Common Topics of Review in M&A Due Diligence

This practice note discusses the topics of review that counsel generally should consider in a due diligence investigation for an M&A transaction, including: • Charter Documents, Bylaws, and Other Corporate Documents • Contract Diligence • Financial and Debt Instruments • Real Property Diligence • Litigation Diligence • Licenses, Permits and Regulations • Environmental Diligence • Labor and Employment Diligence • Employee Compensation and Benefits Diligence • Intellectual Property Diligence • Foreign Corrupt Practices Act and Other Corruption Diligence • Antitrust Concerns • Tax Diligence • Cybersecurity and Privacy Diligence • Social Media Diligence • Emergency Preparedness and Business Interruption Diligence • Representation and Warranty Insurance

Charter Documents, Bylaws, and Other Corporate Documents

Review of the target company's organizational documents requires obtaining documents from both the seller and the Secretary of State of the state in which the company was formed. The fundamental organizational documents, such as a corporation’s certificate or articles of incorporation, or a limited liability company’s certificate of formation, are public records; on the other hand, the governing documents, such as bylaws, limited liability company agreements (also known as operating agreements), and stockholders' agreements are typically not publicly filed (except for public companies) and must be obtained from the seller. Corporate records, including the minutes of Common Topics of Review in M&A Due Diligence board and committee meetings, are also not public documents and must typically be obtained directly from the seller.

The company's organizational document will name the state in which the target company was formed, which in turn will tell the buyer's counsel what statutes to look to for voting requirements, merger mechanics, and similar transaction matters. The buyer's counsel will also want to obtain confirmation from the Secretary of State that the target company is (or is not) in good standing. In the case of a corporation with preferred stock, the certificates of designation (or analogous documents defining the rights of such preferred stock) may also be public documents, and in any event must be reviewed carefully to determine how any shareholder consent required for the transaction must be obtained, and what special treatment, if any, those shareholders are entitled to in respect of their shares.

The governing documents — bylaws, limited liability agreement, stockholders' agreement, if any, and similar documents — may also contain information that affects the structure of the transaction and specific director or stockholder consent rights and must be reviewed with care. The buyer's counsel should review the applicable statutes and confirm that the documents were properly adopted by the company. Similarly, counsel should review the minutes of board meetings and any resolutions of the board, to confirm that proper procedures were followed when the company issued equity interests, adopted or amended corporate documents, or took other formal actions.

Depending on the form of transaction, the buyer's counsel may want to pay particular attention to reviewing information regarding the target company's capitalization structure provided in these documents. These documents may grant the holders of equity interests in the target company rights which affect the allocation of consideration in the transaction, and which must be factored into the negotiation of the deal and drafting of the transaction documents. The buyer’s counsel should also pay particular attention to subsidiaries that are not wholly-owned by the seller, as third parties may have governance or other rights with respect to those subsidiaries.

A template for reviewing a target company’s organizational documents is available at Organizational Documents Due Diligence Template (Corporation).

Contract Diligence

For many companies, existing contracts represent some of their most valuable assets and the source of significant operating obligations and even potential liability, so buyers will often want to make sure they have a proper understanding of the target’s rights and obligations thereunder. Depending on the nature of the target company's business, the number of contracts provided for review can be quite daunting.

The level of detail the buyer will want to see and the specific terms the buyer will want buyer’s counsel to focus on varies widely from transaction to transaction—the buyer's counsel should consult with its client before beginning contract diligence to determine what information the buyer is seeking to discover from the various contracts provided for review and whether any additional contracts should be requested from the seller. Once the focus is properly tailored, a common approach to managing the information gathered from contracts is to create a table to summarize the contracts reviewed. These tables can then be appended to the due diligence memorandum, to the extent one is provided, for easy reference.

As an initial matter, the buyer's counsel should confirm that each agreement provided in the due diligence investigation is complete and fully executed, constituting a valid contract.

One of the most basic inquiries when reviewing a contract is whether it contains any provisions that would render the contract void or would require consent as a result of the proposed transaction. These provisions can take the form of change of control termination or acceleration rights, anti-assignment clauses, or other transfer restrictions. In an asset acquisition, because the buyer is acquiring the assets of the business and not the target company itself, the seller will have to assign contracts to the buyer, so the buyer or a buyer affiliate can take over for the seller as a party to the contract post-closing; this will usually violate any anti-assignment clauses or change of control or transfer restriction, so the counterparty’s consent will typically be required before the agreement can be assigned to the buyer. In a merger or stock acquisition, the entity being acquired frequently survives the transaction, and

Page 2 of 17 Common Topics of Review in M&A Due Diligence therefore no change to the parties to the contract will be required, so whether an anti-assignment clause or change of control or transfer restriction is triggered depends on how the provision is formulated. If the contract defines a change in ownership as constituting a transfer, the restriction is potentially applicable to a merger or stock acquisition, and consent may be required. For any contracts that are critical to the value of the business being acquired, the buyer may want to consider requiring that appropriate consents be obtained as a condition to closing the transaction or that there be a reduction to the transaction consideration if they are not obtained. Similarly, the parties may want to clarify what efforts should be expended to obtain material consents, including who should be responsible for any expenses associated with obtaining such consents. Failing to account for these provisions may result in the counterparty to a critical agreement having the right to terminate it immediately or shortly after the transaction closes.

Depending on the context of the deal, the buyer may also be interested in duration, pricing, indemnification obligations, warranties, or any number of other provisions. The buyer may also ask buyer's counsel to focus on ongoing liabilities arising from the contracts that will survive the consummation of the transaction and/or the target’s (as opposed to the counterparty’s) termination rights thereunder.

Additionally, a buyer may be ask buyer’s counsel to summarize any exclusivity provisions, which , in certain circumstances, may reach beyond the contracting parties to their affiliates. For example, an agreement may contain a non-compete provision providing that neither the target company nor any of its affiliates may seek to sell certain products outside of a defined territory (e.g., North America). If the buyer is going to assume that agreement and enter into the shoes of the target company in doing so, the prohibition will similarly extend beyond the target company to its affiliates acquired as a consequence of the transaction, which would include the buyer and its other subsidiaries following consummation of the acquisition. The buyer's counsel should pay particular attention to such provisions, as they may result in unintended restrictions being placed on the buyer's business. When the buyer is a strategic buyer, this is an area that merits particular attention.

Contracts in foreign languages or with extensive redactions can require additional time and consideration. With foreign-language documents, the buyer and its counsel will need to assess whether the contract is significant enough to merit full translation or if a mere summary is adequate. Engaging a legal translation firm takes time but is frequently more efficient and cost-effective than using counsel with relevant proficiency. The buyer’s counsel should also consult with its client about whether to engage local counsel to provide guidance on how the translated agreements will be interpreted under local law. Similarly, the materiality of redacted contracts must be evaluated and weighed by the client as it negotiates the transaction with the seller. Redacted (or withheld) contracts are common when there are antitrust concerns; please see Antitrust Concerns below for a discussion of issues arising in that context.

Recent years have also seen the proliferation of software programs designed to help counsel with its due diligence investigation by automating the review of contracts. Some of the principal diligence automation software programs available include Cognitiv+, Diligen, eBrevia, Kira Systems, kReveal and Luminance. Diligence automation software offers the promise of cutting back on the time spent by counsel reviewing contracts during the due diligence investigation, resulting in lower due diligence costs for the client and a faster completion of the due diligence investigation. However, diligence automation software remains somewhat expensive, which limits its potential use to transactions requiring review of a large number of contracts, and there is a learning curve to counsel being able to use it efficiently. If counsel plans to use diligence automation software for a transaction, it must also take care to ensure that it is satisfied with the conclusions the software arrives at, as counsel will ultimately be responsible for such conclusions.

In the wake of the COVID-19 pandemic, depending on the target’s industry, buyer’s counsel should also be particularly attuned to any contracts with governmental agencies relating to efforts to combat the pandemic and/or involving products or services associated with the prevention, diagnosis or treatment of COVID-19, such as personal protective equipment and treatment drugs. Understanding the terms of such contracts, how they may be impacted by government regulations such as the Defense Production Act and the target’s potential liability in the event of a breach thereunder will be of critical importance.

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A template for reviewing a target company’s material contracts is available at Material Contracts Due Diligence Template.

Related Party Transactions

Related party transaction diligence is a subset of material contract diligence that arises whenever counsel determines that an affiliate of the target company has entered into a contractual relationship with the target company, typically to provide services or goods. Related party contracts are especially common in smaller, closely- held companies. The rules public companies operate under require significant disclosure of related party transactions, and often deter companies from entering into them. Due to the sensitivities surrounding this area, the seller’s and the buyer’s counsel should encourage the seller to err on the side of caution in disclosing related party transactions, even if the underlying transaction is a low-dollar value transaction, or the related party relationship is an attenuated one.

Whether brought to the buyer's attention by the seller or unearthed by the buyer's counsel during the course of reviewing the outstanding contracts of the target company, all related party agreements raise the same set of questions. The fundamental inquiry is: does the agreement have the characteristics of an arms-length agreement entered into with a disinterested third party, or does it look like a sweetheart deal?

When the target company enters into agreements with persons or entities controlled by an insider of the target company, an opportunity arises for those interests to enrich themselves at the expense of the target company. If the buyer will be acquiring these relationships in the transaction, it will have to factor the economic impact of these agreements into its valuation of the target company. One type of related party transaction could arise if a member of the target company's board of directors owned a company which is a significant supplier to the target company. The desire to maintain this relationship could impact the director's objectivity. And the presence of the director on the target company's board could allow him or her to encourage the target company to approve entering into an agreement with his or her company on something other than market rates. “Down round” financings (i.e., capital raises where a company valuation is lower than in its prior financing round) resulting in dilution of minority stockholders by controlling stockholders or major investors who control the board, particularly in companies with no or few independent directors, are another type of related party transactions buyer’s counsel should seek to identify.

To the extent a related party transaction appears problematic, the buyer's counsel should arrange for further investigation with the relevant parties to gain an understanding of the circumstances under which the agreement was entered into or the transaction was approved, including in respect of any alternatives that were explored or market research that was conducted, as this will inform the evaluation of the appropriateness of the agreement or transaction.

Related party agreements require advice from counsel that is tailored to the particular situation, and in many instances, the underlying related party transaction is perfectly benign. Nevertheless, the potential for real liabilities to arise from related party transactions means that they must be taken seriously and assessed carefully.

In addition, buyer’s counsel should consult with the client regarding the subject matter of any related party agreements, and confirm whether such related party agreements should be terminated prior to such closing or if the buyer will require the seller to continue providing services through such related party agreements or through a transition service agreement.

Financial and Debt Instruments

If the target company has borrowed money in any capacity, the buyer's counsel will want to focus on reviewing the documentation governing such indebtedness. Depending on the complexity of the target's capital structure, review of these agreements and related documentation may need to be performed by a finance specialist. As with any review of agreements, the buyer's counsel will want to confirm that it has been provided with fully-executed documents, and that all ancillary documents have also been provided. In addition to simply identifying the target company's lenders and the amount of borrowings potentially outstanding, the financial and debt instruments may

Page 4 of 17 Common Topics of Review in M&A Due Diligence contain prepayment penalty provisions which will have to be factored into the negotiations. Furthermore, there may be extensive covenants that may extend to the buyer's business, onerous redemption provisions, or restrictions on change of control transactions which must be addressed. The transaction’s impact on these instruments may need to be factored into the negotiation of the acquisition agreement.

Similarly, to the extent applicable, buyer’s counsel should try to gain an understanding of whether the target has obtained any grants, loans or other financial assistance from a governmental agency in connection with the recently-implemented COVID-19 relief efforts. If it has, buyer’s counsel will then have to perform analyses in respect of the target’s eligibility for such assistance, which will likely be subject to scrutiny as governmental agencies undertake audits of disbursed funds, as well as of the target’s repayment obligations and the availability of forgiveness therefor.

The buyer's counsel will also want to do a public records search for UCC filings to determine what lien filings secured creditors have made against the target company's assets. UCC searches frequently turn up filings made in connection with equipment leases as well. Depending on the form of the transaction, arrangements may have to be made for termination of these encumbrances prior to or as part of the closing of the acquisition.

Real Property Diligence

Real property diligence will typically focus on a review of property owned or leased by the target company. In each instance, a real estate specialist will commonly handle the diligence assignment, unless the value of the property or lease to be acquired is relatively small, or such property is not material to the operations of the target company. Real property diligence may also involve environmental specialists, as discussed elsewhere. See Environmental Diligence below.

Owned Real Property

When the target owns real property, or real property is to be acquired in an asset purchase transaction, the focus should be on whether the seller has valid title to the property, free and clear of liens or other encumbrances on title that might adversely impact the value or intended use of such property. The buyer's counsel should obtain a recent title report, issued by a title company that has examined the public records from the recorder's office for the county in which the property is located, and examine such report to determine whether there are outstanding liens against title that need to be released of record before the transfer can take place.

The title report will indicate whether third parties have any rights or other interests in the property which "run with the land" and will carry over in the transfer. Such rights may include easements granted to utility companies or public agencies in connection with utility services or road maintenance, or rights of access ("ingress and egress") into and across the property. Matters of record shown on the title report might also include agreements which contain transfer restrictions or notice provisions that require notice to or consent from a third party as part of the deal documentation. The buyer's counsel should also examine the results of the UCC searches to see if any liens are asserted against the property which may have been improperly recorded.

The seller may provide information regarding liens against the seller's property, but such information should not be relied on as the sole source of information regarding liens, as liens can be put in place without the knowledge or consent of the property owner. For example, if vendors provided work or materials to the property and were not paid in full, such vendors might have statutory rights to record mechanic's or materialmen's liens against the property. Similarly, neighboring property owners might have lien rights against the property for unpaid amounts under cost- sharing agreements for common-area maintenance charges. Finally, liens for unpaid property taxes are often discovered during diligence and may require attention prior to closing.

If the seller has borrowed money, its owned property will typically be encumbered by a mortgage or deed of trust in connection with the loan agreement. These liens will have to be addressed as part of the transaction, with arrangements made to either pay off the underlying debts at closing and have such liens released of record, or to allow the liens to remain if existing financing arrangements are to remain in place. Similarly, if the buyer is engaging

Page 5 of 17 Common Topics of Review in M&A Due Diligence in a leveraged acquisition, its lenders will typically be very focused on any owned property, as such property will likely be used as security for the loan or loans providing financing for the transaction. The buyer's lenders will expect to receive a lender's policy of title insurance insuring the lien of their security instrument as "first priority" and senior to any other competing liens and will therefore be paying close attention to the state of title for the property and any liens that might have priority over their lien as a matter of law.

Leased Real Property

Leases are specialized contracts often governed by specific statutory provisions. If the significance of the target company's leases (or the leases being acquired in an asset purchase transaction) is relatively minor, buyer's counsel may perform this diligence task without needing to bring in a specialist. The need for assistance from a real estate specialist will increase in proportion to the value associated with the acquired leases, and the number and complexity of such leases.

The buyer's counsel's review of real property leases should focus on fundamental information, including the lease term, rent, termination rights (both of the tenant and the landlord), renewal rights, assignability, rights of first offer and first refusal if the property is sold, and any restrictions on use of the property. If the buyer is seeking financing, and the leases are to serve as collateral for such financing, lenders will also be interested in the subordination and attornment provisions in each lease. The wording of the subordination, non-disturbance and attornment provisions will control whether the lenders are able to forcibly terminate tenants' leases in the event of default on the mortgage. The buyer's counsel should also determine if any lease contains an estoppel provision, such that the lessor would be required to certify to the buyer that the lease is in full force and effect and free of default. These provisions allow the buyer and its lenders to accurately assess the economic terms of each tenant lease in a commercial property to be acquired, for example. All this information gleaned from the leases can be presented in a narrative format, but frequently lends itself well to presentation in a chart or table.

The buyer's counsel will need to focus carefully on the restrictions placed on transferability of the lease. Landlords typically have some level of consent right over lease transfers, but the sophistication of these restrictive covenants varies widely and the language must be examined carefully in light of the form of the acquisition transaction. In an asset acquisition where leases are being acquired, the tenant-party to the lease will typically be changing from the seller to the buyer or a buyer affiliate. In a merger or stock acquisition, the entity being acquired frequently remains unchanged in the transaction, and therefore the tenant-party to the lease may not change, though its ownership will be different. Whether one or both of these situations is captured by the lease's consent requirement will depend on the language of the lease; the former almost always requires consent, the latter can be missed by the lease.

Depending on the precise rights that the landlord has to withhold or condition its consent, a landlord may have the ability to hold up a transaction in order to extract improved lease terms as part of the overall transaction. It is therefore not uncommon to see landlord consents included as one of the closing conditions in the transaction documents. Consequently, precision in the review of transfer restrictions in leases is critical, and care should be taken to ensure that the team members assigned to this task are sensitive to the nuances of the language and the potential for landlords to extract hold-up value from the deal.

To the extent that the buyer determines that any consents may be required, the buyer's and the seller's teams should develop a strategy to work with the landlords to obtain the necessary consents. Frequently, the seller's relationships with its landlords are long-standing, and the process of informing them of the pending transaction and obtaining consents is best handled, at least initially, from the business side, rather than the legal side. In other situations, the seller's counsel may be asked to manage the process of working with the landlords once the initial discussions have been held by the seller's business team. The language of the consent may be a matter of negotiation, and more sophisticated landlords will involve their own counsel in the process. The parties may also want to clarify who should be responsible for any expenses associated with obtaining the landlord’s consent. The buyer's counsel should monitor the process to make sure that obtaining consents does not hold up the transaction.

Litigation Diligence

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The buyer's counsel will often learn about litigation involving the target company by conducting litigation searches in the relevant jurisdictions, as well as through conversations with the seller. The buyer's counsel should look to audit response letters provided by the seller's outside law firms to the seller's outside auditors as another source of information regarding litigation.

As a threshold matter, the buyer's counsel will need to determine the appropriate jurisdictions in which to investigate target's litigation profile. Plaintiffs have a great deal of flexibility in selection of venue, and there is no centralized repository of information regarding pending lawsuits in the U.S. Each jurisdiction is essentially independent, and separate searches must be initiated in each that is of interest. When performing litigation searches, the buyer's counsel should typically focus on three places: (1) the target company‘s jurisdiction of formation, (2) the jurisdiction of the target company’s main offices, and (3) the jurisdictions in which the target company has significant business operations.

The buyer's counsel must exercise judgment in deciding which jurisdictions should be searched. In determining where a seller would be most likely to be sued, the answer is usually a fairly narrow list of jurisdictions, because plaintiff's counsel is typically interested in suing the target company somewhere where it has adequate resources and jurisdictional requirements can be met. The buyer's counsel should also be sensitive to the need to search at all levels in the relevant jurisdictions, not merely the federal courts or major state courts. County courts, and in some cases municipal courts, should be searched as well.

The federal court systems have databases that are relatively simple to search. Results are returned to counsel quickly, and filings of interest can be ordered and obtained swiftly as well. Results from state systems, however, typically take longer to be returned, so these searches should be initiated as early in the process as possible.

Once the results of these searches are in hand, the buyer's counsel will want to discuss the findings with the seller's counsel to improve its understanding of the materiality of the pending litigation to the target company. The buyer's counsel will typically then meet with its client to discuss the findings. The seller's counsel may be asked to schedule conference calls between the buyer's counsel and the attorneys handling the litigation for the company as part of this process, as the seller's counsel will not necessarily be handling litigation matters for the target company. Depending on the nature of the litigation, the buyer's counsel may want to consider bringing in subject-matter specialists to review the matter at issue. Based on the advice of counsel, the buyer will need to make a business judgment as to the importance of the litigation to the transaction. The parties may frequently choose to address major litigation risk by including indemnification provisions that specifically address the litigation, providing for special agreements regarding liability for, and control of. the litigation, and/or obtaining litigation insurance coverage.

Licenses, Permits, and Regulations

Most businesses have a multitude of licenses and permits they need in order to function, but not all of them will be material to their operations. The nature of the business to be acquired will determine the appropriate scope of diligence in this area. Certain industries, such as healthcare and government contracting, are heavily regulated. Transactions in these industries will raise a host of permitting and licensing issues that may require the buyer's counsel to allocate additional resources and even legal specialists to this diligence task.

The licenses and permits of interest in diligence are those which are both material to the business and not easily transferred or obtained in the first instance, such as licenses to operate, which are issued only after satisfactory background checks on the business and its owners. The buyer's counsel will need to focus the attention of the appropriate people in the business team on the task of arranging for transfer of these licenses or applying for replacements. As this process will typically involve third-party government agencies, the potential for delay should not be underestimated. The buyer may wish to include the transfer or replacement of key licenses and permits in the closing conditions, but the seller may understandably resist having the closing hinge on the actions of third parties. Post-closing covenants may be used as a compromise in private transactions.

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Buyer’s counsel should also seek to understand how, if at all, the COVID-19 pandemic has affected the target’s operations from a regulatory perspective. For example, many companies are now subject to new regulations and restrictions and buyer’s counsel should have a full understanding thereof, including in respect of their expected duration and the target’s efforts to comply with the same or seek exemptions therefrom. Similarly, many companies have experienced delays in obtaining or renewing licenses and permits as a result of the pandemic, and buyer’s counsel should make sure it is aware of any such delays.

Environmental Diligence

Environmental diligence is the province of specialists, and a detailed discussion of the nuances of this area of practice is beyond the scope of this article. What the general practitioner needs to know is how to recognize a need for environmental diligence and the appropriate steps to take should that need arise.

Environmental diligence can be necessary any time the target company owns property or leases real property. Environmental liabilities attach not only to landowners, but also to tenants who cause environmental damage. The scale of liability can be quite large, particularly when the damage caused reaches from the property itself into neighboring parcels. The risk of liability for environmental damage is not always susceptible to allocation by the parties (though, through indemnification provisions, the parties can allocate financial responsibility for liabilities). In certain circumstances, criminal liability can arise from environmental damage, which will follow the party that caused the damage, even after the property itself is transferred, despite any indemnification or provisions purporting to allocate liabilities and costs associated with the damage.

Significant liabilities can arise from what are otherwise seemingly insignificant parcels of land. If environmental damage is suspected, environmental specialists should be called in, even if the property is only a minor piece of the transaction. Even where the property is leased by the seller rather than fee owned, an environmental specialist may be required, as such liabilities sometimes may attach to tenants (as opposed to owners) if certain environmental harm has been done.

In reviewing a target company, the buyer's counsel should think through the likelihood of environmental damage based on the industry of the target company and should investigate the history of the property and the surrounding area. The buyer's counsel will want to know how the seller has used the land, how the land was acquired, how the prior owners used the land, and how properties in the immediate area have been used and will want to push that inquiry as far back as it can reasonably be carried. When certain industries are involved, such as chemical manufacturing, there is a risk of significant environmental liabilities being associated with the property. The buyer's counsel should consider requesting and reviewing the transaction documents by which the land was acquired, and any environmental reports conducted at such time, if available.

Environmental counsel may recommend that certain on-site physical investigations be conducted on a particular subject property. An initial investigation often includes a set of defined analyses known as a Phase I Environmental Site Assessment (a "Phase I"). While a Phase I requires an on-site visit to visually inspect the condition of the subject property, invasive testing is not part of a Phase I. Rather, an environmental consultant will research the history of the property through public records searches, examination of neighboring properties, and conversations with people likely to have information regarding the property. Prior to performing a complete Phase I, counsel can also consider engaging a third party consultant to do searches of public records regarding the subject property. Performing a Phase I on the subject property may provide the buyer with the protections of the judicially recognized "Innocent Landowner Defense" safe harbor with respect to potential liability under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (42 USCS § 9601) ("CERCLA"). Furthermore, individual states may provide additional legal protections if a Phase I has been performed.

If the findings of the Phase I reveal a "Recognized Environmental Condition," a Phase II Environmental Site Assessment (a "Phase II") may be recommended. A Phase II is typically more expensive and time-consuming because it involves sampling on the site. The consultants will take samples of soil, water, and/or building materials

Page 8 of 17 Common Topics of Review in M&A Due Diligence and test them for contaminants. The results of the Phase II may include recommendations on how to deal with the contamination, as appropriate.

If the parties wish to explore remediation of the subject property based on the recommendations contained in the Phase II report, a Phase III Environmental Site Assessment (a "Phase III") can be performed. A Phase III involves a further, more intrusive, investigation of the subject property for the purpose of determining the precise scope of the contamination and developing a plan to address the problem. A Phase III may involve detailed modeling, ongoing monitoring, and invasive testing as the remediation plan is developed and tested. The report accompanying a Phase III may provide multiple options for dealing with the contamination and can provide a detailed road map to cleaning up the contamination of subject property.

If on-site investigations are to be performed, the environmental specialist will need to engage consultants to carry out the investigations. This will require time both for the engagement of the consultants (and negotiations of their engagement terms, if the scale of investigations is particularly large) and for the performance of the work.

In order to perform a Phase I or Phase II, the buyer's consultants will need access to the property under investigation. This is often a relatively simple process when the property is owned by the seller. The matter can be more complicated when property is leased, depending on the nature of a tenant's business and operations, as well as the lease terms. The seller may also be uneasy having environmental consultants on the property, as their presence may cause disclosure of the potential transaction earlier than the seller would prefer.

If the seller's counsel believes that environmental issues are likely to be significant to the negotiations of the transaction, counsel may consider advising the client to engage consultants of its own to perform parallel investigations. The buyer will likely be referencing the consultants’ findings in pressing the negotiations of the transaction documents and may be unwilling or unable (under the terms of its engagement letter with its consultants) to provide seller with access to the findings. However, if the seller learns about an environmental condition from the buyer or through its own investigation, such information may trigger a legal obligation to report the findings to a public agency responsible for protecting human health or the environment. The buyer and seller should consider that possibility before undertaking any environmental investigation, especially a Phase II.

Labor and Employment Diligence

Labor and employment diligence can frequently involve specialists, depending on the composition and geographic location of the target company's workforce and the type of industry under consideration. A specialist should be brought in if buyer's counsel determines, on consultation with its client, that this area is of particular concern, particularly given the continued increase of employment class actions and administrative enforcement activities in certain jurisdictions. In identifying areas to diligence, special consideration should be given to the specific types of lawsuits and enforcement activities that have been affecting the target’s industry.

If the seller's workforce is unionized, if there are significant labor contracts in place, or if recent organization efforts have been made, the buyer's counsel will immediately want to bring in specialists. The buyer's counsel will always want to review the target company's history of U.S. Equal Employment Opportunity Commission and other employee claims against the target. The buyer's counsel may wish to hire investigators to obtain information regarding the target company's executives, but must take care to consult with labor and employment counsel regarding any state-specific issues associated with such investigations and to ensure compliance with the Fair Credit Reporting Act (15 USCS § 1681) and its state law counterparts.

The buyer’s counsel should request a list of the target company’s employees by job position or classification, base salary levels and hourly wages, location, and whether each employee is classified as exempt or non-exempt from the wage and hour laws. Improper classification of employees can result in exposure to wage and hour class action litigation and is a risk which should be understood during the due diligence investigation.

The buyer's counsel should request copies of any non-compete agreements the target company has entered into with members of its workforce, independent contractors or other third parties. The buyer's counsel should also

Page 9 of 17 Common Topics of Review in M&A Due Diligence review the target company's standard employment agreements for non-compete and invention assignment provisions, among other issues. The buyer will want to assess what protections are in place to prevent employees of the target company from departing after the transaction closes and setting up competing businesses.

The buyer's counsel will want to consult with its client on any plans for the hiring or termination of the target company's employees and on any changes that may materially affect the employees' terms and conditions of employment. For example, if more than a certain amount are to be terminated as part of the transaction, proper notice must be provided to the workforce in order to avoid triggering liability under the Worker Adjustment and Retraining Notification Act (29 USCS § 2101) ("WARN Act") and under certain state law equivalents. The WARN Act generally requires 60 days' advance notice of mass layoffs or plant closings be provided to workforces, subject to certain enumerated and fact-specific exceptions. In general, businesses employing more than 100 full-time employees are covered by the WARN Act; smaller businesses are outside the scope of the statute but may be subject to state law equivalents of the federal WARN Act. Depending on the timing of the closings or layoffs, either the seller or the buyer can be responsible for providing the required notification, so both sets of counsel should be involved in determining how to comply with the statute, if applicable.

If any of the workforce is outside the United States, the buyer's counsel should strongly consider engaging local counsel. Employee protections vary dramatically by country and are frequently far more protective of the employee than the U.S. system. This is true even if there are no present plans to terminate employees in the transaction — buyer's counsel should ensure its client is educated on nuances of the local labor laws it will be subject to after the transaction closes.

Employment of undocumented workers is prevalent in certain industries, particularly those involving low-wage low- skill positions. If the target company is in such an industry, there is a risk that the workforce is going to become a source of administrative scrutiny or liability for the buyer after the transaction closes. There are state and federal issues at play here, and the liability associated with violations can be quite significant and even include criminal sanctions, so the buyer's counsel will need to carefully diligence this topic if the target company is in such an industry.

Buyer’s counsel should also attempt to understand how the target’s workforce has been, or is expected to be, affected by the COVID-19 pandemic. At a minimum, Buyer’s counsel should have an understanding of the target’s views on its employees’ risk of exposure to, and potential spread of, COVID-19 and the steps it is taking to address and minimize those risks, as well as any safety regulations applicable to the target and the actions taken to comply with them. Similarly, buyer’s counsel should try to come away from the diligence process with a clear picture of the target’s ability to operate under a number of emergency scenarios, including how operations would be affected if a large number of employees were incapable of being physically present at the target’s offices and whether the target has the capacity and resources to effectively implement remote working for its employees.

Employee Compensation and Benefits Diligence

Compensation and benefits diligence typically calls for the review of a target company's employee compensation structure (including equity compensation and severance/change in control obligations related to compensation arrangements) and employee benefits programs. As a part of the review of employee benefit programs, the buyer's counsel will want to assess the target company's pension obligations, if any.

Executive Compensation

Review of executive compensation packages is analogous to review of any other contracts. If the management team is to be retained and the existing compensation packages will remain in place, the exercise will be more for informational purposes and less for the preparation for negotiations. However, often, management compensation packages are renegotiated as part of the transaction. If any members of management are to be terminated or if new compensation packages are being negotiated as part of the transaction, the exercise quickly becomes more complex and the buyer's counsel should recommend the involvement of specialists.

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Frequently, executive compensation packages are structured such that in a change of control transaction, payments to the executive are triggered, regardless of whether the management team is being retained or replaced. It is essential to understand how the transaction impacts these packages so that appropriate planning can be made, and the impact on the deal value can be understood.

Executive compensation packages may be structured to provide executives with a "walk right" in the event of a change in control. This is a concern if the buyer wants to retain the existing management team. Conversely, there can be limitations on the target company's ability to terminate members of management, which are implicated if the buyer wishes to install a new management team. The buyer should closely review the post-closing payment obligations to terminated executives pursuant to any “golden parachute” plans in effect and factor this information into the deal negotiations.

Payments to certain executives as part of the transaction can trigger tax liability for the executives under Section 280G of the Internal Revenue Code if the payments are deemed "excessive" under the code, and trigger a corresponding loss of the right to deduct these payments by the target company. Compensation packages must be examined carefully to assess what liability, if any, could arise under 280G as a result of the transaction. The analysis is complex, and benefits specialists should be involved any time these issues arise.

Shareholder approval can be required under 280G to avoid excise tax liability on such payments. Accordingly, it is important to evaluate potential 280G issues early in the diligence process. While the management personnel who may be affected are not necessarily clients of either the seller's counsel or the buyer's counsel, typically each side is motivated to explore this area. Members of management should be advised to retain their own counsel if the level of compensation involved is significant or if Section 280G issues are raised.

Benefits Plans and other Compensation Programs

In addition to executive compensation matters, buyer's counsel will want to perform diligence on the target company's overall compensation programs and benefit plans. Investigations must be made of the target company's employment agreements; bonus, equity, and severance programs; deferred compensation programs; health insurance and retirement plans, including 401(k) and similar plans; and other provisions the target company has made for providing pensions, with particular attention paid to whether the pensions are appropriately funded.

If the buyer is a strategic buyer, the business team may be planning to merge the target company's plans with its existing plans. In any event, the buyer will have to confront questions of how to handle the target company's employees' accrued benefits in the transaction, including equity compensation plans and vacation time. Similarly, in an asset acquisition, the buyer may also undertake certain obligations in respect of transferring employees, such as providing comparable compensation and benefits to them, which may require it to understand the target company’s compensation and benefit plans, and the parties typically allocate responsibility between themselves for any severance payments to be made to any non-transferring employees. To confront these questions and issues effectively, the buyer’s human resources team will likely have to work closely with the target company's team.

Intellectual Property Diligence

Intellectual property diligence will primarily focus on (1) the seller's title to the intellectual property it has developed or acquired, (2) the seller's licensed rights to use intellectual property owned by third parties, (3) the transferability of such licensed rights, and (4) intellectual property rights that the seller has granted to third parties. In the course of performing intellectual property diligence, the buyer's counsel may also evaluate and inform its client regarding the adequacy of the target company's protections for its intellectual property, provisions for disaster recovery and policies regarding the use of personal information. With respect to the adequacy of the target’s protections for its intellectual property, it is worth noting that U.S. governmental agencies have become particularly attuned to intellectual property sharing and licensing involving Chinese counterparties, so if the target has any contracts or joint venture relationships with such entities, buyer’s counsel should bring these to the buyer’s attention and consider the implications they may have on the transaction, including in respect of regulatory approvals. The

Page 11 of 17 Common Topics of Review in M&A Due Diligence parameters of the investigation will vary depending on the nature of the transaction, the target company's industry, and the role of intellectual property in the target company's business.

Owned Intellectual Property

If proprietary intellectual property is to be transferred or acquired in the transaction, the buyer's counsel should determine whether the seller owns any registered intellectual property, including registered trademarks, patents, registered copyrights, domain names, and applications for the foregoing. The buyer's counsel should compare the lists of such registered intellectual property to the information maintained by the United States Patent and Trademark Office and equivalent foreign offices to ascertain the status of any registrations. For domain names, the buyer's counsel should search the WHOIS database, which lists all registered users of Internet resources, to confirm that the seller is listed as the registrant of the domain names. WHOIS can be accessed at: https://whois.nic.name/.

The buyer's counsel should schedule follow-up conversations with the seller's counsel to resolve any questions raised by the findings. The buyer's counsel should also review all available agreements the target company has entered into with current and former employees, consultants and any other persons or entities that have created intellectual property for the target company to confirm that ownership of the intellectual property was properly assigned to the target company. This inquiry will focus on confirming that the applicable agreements contain appropriate language assigning all rights to intellectual property created to the target company, as well as language creating an affirmative obligation on the part of the author of the intellectual property to take any further actions necessary to perfect ownership of such intellectual property in the target company.

Not all intellectual property can be registered, and companies from time to time may make strategic decisions to not register intellectual property which could have been registered. For instance, a company may choose to keep an invention as a trade secret, rather than permit it to be published as a patent. Also, software can be copyrighted as a written work, but companies frequently choose not to take this step. Therefore, the database searches alone may not be sufficient to give the buyer comfort on the seller's claims to own the intellectual property it is purporting to have the right to transfer in the transaction.

The buyer's counsel may discover that the registrations for intellectual property which the target company purports to own are in the names of the actual individuals who created the works, or in the names of other entities or persons altogether. In particular, this issue may arise in the context of internet domain names, as some jurisdictions do not permit foreign entities to register internet addresses with them. In that case, the buyer's counsel will need to work with the seller's counsel to determine what steps will be taken by the seller to obtain both ownership and control of the domains for eventual transfer to the buyer. For further discussion of intellectual property assignment agreements and licenses, see Intellectual Property Assignment Agreements and Licenses in M&A Deals.

Licensed Intellectual Property

The buyer's counsel should request that the target company provide copies of all agreements to which it is a party whereby the target company receives a license to third-party intellectual property (inbound licenses) or the target company grants to a third party a license to any intellectual property (outbound licenses). As an initial matter of contract due diligence, the buyer's counsel should determine whether the proposed transaction violates the anti- assignment provisions contained in the licenses and/or whether consent by a third party is required. The buyer's counsel should also assess whether the license is exclusive or not, how soon the license will expire, the target company's remaining obligations, whether sublicense rights were granted, who will own modifications and derivative works of the licensed intellectual property, representations and warranties made by the target company, indemnification obligations, and whether there are any non-compete or other restrictions placed on the target company. For inbound licenses, the buyer's counsel should specifically look at any use restrictions, as the buyer may have a desire to use the licensed intellectual property in an expanded or different manner. For outbound licenses, the buyer's counsel should specifically evaluate whether any updates or upgrades were promised as part of the license, as the buyer may desire to transform the product post-acquisition and may find itself contractually required to provide the new "upgraded" product to existing licensees.

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License agreements relating to off-the-shelf software are often of less significance because generally the buyer would be able to obtain its own license to the software post-acquisition, if needed. The buyer's counsel should consult with its client before spending significant time reviewing off-the-shelf software licenses. Some clients may already have their own license relationships with the software providers which may provide them confidence that a license term will be extendable or that the licensor will grant consent to assignment. While the buyer's counsel should request copies of the license agreements for all of the target company's software, counsel may conclude, upon consultation with its client, that not all such licenses should be reviewed to the same level of detail.

Foreign Corrupt Practices Act and Other Corruption Diligence

If the target company has operations outside of the United States, or is a foreign company trading on a U.S. exchange, the buyer's counsel should assess the implications of the Foreign Corrupt Practices Act (78 USCS §78a) ("FCPA") on the transaction. The FCPA is a significant enforcement priority for both the Department of Justice ("DOJ") and the Securities and Exchange Commission ("SEC") and many prosecutions in recent years have arisen from an acquisition context.

The FCPA's anti-bribery provisions make it illegal for U.S. companies and registrants to corruptly offer or provide, directly or indirectly, money or anything of value, to officials of foreign governments or foreign political parties with the intent to obtain or retain business. In addition to the anti-bribery provisions, the FCPA's books-and-records provision requires issuers to make and keep accurate books, records, and accounts, which in reasonable detail accurately and fairly reflect the issuer's transactions and disposition of assets. Finally, the FCPA's internal controls provision requires that issuers devise and maintain reasonable internal accounting controls aimed at preventing and detecting FCPA violations. Because there is no requirement that a false record or deficient control be linked to an improper payment for an FCPA violation to be found, even a payment that does not constitute a violation of the FCPA’s anti-bribery provisions can lead to prosecution (under the accounting provisions) if inaccurately recorded or attributable to an internal controls deficiency.

Three major areas of FCPA concern include (1) what constitutes an improper payment actionable under the FCPA; (2) who is a representative of a foreign government; and (3) the conduct of third-party representatives. As to the first issue, the FCPA covers more than overtly corrupt cash payments, including extravagant gifts and travel and entertainment expenditures to establish business relationships (practices common in many cultures). The question of who is a government representative becomes very complex in countries where the government owns, controls, or has ownership positions in many companies that in the U.S. would be considered commercial businesses. Finally, many FCPA enforcement actions arise from payments made on behalf of U.S. parties by their third-party agents, and in some cases, even distributors.

As determinations surrounding these issues are highly subjective and the consequences of running afoul of the FCPA can be severe, if the buyer's counsel has reason to believe the transaction raises FCPA issues, a specialist should be involved. There are many publicly available services that provide initial snapshots of corruption risks, including Transparency International's Corruption Perceptions Index. See http://www.transparency.org/research/cpi/overview.

In FCPA due diligence, the buyer's counsel should request copies of any agreements with foreign governments, foreign government controlled entities, officials (former or current), and politicians (former or current). The buyer's counsel should also request copies of the target company's policies, manuals, and training materials regarding compliance with the FCPA; reports related to audits conducted internally or by U.S. government; and voluntary disclosures made to the government regarding possible violations. Strong representations and warranties in this area are also strongly advised.

FCPA actions can and are brought by the DOJ and SEC on various theories of successor liability after a transaction closes. The buyer can be found liable not only for actions taken after the transaction closes, but also for actions taken by the target company prior to the acquisition. Both the SEC and the DOJ are willing to pursue claims – both civil and criminal in nature – against the buyer even when the buyer itself has brought the target company's FCPA

Page 13 of 17 Common Topics of Review in M&A Due Diligence violations to the attention of the authorities. See http://www.sec.gov/news/press/2011/2011-146.htm. The DOJ has issued guidance on how it expects the buyers to perform both pre-acquisition diligence and post-acquisition monitoring of potential FCPA matters. See http://www.justice.gov/criminal/fraud/fcpa/opinion/2008/0802.pdf.

In addition, if the target has received grants, loans or other financial assistance from a governmental agency in connection with the recently-implemented COVID-19 relief efforts or if it has received exemptions from COVID-19- related regulations or restrictions, it would be reasonable for buyer’s counsel to expect that the target may become subject to a heightened level of regulatory scrutiny. Accordingly, buyer’s counsel should also seek to understand how such financial assistance or exemptions were secured and pose questions as to the target’s application process, including whether third parties or intermediaries were retained in connection therewith.

Antitrust Concerns

Certain transactions will require the parties to submit filings under the Hart-Scott Rodino Antitrust Improvements Act of 1976 (15 USCS § 1311) (the "HSR Act") to the Federal Trade Commission (the "FTC") and the DOJ. In addition to requiring the parties to observe a waiting period prior to closing, a filing made pursuant to the HSR Act serves to notify the FTC and DOJ of transactions that may raise antitrust concerns. The information necessary for determining whether a "Notification and Report Form for Certain Mergers and Acquisition" (an "HSR filing") must be filed for the transaction is available on the FTC website at: www.ftc.gov/bc/hsr/index.shtml. Counsel should consult with an antitrust practitioner to confirm that it has the most current information because there are a number of exclusions, interpretations, and regulations that govern the filing determination, and the thresholds used to determine whether an HSR filing is required are adjusted annually to account for inflation.

The buyer's counsel and the seller's counsel should work together to make the initial assessment of whether an HSR filing is required. More detailed analysis of whether a filing is required based on the proposed deal structure is available here: Antitrust and Regulatory Considerations in an M&A Deal.

If the transaction raises antitrust concerns, special care must be taken during the due diligence process (and throughout the entire transaction negotiation process, right up to the closing) to avoid actions which are impermissible under the antitrust laws. There are two general antitrust concerns that commonly arise during the due diligence process. First, the HSR Act prohibits transacting parties from merging their operations prior to the expiration of the HSR waiting period. Violations of the HSR Act — also known as "gun-jumping" — can occur where, during the HSR waiting period, one party makes ordinary course business decisions for the other party, assigns personnel to supervise employees of the other party, or represents the other party in dealings with third parties (such as customers).

Second, throughout the pre-closing period, Section 1 of the Sherman Act (15 USCS § 1) prohibits merging parties from coordinating their businesses in areas where the parties compete. This is particularly true in transactions between competitors. Among other activities, improperly exchanging confidential and competitively sensitive information (such as prices) or coordinating competitively sensitive business decisions (such as whether to bid for customers) could raise serious antitrust concerns.

While the buyer's team may be eager to commence integrating the target company's business and operations with its own as early as possible, doing so before a transaction actually closes may be prohibited anticompetitive behavior. Coordination on customer contracts, sharing of pricing information, or coordinating strategic planning can result in civil or criminal liability under the antitrust statutes. Because a private right of action has been recognized under these statutes, competitors can attempt to attack the transaction, before or after it closes, on these grounds.

During the due diligence process, the buyer's counsel and the seller's counsel will want to wall off their respective business teams from the other party's sensitive information through the use of special protocols for handling such information. Determining the precise contours of what should be off-limits to the business people, and what level of access they should be permitted for everything else, will require working closely with antitrust counsel. As a general matter, the buyer and the seller personnel responsible for the management of the directly competing business lines should be restricted from accessing customer-specific information, pricing information, or relevant contracts. In

Page 14 of 17 Common Topics of Review in M&A Due Diligence some circumstances, the parties may need to engage third-party consultants to conduct the due diligence review and report findings in a sanitized manner so as to eliminate such competitively sensitive information. In addition, to avoid the appearance of "gun-jumping," any plans to integrate the parties' operations should not be implemented prior to the expiration of the HSR waiting period.

Tax Diligence

Tax diligence is performed by specialists, typically accountants or other tax professionals, not lawyers. The role of buyer's counsel in tax diligence will often be supervisory — the buyer's counsel will need to confirm with its client that a plan is in place to perform tax diligence on the target company and will want to establish a line of communication with the firm handling the tax diligence. Tax counsel on both sides will want to stay in close contact regarding the status of diligence to understand the tax posture of the target company, which may impact the transaction structure, and to understand any other tax-related issues that require special treatment in the purchase agreement. At times, however, there may be areas of tax diligence that counsel will be responsible for — in particular, matters regarding tax sharing agreements, tax disputes, and the like.

Cybersecurity and Privacy Diligence

As cybercrime has become ever more prevalent, cybersecurity has developed into a growing area of focus in M&A due diligence, especially in transactions that involve telecommunications, entertainment, or technology companies. The buyer should ascertain whether the target company has had any breaches of its security systems, thus compromising its digital assets, or if the buyer will potentially be assuming liabilities for past noncompliance with privacy and data security laws by the target company. The buyer will want to determine how the target company has responded to such breaches, if any, and how the target company structures its data security programs. The scope of the cybersecurity investigation depends on the transaction, the applicable industry, the value of the target’s digital assets, and the regulatory environments applicable to the jurisdictions in which the target company does business. The buyer will also want to evaluate the target company’s compliance with the European Union’s General Data Protection Regulation (the “GDPR”), which imposes significant privacy- and data-related legal obligations on companies that are located in the European Union or offer goods or services to individuals in the European Union. Failure to consider the GDPR may expose the buyer to significant penalties for non-compliance.

Social Media Diligence

Due diligence generally includes a review of the target company’s marketing strategies, which should include a review of the target company’s social media presence. Buyer’s counsel should request from the seller information related to the target company’s social media presence, including (1) a list of social media platforms used by the target company and the associated URLs, (2) names of employees or other parties who control and post to such social media accounts, (3) the target company’s social media policy, (4) the target company’s internal policies for its social media accounts, and (5) the target company’s approach to monitoring and enforcing compliance with the social media policy.

Buyer’s counsel should also look for and review unauthorized social media accounts or postings regarding the target company’s business. This may provide the buyer with additional insight into the reputation of the target company as well as identify any misuses of the target company’s intellectual property. Employee misuse of social media can expose target companies to litigation, lead to dissemination of confidential information and affect the reputation of the target company, all issues the savvy buyer will want to know as early as possible in the negotiation process.

Emergency Preparedness and Business Interruption Diligence

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Emergency preparedness and business interruption have been other areas that have been the subject of increasing focus by buyers in recent years, and they are likely to continue growing in importance following the significant disruptions to business operations brought about by the COVID-19 pandemic. The appropriate scope of this diligence will ultimately depend on a number of factors, including the industry in which the target company operates, the specific emergency or business interruption risk the buyer may be concerned about, any ameliorating facts, such as potential reserves to address the issue, and the buyer’s appetite for risk.

Other materials relating to these issues that a buyer may request to see as part of its due diligence, include emergency preparedness plans, temporary or permanent management succession plans and business interruption plans or analyses, such as analyses on potential alternative suppliers, employee remote working feasibility and capacity and studies of potential impact of emergencies on working capital. As with any other area of diligence, any significant deficiencies in these areas identified by buyer’s counsel should be brought to the attention of the buyer, so that it can evaluate any impact they may have on the terms of the transaction and/or determine whether to remediate them following the closing.

Representation and Warranty Insurance

In recent years, as the use of representation and warranty insurance has become more prevalent, the buyer’s due diligence investigation has also acquired additional importance, as the insurer will typically ask for, among other things, any work product prepared by buyer’s counsel, as well as one or more calls with buyer and its representatives to discuss any issues that arose during its due diligence investigation and how buyer got comfortable with them. Failing to provide satisfactory answers to the insurer’s questions may result in exclusions from the policy, which may in turn require, among other things, revisions to the language of the representations and warranties or the indemnification requested from the seller.