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by Vault Law Editors | March 10, 2009


Due diligence

Due diligence, also called document review, is the process of reviewing existing legal and business contracts of a business (including corporate documents, agreements and financial statements) for potential problems and issues prior to a proposed transaction, such as a merger or acquisition. The usual goal is to make sure that there is nothing in any of the contracts that would prohibit the sale of the company (or require a third party's consent) and to make sure that the contract will not terminate as a result of the sale. Usually, an associate will catalog the documents he or she has reviewed and write summaries of the key agreements. For example, when a merger is being considered and the acquirer hasn't had the time to read all of the contracts of the company it is considering purchasing, the lawyers will be expected to summarize the agreements. The purpose of due diligence is to give your client the clearest possible picture of the company you're examining, so the client can assess the risks and benefits of going through with the contemplated transaction.

In an initial public offering, due diligence involves reading agreements that are summarized in the deal prospectus -- the document given to prospective investors summarizing important information about the company and the deal -- to make sure the prospectus is correct. If you are representing an underwriter in a securities offering, you will review documents so that the underwriter can claim to have made a reasonable investigation of the issuer's statements in the offering document. Basically, it's done so that the underwriter will be able to claim the due diligence defense if there is a material misstatement in the offering document. ("I investigated and everything looked fine so don't come after me with a lawsuit because the investors lost their money.")

A junior associate does more due diligence than contract drafting because one of the best ways to learn to draft contracts is to read a lot of them. In the past, lawyers frequently traveled to the company they were reviewing and spent a few days, or however long it took, to review all the materials pertinent to the transaction. Some attorneys have noticed a trend toward cutting back on lawyer travel. Apparently, clients have discovered it's cheaper to have their own employees copy all the documents and send them to the law firm for review.

If you do travel to the company, document review is a great way to bill a lot of hours in a short period of time. You don't waste time looking for work or trying to decide whether to go to lunch with your colleagues. And no one can give you any non-billable work to do, like updating the firm's research files. The company sets aside a room for you and puts all the documents in there, and you read and read and read all day. They send in breakfast and lunch, and you keep reading (and billing). If the company will not let you stay there when they close for the evening, you and your colleagues will go out to dinner and stay overnight in a nice hotel, for which the client pays. If the company does let you stay in their offices, you might be there until 1 or 2 in the morning. Most lawyers find the work tedious, but it's excellent training on how to draft contracts and how to review them for pertinent information. In addition, it's a chance to get to know your colleagues really well. On rare occasions, you'll get to do a little detective work if the company has not supplied the proper documents and you have to interview employees to determine where they are.

Research and writing memos

Researching legal issues and writing memoranda about them is something that you should learn in law school, as research and memoranda writing are essential for all aspects of a law practice. However, this process is rarely the same in a law firm. Not only are memos in corporate law slightly less formal and slightly less constrained by citation rules, your superiors might have very different ideas about what constitutes a useful, readable document. In a corporate law department, you are looking up applicable laws and figuring out what practical impact they have on your client's decisions and actions, rather than assessing the state of the law on a certain issue in the abstract. It's important to research and write the memo as quickly and efficiently as possible without sacrificing thoroughness and accuracy. Don't be surprised if your first memorandum comes back to you bleeding with editorial suggestions. And don't let it bother you. Just make sure to incorporate all of the suggestions into your revision and ask questions if you don't understand a comment.

Contract drafting and review

Drafting a contract is preparing the contract from the beginning -- usually starting with a form and then tailoring it to fit the needs of the parties. You put down in words what the parties have agreed to in principal as best as you can so that there are no ambiguities in the future when the same parties or others read those documents. Then you or your senior associate will go back and forth with the lawyers for the other parties to revise and refine the document until all parties are comfortable signing. Negotiation of the contract involves some compromise. Once you understand what is important to your client and what they can live with or without, you try to strike the best deal for them without risking endless delay or total breakdown of the process. It's best not to spend too much time trying to hash out issues that aren't really essential to your client.

Review of a contract is simply reading the contract to determine what the parties' rights are under its terms and whether any of the terms may be detrimental to your client. When you're starting out, the person who gives you the assignment will tell you what to look for. Ultimately, you'll have read so many agreements that you'll know what's standard and what could be disadvantageous to your client.

Formation and "housekeeping" of corporate entities

As a new corporate associate, you will learn to draft basic certificates, like a certificate of incorporation. These certificates are modeled after a form, so such tasks are pretty easy. In many firms, this kind of work is also handled by experienced paralegals, and those paralegals can often be a great source of knowledge for a new associate.

But before you file the papers, someone has to determine what would be the best structure of the organization, depending on the clients' goals. Examples of different legal entities include general partnerships, limited partnerships, limited liability companies, C corporations, S corporations and business trusts. Each structure offers its own legal and tax advantages and disadvantages. For example, a limited liability company, which is a hybrid between a partnership and a corporation, might provide the best tax treatment while retaining the limited liability advantage of a corporation. If the company wants to trade shares on an open market ("go public"), they have to use a standard corporate form, or C corporation, since that is what stock exchanges usually require. For a smaller company, with no immediate plans of going public, an S corporation, which, unlike the C corporation, does not pay income taxes on earnings (instead, the shareholder pays income tax on dividends), might present a better solution.

Forming the company is easy, and a paralegal can usually accomplish this task, although it is a good idea for a new lawyer to learn the process and be able to review the paralegal's work. The hard part is determining what the rights of the owners are in relation to each other, including consideration of how the parties are going to get out of the relationship if they decide their goals are not being met, and making sure that all of this is reflected in the company's documents, whether via a shareholders' agreement or an LLC agreement, in the articles of incorporation or bylaws, or even on the share certificates themselves. As a new lawyer, you won't be making these decisions. Either you'll be executing the instructions of another attorney, or taking a crack at the project yourself and then learning the correct reasoning when the someone else reviews your work.

After you have created a legal entity under the applicable state law, you have to continue to ensure that proper documentation is made of the company's decisions and actions so that there is a clear corporate history of regulatory compliance. Corporate "housekeeping" involves drafting and filing the necessary paperwork to maintain an entity's corporate status with the appropriate governmental entity, usually a state secretary of state's office and the Internal Revenue Service. For example, you may draft and/or review board of directors' resolutions, file tax records, maintain and prepare stock certificates, and draft partnership or shareholder agreements.

Often, small companies are formed without the advice of a lawyer. When this happens, the corporate formalities, other than the filing of simple articles or certificate of incorporation might be largely ignored. This doesn't usually become a problem for the company until it becomes an acquisition target (meaning someone wants to buy the company) or when the company has expanded and wants either to start raising capital through the sale of shares or to go public. At this point, a lawyer will often have to work with the client to recreate the records that the corporation needs and may even have to amend the articles of incorporation to permit for the issuance of additional and different types of shares. You will have either to know or to research the corporate statutes of the state of the company's organization to make sure that the company is in compliance with the state's requirements.

Preparing filings for state and federal agencies

It's likely that a new associate will prepare filings other than corporate organizational documents. At a minimum, an associate will usually get some exposure to corporate securities filings. When a company wants to start selling shares to people who were not involved in the inception and management of the company, that company must share a great deal of information about itself. The kind of information the company must provide and the format in which the information must be provided depend on the level of financial sophistication of its investors. The Securities and Exchange Commission (SEC) regulates this process. If your client wants to sell shares to all kinds of investors, they "go public" and are "traded on an open market." If they choose to do this, they will be subject to very strict disclosure requirements. The documents they have to produce are lengthy (usually over a hundred pages) and extremely number-intensive. They must comply with very specific rules and regulations. Most associates will spend some time proofreading these documents and researching applicable laws and regulations.


Filed Under: Law

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