit the due diligence, particularly statutory searches, this should be documented and confirmed by the client in writing, following your clear advice to the contrary.
If possible, negotiate sufficient time to conduct these searches or provide for a reasonable holdback of a portion of the purchase price. Your failure to conduct statutory lien searches and to confirm basic representations about the business may constitute professional negligence.
When approaching due diligence searches, it is important to determine the appropriate jurisdictions in which to proceed. In a share acquisition, searches should be conducted in each jurisdiction in which the company is carrying on business. In an asset transaction, searches should be conducted in the jurisdictions in which the assets are located.
This is also a good point to negotiate sufficient time to deal with the assignment of any leases, particularly a lease of the premises that the business occupies. Sometimes this process can require weeks of negotiations, particularly if the seller expects to be released from any further obligations or if the purchaser has a less-than-stellar credit rating.
The searches conducted for either an asset or a share purchase are to a certain extent the same, except in a share purchase sale you have additional concerns, for example, about the status of the shares and general company liabilities. Compare the list of searches laid out in the Law Society’s Asset Purchase Procedure checklist and the Law Society’s Share Purchase Procedure checklist.
The following is an abbreviated list of the most common searches conducted by the purchaser’s lawyer (many of the most common searches can be performed for you by registry agent companies):
- Corporate Registry: to obtain the current Notice of Articles and annual report information, determine whether the company had any previous names, determine whether company was ever struck off and subsequently restored; and determine who the directors and officers are. Registration with BC Online gives you quick access to most of this information.
- Personal Property Registry: for notices of certain encumbrances on personal property. If any serial numbered goods, motor vehicles, aircraft and the like are included in the purchase (or are owned by the target company in a share purchase) the appropriate vehicle information number or serial number must also be searched. Registration with BC Online allows quick searches of the personal property registry database (but remember that many encumbrances, such as statutory liens, do not require registration under the PPSA).
- Real Estate Title Searches:
- Land Title and Survey Authority of BC for charges on title of land and for copies of leases. Registration with BC Online gives you quick access to most of these documents.
- Indian and Northern Affairs Canada — if the vendor leases all or part of the land used in the business and the land is situated on a reserve.
- Records office: for review of target company minute book (for share purchase agreements):
- Examine all registers and determine if there are any deficiencies regarding the following:
transfer and/or allotment of shares
- Examine share registers, share certificates, waivers of pre-emptive rights (if any – these may be relevant in older companies that were formed under the former Company Act, where formal waivers of pre-emptive rights were an often-overlooked technical requirement) and resolutions authorizing issuance, transfer, and buy back of shares to determine if shares are validly allotted, issued, fully paid, transferred and redeemed.
- For older companies that were formed under the former Company Act, examine the documents related to the transition of the company under the Business Corporations Act, to assess whether the requisite formalities were complied with and whether or not the pre-existing company provisions continue to apply to the company.
- Examine cancelled share certificates. Can they be located? Are they properly endorsed? If transferred from an estate, have the appropriate tax releases been obtained? If recent transfers from spouses, consider the Family Law Act.
- Determine if directors' and shareholders' meetings have been properly constituted and if the directors have been validly appointed.
- Determine if every transaction and material contract has been properly authorized.
- Do the minutes disclose any contracts or commitments of which the purchaser was unaware?
- Civic/municipal/provincial offices: for arrears of business taxes, licensing bylaw violations, land taxes, zoning or restrictive bylaws.
- WorkSafe BC: outstanding payroll assessments and investigations. This is an important search that should not be ignored, as it is not uncommon for certain types of businesses to owe money to WorkSafe BC or to be under investigation as a result of a worker having been injured.
- Canada Revenue Agency: for corporate income taxes, GST, and employer remittances. If the vendor or target company does not submit the request in writing, then the purchaser’s written request for a “comfort letter” must include the vendor’s or target’s business identification numbers and be accompanied by the vendor’s or target’s written consent (which must be signed by a current director of the company who must provide his or her social insurance number for identification purposes). The request can take a month or more for the response to be received.
- Insurance agent: to confirm placement of adequate insurance.
- Office of the Superintendent of Bankruptcy Canada: to ensure that the company is not an undischarged bankrupt.
- Bank of Canada: Bank Act search (depending on the business). Searches can be carried out by contacting the Bank Act Section 427 Registry.
- Courthouse/sheriff's office (bailiff): Writs of execution or other attachment proceedings. In addition to the courthouses, contact the bailiff service in the relevant jurisdiction(s).
- Court registry: for litigation commenced and judgments registered.
- Employment Standards Branch: search for certificates for unpaid wages and pending investigations or orders.
- Human Rights Tribunal: for pending complaints against a target company. The judgement database of the Human Rights Tribunal can also be searched for past decisions involving a target company or vendor which may be relevant to the business.
- Customs collection: customs liens (e.g., with an import/export business).
- Insurance Corporation of British Columbia (for vehicle ownership information if the business owns vehicles).
- Ministry of Small Business and Revenue: for arrears of provincial sales taxes still outstanding and, in limited cases, outstanding corporation capital taxes. General corporations have not been subject to the corporation capital tax for several years, but banks, trust companies, and credit unions continue to be liable above certain threshold amounts.
- Searches for special assets: such as the Office of the Gold Commissioner for certain mineral claims or leases.
- Credit and complaint searches: including Dun and Bradstreet, Better Business Bureau, and credit bureau. This can be a useful search if the business is being purchased as a going concern (e.g., share purchase).
- Waste Management (Environmental Management Act): BC Online provides access to the BC Contaminated Sites Registry, and where the assets being purchased include land or the target company owns land, the property description can be searched to determine whether there are any existing investigations, such as pollution abatement orders, regarding the property.
- Lastly, don’t forget the potential impact of the Family Law Act (relating to claims to the assets or shares by a spouse), the Investment Canada Act, the Competition Act (relating to mergers and notifiable transactions), and other relevant legislation, upon the transaction.
Refer to the Due Diligence Deskbook (looseleaf, The Continuing Legal Education Society of BC) for examples of sample search letters. For some of these searches you will have to obtain the written consent of the vendor to release of the search results to you.