Legal due diligence when buying a business

Conducting due diligence is an essential step before buying a business. This article discusses some of the basic searches that apply to most transactions.
Langley_Surrey_Business Lawyers

Conducting due diligence is an essential step before committing to buying a business. The term “due diligence” encompasses a wide range of topics that go far beyond the type of due diligence that lawyers can provide. Outside of legal due diligence performed by a lawyer, buyers will also typically consider financial and accounting due diligence, insurance due diligence, and other types of due diligence depending on the type of business being acquired (e.g. environmental, engineering, information technology, etc.)

There are 3 main areas that lawyers look at when considering legal due diligence:

  1. statutory searches
  2. document review
  3. regulatory approvals

Additional steps may be required depending on the nature of the transaction and of the business being acquired.

This article provides a high-level summary of the basic statutory searches conducted in a typical business acquisition in British Columbia, and is written from the perspective of a purchaser of a business in British Columbia.

The purpose of legal due diligence is to try to identify as much as possible about the target business before committing to purchase it. While it is impossible to determine every possible fact and circumstance for a target business, there are numerous steps that can assist in drawing out issues before they become a problem for a buyer.

Statutory Searches

There are a wide variety of public searches that lawyers routinely perform for clients in context of a business acquisition. Although not all searches are mentioned in this article, these are some of the basic searches that apply to most transactions:

Corporate Registry Searches

If one or more of the seller or any other party (such as a guarantor or indemnifier) to the transaction is a corporation, corporate registry searches will be performed. Among other things, these searches can confirm:

  • whether the company was validly incorporated;
  • whether the company is active and in good standing with the corporate registry;
  • who the directors of the company are;
  • the legal name of the company;
  • the location where the company may be served legal documents and where its records are stored (i.e. its registered and records office); and
  • the nature of its share structure.

Sometimes inferences can be made from a corporate search. For example, if a corporate search yields that the target company has not filed its annual reports for 2 years and is in the process of being dissolved, this may indicate deeper problems such as internal disorganization or neglect for mandatory legal filings. It is not always the case, but often a company whose corporate registry documents are not current will not be current with other government filings.

Bank Act and Bankruptcy Searches

Section 427 of the Bank Act (Canada) allows certain businesses to grant security to banks over certain property. The list of property that can be encumbered under this section is broad and may apply to a wide range of businesses. Since section 427 security effects a legal assignment of goods to the bank, it is important for buyers of a business to know if such security exists. A search of the Bank Act Security Registry can accomplish this.

It is important to know whether a target business is or has been subject to bankruptcy or other formal insolvency proceedings. Information about the existence of bankruptcy and insolvency proceedings can be obtained through public searches. The nuances of bankruptcy and insolvency law are complex and go beyond the scope of this article—if a bankruptcy search yields any abnormal results, specialized legal advice will usually be required.

Court Registry Searches

A search of the various court registries can assist in determining the existence of actual or pending litigation against a target company. Actual, pending or threatened lawsuits can impact the seller’s ability to transfer assets or shares to a buyer. When acting for a buyer, lawyers often search court registries in each jurisdiction where the seller carries on business to try and identify litigation issues.

Land Title Records Searches

Whenever an acquisition includes an interest in real estate (such as a transfer of ownership, or transfer of a lease of real estate), land title searches should be conducted. Among other things, a search of title can indicate the legal owner of the property, the presence of legal and financial encumbrances on the lands (such as mortgages, easements, leases, restrictive covenants, or judgments), and can confirm the correct legal description of property.

Where land or lease is being acquired, this will trigger numerous additional legal due diligence steps for consideration by the lawyer and their client, such as: environmental, zoning and land use, and municipal searches.

Personal Property Registry Searches

Searching the Personal Property Registry can provide information about security interests and liens registered by creditors against a target business’ assets. Generally speaking, a purchaser will want to ensure that the business assets are free of any encumbrances and liens. Although the Personal Property Registry cannot identify every type of possible lien against property, it is a very useful search to identify many of the typical liens and encumbrances registered by creditors in British Columbia.

Workers’ Compensation Records

If a target business has been an employer in British Columbia (note: the Workers’ Compensation Act contains a broad definition of “employer”), Workers’ Compensation records will be searched. These searches can yield whether or not an employer is registered with the Workers’ Compensation Board, as well as outstanding assessments and penalties against the target.

As a buyer, it is important to know about non-registration or the existence of outstanding assessments or penalties. Significant penalties can apply for non-registration, and the employer is liable for the costs of all injury claims to workers arising during a period of non-registration. These costs can be significant, even for what appear to be small injuries. Since amounts owing under the Workers’ Compensation regime can result in charges against the target business, it is important for buyers to be aware of and conduct the appropriate searches of Workers’ Compensation records.

Employment Standards Searches

A search of the Employment Standards branch can provide information about unpaid wages, holiday or termination pay of BC-regulated employees (federally regulated businesses are subject to additional legislation). Importantly, unpaid wages constitute a lien on all of the property of the employer. Therefore, the Employment Standards search is important whether or not a buyer will be taking on employees of a target business.

There are numerous aspects of legal due diligence that can be performed in the context of a purchase and sale of a business. This article discussed some of the basic searches that apply to most transactions. However, there are numerous other searches that your lawyer may wish to perform as part of the due diligence for your specific transaction.

All of the searches and legal due diligence discussed in this article have limitations—before relying on the results of any legal due diligence, legal advice is strongly recommended.


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