Corporate Legal Due Diligence in Malaysia: An overview and its significance

What and why

Due diligence refers to investigations and research conducted on a business or individual before entering into an agreement with another party. The Securities Commission Guidelines define due diligence as a process of conducting enquiries and investigations, assessing risk tolerance, and ensuring timely, sufficient, and accurate disclosure of material statements, information, and documents.

Conducting due diligence is an important step in share acquisitions and corporate transactions, regardless of whether the acquirer is seeking a controlling or minority interest in the target company. The legal principle of "caveat emptor", or "let the buyer beware", is the reason for due diligence. The burden is on the buyer to ensure that the goods or shares they are purchasing have the desired quality and value. Thus, due diligence is crucial for buyers to avoid unforeseen harm.

In Malaysia, the regulatory framework for public listed companies requires high standards of disclosure and due diligence in corporate proposals and share acquisitions. Investors have the responsibility to assess the merits of primary offerings of securities, while the target company must adopt high standards of disclosure. This article specifically refers to the legal due diligence process in merger and acquisition transactions in Malaysia.

Mergers and Acquisitions

In a company share acquisition transaction, the seller is not required by law to disclose any defects or liabilities of the target company unless the buyer specifically requests such information. Therefore, it is crucial for buyers to conduct a thorough investigation into the target company's affairs to develop an effective risk management strategy. However, due diligence is not a one-size-fits-all exercise, as different investors have varying risk tolerance levels and investment goals. For example, due diligence for the financial or health sector may require more regulatory and voluminous information compared to a smaller target company in the media and communications industry.

Corporate due diligence in Malaysia is categorized into three distinct areas: financial/tax, commercial/technical/operational, and legal due diligence.

Legal Due Diligence

Legal due diligence is a highly structured process that is tailored to the specific needs of each transaction. The scope of legal due diligence depends on various factors, including the size and complexity of the deal, the level of confidentiality required, the industry of the target company, and the relationship between the parties involved. In Malaysia, lawyers are commonly hired to conduct legal due diligence on behalf of potential buyers, as well as prepare transaction documents such as the terms and conditions, representations, warranties, and disclaimers. In this process, the lawyers will create a comprehensive list of preliminary inquiries that are tailored to the specific transaction, which will serve as a guide to other professionals who may be providing information or documents for review.

Legal due diligence involves a review of key areas such as corporate information, business activities, material contracts, litigation, personnel, real property, intellectual property, and compliance with laws and regulations. The first step in legal due diligence is reviewing all corporate information, including the memorandum and articles of association of the target company, as well as minutes of shareholders and directors meetings. This will provide a guideline to the basic corporate structure of the target company and any associated companies or interests held by the target company or its directors.

Legal due diligence also involves an analysis of contracts to uncover triggering termination clauses and/or breach clauses that may be pertinent for the buyer to be aware of. The objective is to determine whether a change of ownership in the company would nullify the contract. Additionally, legal due diligence will encompass the potential discovery of any existing litigation action the target company is subjected to, as well as a review of all employment contracts, including remuneration, length of employment, and termination provisions.

Depending on the nature of the business and industry sector of the target company, legal due diligence will also involve a review of licenses and approvals required, as well as an assessment of intellectual property matters such as trademarks, trade names, copyrights, or patents that have been registered or pending. Arrangements with third parties are also reviewed to ensure that any intellectual property is protected by confidentiality or non-disclosure agreements.

In a nutshell

Careful attention must be given to the process as poorly executed due diligence may result in acquisition issues and costly legal proceedings. The ultimate goal is to conduct a thorough review of the target company to uncover any hidden problems. Before proceeding with the transaction, the potential buyer should be fully informed of any risks and disclosures presented in the legal, financial, and commercial due diligence reports to ensure confidence in the decision-making process.

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