Due Diligence - Roping the Wind for Dust Particles

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Due DiligenceRoping the Wind for Dust Particles

Presented by: Brian AbrahamSeptember 28, 2011

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What is due diligence?

• Due diligence is an important step toward the acquisition of a business – assets, property interests, shares, and/or mixed elements

• It is a process by which clients, lawyers and other advisors tryto learn as much as possible about a target business or property before committing funds to enter into an option; joint venture lease

• Legal due diligence is just one element of due diligence process

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CREATING A DUE DILIGENCE FRAMEWORK

Why due diligence?

• Lawyer’s role in due diligence is to ensure achievement of client objectives

• Why does the client want to acquire the ‘target’property or interest?

• Will the client’s acquisition of target business help them achieve their end objectives?

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Different purposes for due diligence

• Some due diligence is “target” focused, this type of investigation attempts to address the risks and or issues regarding what is being acquired– e.g. existence of underlying agreements,i.e. royalties

• Transactional due diligence addresses the risks and or issues concerned with getting the deal done– e.g. loan agreement requires consent of third parties for transaction, original owner

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Why due diligence?

• Time, cost, and transaction constraints are important to consider

• Due diligence expectations and processes should be set out in writing for both counsel and client and should be re‐assessed as new information is learned and evaluated throughout the process

• Regularly scheduled meetings for updating purposes

• The creation of a due diligence framework, frequent status reporting and a simple easy to update format can help make the process go more smoothly

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Legal Due Diligence ChecklistBasic Corporate Documents

Searches

Property Records

Securities Regulation and Issuances

Shareholder Information

Material Contracts

Underlying Contracts

Financial Information

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Legal Due Diligence Checklist

Employee Compensation/Benefits Plans

Patent, Trademark and Copyright Matters

Proprietary Information

Tangible Property

Litigation and Audits

Environmental

Management

Local Customs and Practices

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Basic Corporate Documents• Bylaws, including all amendments.• Articles of Incorporation, including all amendments.• Minutes of all meetings of directors, committees of directors and

shareholders, including copies of any written notices (if given) or waivers thereof and any written consent to action without a meeting within the past five years.

• List of all provinces, states and countries where property is owned or leased or where employees are located, indicating in which provinces, states and countries the Company is qualified to do business.

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Basic Corporate Documents• Copies of any voting trust, shareholder or other similar agreement

covering any portion of the Company’s shares.• Copies of all agreements relating to repurchases, redemptions,

exchanges, conversions or similar transactions.• Copies of all agreements containing registration rights or assigning

such rights.• Copies of all agreements containing pre‐emptive rights or assigning

such rights.• All quarterly and annual reports, proxy materials and any other

communications to the Company’s shareholders within the past five years.

• List of all subsidiaries.

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Searches• Applicable registries/names/jurisdictions• Local advice is critical – even in Canada!• Mining Recorder or equivalent• Land Offices e.g. BLM, County

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Securities Regulation and Issuances• All securities filings within the past five years.• Agreements relating to sales of securities by the Company including

any private placement memoranda or other offering circulars within the past five years.

• Stock option or purchase plans and forms of option or purchase agreements which have been or may be used.

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Securities Regulation and Issuances• All securities permits, registrations, notices of exemption and consents

for issuance or transfer of Company’s securities and evidence of qualification or exemption under other applicable securities laws.

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Shareholder Information• Records setting for all issuances or grants of stock, options and

warrants by the Company.

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• Material Contracts• Property agreements, areas of interest, consents, royalties, clawback

rights, right to market product• Confidentiality agreements• Strategic alliance agreements• Bank line of credit agreements, including any amendments, renewal

letters, notices, waivers, correspondences, etc.• Other material agreements evidencing outstanding loans to or

guarantees by the Company, including correspondences.• Material contracts with suppliers, manufacturers or customers. Please

indicate which suppliers are sole source.

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• Material Contracts• Partnership, lease, option or joint venture agreements.• Any other material contracts outstanding.

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Financial Information• All management letters or special reports by auditors and any

responses thereto.

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Financial Information• SEDAR, EDGAR, quarterly, MD &A, AIF’s, Annual Reports, News

Releases• All audited and unaudited financial statements of the Company,

including balance sheets, income statements and statements of changes in financial position.

• All letters from accountants of the Company regarding the Company’s control systems, methods of accounting, etc.

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Financial Information• Recent analyses of the Company or its industries prepared by

investment bankers. engineers, management consultants, accountants or others, including marketing studies, credit reports and other types of reports, financial or otherwise. Company projections for future periods.

• Company projections for future periods.• Any special reports by auditors (e.g., as to control procedures).

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Financial Information• List of all fixed assets of the Company and its Subsidiaries together

with depreciation schedule if available.• Bank letters or agreements regarding lines of credit.

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Employee Compensation/Benefits Plans- employment agreements or severance agreements with officers or key personnel.

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Patent, Trademark and Copyright Matters• List of all foreign and domestic patents and patent licenses held by the

Company.• Copies of all material agreements for licensing of Company technology

to third parties.• Copies of all material agreements for licensing of technology from

third parties.• Proprietary data.• Any pending patents or trademarks.

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Tangible Property• List of real and material personal property owned by the Company.• Claims, concessions, permits, licences, leases (examine terms and

conditions).

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Litigation and Audits• Active litigation files, including letters asserting claims, complaints,

answers, etc.

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Litigation and Audits• Any material litigation settlement documents.• Any decrees, orders or judgements of courts or governmental

agencies.• Information regarding any material litigation to which the Company is

a party or in which it may become involved.• Property expenditures, write‐offs particularly with the advent if IFRS.

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Environmental• Schedule of all instances in the past in which the Company has

corrected unsafe working conditions.• Schedule of all permits, certificates, registrations or approvals

obtained from any governmental body responsible for environmental or health regulation.

• Any notices of violation or requests for information that have been received or threatened at any time for alleged failure of any facility to comply with applicable environmental laws, permits, certificates, registrations or approval.

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Environmental• Schedule of any environmental problems, conditions or issues known

to the Company concerning the Company’s business or any known violations or potential violations of applicable environmental laws.

• Schedule of any discharges or releases of Hazardous Materials into the environment by the Company.

• Schedule of the location, size and contents of any underground or aboveground storage tanks or PCB transformers owned or used by the Company.

• Description of all hazardous wastes that are disposed of on and off site by the Company and a description of the procedures for disposal of such wastes (including a list of all disposal sites and transporters).

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Environmental• Description and status statement of all completed, pending or

threatened regulatory, judicial or administrative actions relating to the Company.

• Description and status statement of any investigation, remediation, removal or monitoring actions relating to any of the Company’s facilities.

• Environmental assessments, reports or audits performed by the Company or any other party relating to any of the Company’s facilities or operations.

• Schedule of Hazardous Materials management plans, emergency response plans, inventory reports, and other environmental reports, policies and notices required by environmental law to be filed by the Company with any governmental body.

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Management• Founders agreements, management employment agreements,

indemnification agreements, and "golden parachute" agreements, if any.

• Schedule of all compensation paid in the most recent fiscal year to officers, directors and key employees showing separately salary,bonuses and non‐cash compensation (e.g. use of cars, property, etc.).

• Bonus plans, option agreements, retirement plans, pension plans,deferred compensation plans, profit sharing and management incentive agreements.

• Agreements for loans to and any other agreements (including consulting and employment contracts) with officers or directors,whether or not now outstanding.

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Management• Organizational chart.• Extensive, broad scope.• Starting point for planning legal investigation.• Cost limitations.• Effective use of time available.• Legal investigation needs to be focused.

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Local Customs and Practices• Critical on foreign transactions.• Unwritten laws.• Community consultation.• Aboriginal claims.

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Where does Legal Due Diligence get their information?1

• Site visits• Data room visits• Commissioning specialist reports• Collection of public information

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How does a business deal focus and guide the due diligence process?

How is the Transaction structured?

Objectives:• staged due diligence• threshold issues

What should you look at to assess risks?

Value drivers

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How does a business deal focus and guide the due diligence process?All the members of due diligence team need a basic understanding of the particular transaction structure, risks, value drivers, and objectives.• Plan regular due diligence team meetings, need to know basis• Team

• Management

• Engineering, geology, metallurgy

• Accounting

• Legal

• Environmental

• Country experts

• Tax advice

• Political risk

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Transaction Structure

Is it an Asset purchase, a share purchase or a transaction with mixed elements?• This information helps to determine scope and extent of due diligenceWhat type of business is the “target” involved in?• This information helps assess risk

Key elements of the business

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Transaction Structure

Assets/liabilities

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Key Due Diligence Points

Due diligence is a responsive multi‐stage process

This investigation must be as thorough as possible to accurately assess the ‘‘target’’ acquisition or transaction within the particular timeframe, cost, and client constraints

Due diligence is a value driven process because it serves to further inform both the acquirer and the “target” of the appropriate “target’’ value

Comprehensive due diligence exposes unexpected or unknown liabilities before the deal is closed and offers an opportunity for both sides to re‐assess the preliminary agreement terms

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Key Due Diligence Points

Preliminary review of certain issues

Threshold review to identify key issues

Auction process can drive access and economics of due diligence

Thorough due diligence review

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Identification and Assessment of Key RisksNeed background to business being acquired

Public disclosure – securities filings on SEDAR/stock exchange

Websites

Media search

Financial statements

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Identification and Assessment of Key RisksNotes to financial statements – contingencies/commitments/subsequent events

Management’s discussion and analysis – trends, uncertainties, liquidity

Risk factor disclosure in public documents

Assessment of risks – identify key risks

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Types of Due Diligence – Functional Types

Legal due diligence

Financial due diligence

Accounting due diligence

Operational due diligence

Technical due diligence

Environmental due diligence

Tax due diligence

Regulatory due diligence

Legal element to all types of due diligence

Country risk

Political risk

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Business & Legal Due Diligence Done in ParallelCoordination

Constant reassessment of findings in light of other findings – consistency of results, red flags, re‐interpretationImportance of a legal issue depends on business issues• Loan covenants more important where company in default?

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Business & Legal Due Diligence Done in Parallel

Regular communication and sharing of results/findings

Work sharing – intranet/portals

War rooms

Issue‐based due diligence rather than functional• e.g. sales agreement team rather than legal/business/financial teams

Contract review can be confirmed against the due diligence searches that have been performed

Agreements can relate to one another e.g. areas of interest, overlapping royalties

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What is not covered by due diligence?

Due diligence impacts the ability to negotiate transaction terms

Representations and warranties are a risk allocation mechanism

Due diligence allows risk assessment and impacts "requirement" for representations and warranties• Areas of non‐risk

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What is not covered by due diligence?

Due diligence can be a substitute for representations and warranties• Competitive bid/auction situations• Allows assessment of need for representations and warranties• Representations and warranties can be important in the assessment of

non‐financial risk of a transaction• As Is Where Is deals

Effective due diligence can help get the deal

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Mining Considerations

Confidentiality agreements

Proprietary data

Professional obligations to disclose

Overlapping agreements

Technical matters need experts

Access to key people

Material undisclosed information

Cultural differences

Areas of Interest

Strategic Alliances

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Mining Considerations (continued)

Fraudulent activities

Tenure system

Agreement requirements

Foreign entities, operations

Political risk

Country risk

Aboriginal matters

Local customs and practices, cultural matters

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Who do you talk too

Confidentiality

Technical questions

Site visits

Detailed checklists

Due diligence questionnaire

Data rooms

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Due diligence request listcorporate structurearticles, by‐lawsindebtednessproperty interestsmineral projects

ownership

contracts

company rights

access

infrastructure

rights of mineral owner and third parties

third party consents

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Due diligence request list (con’t)employment mattersenvironmental matterslitigationrelated party transactionsintellectual propertyassets and businessgovernment reportsinsurancemiscellaneous

Brian E. AbrahamBrian.abraham@fmc‐law.com

+1 604 443 7134

The preceding presentation contains examples of the kinds of issues companies dealing with due diligence could face. If you are faced with one of these issues, please retain professional assistance as each situation is unique.