Hidden Terms Best Uncovered with Thorough Diligence

One of the most important steps in any mergers and acquisitions (M&A) transaction is the examination of the target’s written contracts to review the terms and conditions of each, to evaluate whether those continuing obligations are worthy of assumption and to ensure that each contract can successfully be assigned or terminated without causing a breach of such contract.

At first glance, this may appear to be a straightforward, simple task. Most business owners are fairly confident that they are cognizant of all of their business activities and can identify the full scope of their outstanding and ongoing contractual obligations. However, conducting a proper and full review of these contracts requires attention to detail, and a thorough review of the target’s business records. A complete and careful review is necessary to minimize the risk of incurring unforeseen liabilities, additional expenses, or taking on unwanted contractual obligations.

Many contracts in today’s business world are made with a click of a button. A contracting party expressly agrees to terms and conditions on a vendor’s website. The terms may be referenced and incorporated in a purchase order or invoice. Many companies find that they have inadvertently agreed to unexpected obligations. Such terms and conditions include lengthy notice periods for termination, burdensome procedural requirements under change of control provisions, inconspicuous rights of first refusal, prohibitions on assignment, and liquidated damage provisions for early termination. Such terms must be identified prior to a sale.

Other contracts may be premised on or amend prior agreements. For example, many software licenses or specialty services are subject to master service agreements which are subsequently modified or expanded by the software or service-specific addenda. The end result of such agreements is having multiple sets of terms and conditions which may interplay with one another or override certain provisions of the other. Each of these separate documents must be identified and reviewed as part of diligence review, finalizing disclosures, determining assignability of contracts, and terminating existing obligations in order to ensure all proper notices are given and all required procedures are followed to avoid a potential breach.

While it is likely a difficult task to keep track of all of the various contracts and the accompanying terms and conditions applicable to a company’s business activities, it may be very helpful in the long run to keep an ongoing ledger or spreadsheet of all the business’ various contracts. Implementing a record retention policy that requires physical storage of all written contracts, along with a contract summary spreadsheet, can go a long way toward facilitating diligence review in the event of a sale of a business and enabling quick comparisons of the terms and provisions of vendor contracts. A few key informational items to include on such a spreadsheet are the legal name(s) of the vendor, the date the contract is executed, term lengths and pricing, contacts listed on the notice provisions, and whether the contract is subject to additional terms and conditions listed on a vendor’s website. Include the web link, as these additional vendor terms and conditions often change.  Also, a periodic review of accounts payable may help identify an existing contractual obligation that is no longer necessary or can be renegotiated, or perhaps bring attention to an unwanted price increase or service reduction.

If you would like more tips on how to organize and catalogue your contracts and outstanding business obligations, or if you have more questions about what may be required when preparing to sell your business, please reach out to our Business and Finance Department by contacting me at jsmith@pullcom.com or by phone at (203) 330-2083.