Due diligence

Due diligence is the process whereby the purchaser carries out an investigation to:

• • determine if it is acquiring what it thinks it is acquiring;
• • evaluate the benefits and risks;
• • flag issues to be dealt with prior to entering into a binding contract; and
• • test the representations made by or on behalf of the vendor.

If due diligence is not undertaken, the purchaser must rely on the vendor's warranties in the contract (if any) and must typically commence proceedings to enforce its rights under the warranties if they are breached. Even if the purchaser is successful, the recovery of damages will depend on the financial standing of the vendor or may be limited as a matter of law (see eg Bain v Fothergill (1874) LR7HL 158; [1874-80] All ER Rep 83 in the states where it still applies).

Whether or not the parties enter into a preliminary agreement or formal due diligence will depend largely on the nature of the property being acquired. For instance, where the purchaser is acquiring a single retail shop which is subject to a lease due diligence may be a matter of the purchaser's solicitor requesting information and documents from the vendor's solicitor prior to exchange. The vendor's response may be the subject of vendor warranties included in the contract or rights arising if there has been a breach of the statutory obligations of the vendor under the relevant state or territory legislation.

Where the property being acquired is, eg a multi-story office building, the parties may enter into a Heads of Agreement which will contain, amongst other things, obligations of confidentiality and the key terms agreed by the parties in principle and possibly an exclusive dealing arrangement.

If due diligence is undertaken it should be concluded with a report to the client prior to the expiry of the due diligence period as the purchaser will need time to absorb it and to respond. If no due diligence is undertaken, a comprehensive letter of advice should be prepared.

Due diligence requires a team approach and usually involves at least two of the following disciplines:

• • legal;
• • financial;
• • structural;
• • contamination; and
• • technical.

An effective due diligence process requires:

• • the flow of information ideally coordinated by one representative from each side;
• • requests for information; and
• • control of the flow and management of information and documents.

See Due diligence.