What is covered in this guide?
- Classify documents
- Using review checklists
- Assessing contract materiality
- Contract expiry
- Contract parties and their role
- Related party contracts
- Example contract review
Classify documents by document type
It is tempting to launch into the contract review without a plan or agreeing a scope of work with your client.
After the seller has uploaded the contracts to the data room, we suggest classifying the contracts so you know what you have, what is missing and it will help you assign to reviewers based on their expertise.
Based on the classification, use a suitable review checklist. It's not appropriate to use the same checklist for all document types so your checklist will need to be tailored based on the document type.
Helpful resources
SALI (Standards Advancement for the Legal Industry) has a list of standardized document types you might need to review as part of due diligence. You can find out more about SALI (Standards Advancement for the Legal Industry) here. We also provide a list of document types we support in Due here.
Using review checklists based on the document type
It’s important to use a checklist for the following reasons:
- Different types of contracts have different legal requirements, clauses, and provisions that need to be carefully examined. For instance, an employment contract will have different key elements compared to a lease agreement or a supplier contract.
- Using a tailored checklist for the specific type of contract ensures that you do not overlook any critical aspects or terms that could significantly impact the transaction or the client's interests.
- Specific checklists help you maintain consistency within your team of reviewers ensuring nothing is missed and it makes it easier to compile the review summaries into a report.
- Utilizing the correct checklist can also help you prioritize the review process, focusing on the most critical areas first, and allocating time and resources effectively.
Don't have a checklist?
If you don’t a checklist or one that suits your document type, refer to our checklists on Due's website here.
Is the contract "material"?
Often the client will agree a materiality threshold for the due diligence process. This can be a quantitative or qualitative materiality threshold. Make sure you check that a document is material and/or within the client's scope before spending time reviewing it.
Has the contract expired (or nearing expiry)?
Expired contracts
Before starting to review a contract, check that the contract has not expired (the expiry/end date has past). If the contract is expired, you can raise this with your client as the target will need to mitigate risks associated with lapsed agreements.
To determine whether a contract has expired, you will need to check the end date (or expiry date) of the contract and whether there are any options to extend the term of the contract that haven’t been exercised yet.
If a contract has expired, it may present an opportunity for renegotiation or the establishment of new terms and conditions that better align with the current needs and interests of the parties involved.
Nearing expiry
If the contract's expiry date is nearing (e.g. within the next 6-12 months), you might also need to flag this with your client as they might need to negotiate an extension before completion.
Who are the contract parties and what is their role?
Commonly, parties enter into a contract in one of the following ways (not an exhaustive list):
- as a person or individual (acting alone or acting as a trustee for and on behalf of a trust)
- as an organisation such as a company or an incorporated joint venture (in its own name or acting as a trustee for and on behalf of a trust)
It is important to identify the contract parties for the following reasons:
- Determine which rights and obligations apply to each party
- Determine whether the contract parties are a Target Company or a company within the Target Group
- Evaluate the quality of the counterparties to perform the contract (e.g. this might be relevant if the target is in a joint venture with another party)
- Determine if the parties are related (see more information about related parties below)
Cross-check with public registers
You can check the company names and numbers in the contract by searching public registers. For example, in Australia, you can confirm:
- The Australian Company Number (“ACN”) is correct here.
- The Australian Business Number (“ABN”) is correct here.
If your search reveals that the company number in the contract is different to the register, you should speak with your supervisor about how they prefer you to record that discrepancy.
Check for name changes
After searching the company number of a party in the contract, you might discover that the name of the company in the contract is different from the company name in the register.
In these circumstances, check with your supervisor how they prefer you to record the change of name (e.g. your client might find it useful for you to reference their current name followed by their former name in brackets).
Check for contract assignments
You might notice the target company is not stated as a party in the original signed contract. This might be because the contract was assigned to the target company after it was signed. If this is the case, you will need to request the seller or target company provide the assignment deeds to review.
What is the target company’s “role” in this contract?
If the target company or a subsidiary is a party to the contract, ascertain their “role” within the contract. Sometimes their “alias” is their role, but not always.
Some examples include:
- In a lease agreement, roles include a "tenant", "landlord" and sometimes, a "guarantor"
- In a loan agreement, roles include a "borrower", "lender" and sometimes, a "guarantor"
- In an employment contract, roles include an "employer" and "employee"
- In a commercial contract, roles include a "buyer" and a "seller'
By knowing this, we can make quick assumptions about the Target Company or a target group company, such as:
- if the Target Company is a Tenant, we know it is responsible for paying rent and it doesn’t own the property;
- if the Target Company is a Borrower, we know it has loaned some money from a lender and it will likely need to repay the loan;
- if the Target Company is an employer, it might have accrued liabilities owing to the employee.
When reviewing the contract, you should review it from the perspective of the group company and whether the rights and obligations of the group company are market standard.
Is the contract between related parties?
A contract between related parties (or a "Related party contract") are often considered a "material contract" so it's likely you will need to review them irrespective of monetary value.
It might not be immediately obvious that the parties are related so you should seek clarification from the seller or target which contracts (if any) are related.
Are there any related party contracts?
Identify related party contracts by:
- Asking the Seller or target company for a list of related party contracts
- Asking during the RFI/Q&A process
- Confirming by looking at public records or online.
Once you have a list of related party contracts, confirm the parties are in fact related.
Who are related parties?
Below are examples of parties that are related.
- An entity that controls a company is related to that company
- If 2 or more entities are both controlled by the same holding company, then those entities are related
- A director of a company is related to that company
- Spouse and children of the Company Director are related to Company
- Directors of an entity that controls the company are related to that company
- Spouse and children of a Director of an entity that controls the company are related to that Company
Review the related party contract
Review the contract to determine whether it was entered into on arm’s length terms. Examples of things to look for:
- Standard T&C’s
- Advice sought
- Written contract
- Market rates
- Signed contract
- Negotiated terms
- Undue influence
Will the contract continue after completion?
Determine whether the parties want the contract to continue after the transaction is completed.
- Ask the Seller via RFI/Q&A
- Parties must be willing to uphold obligations
- Consider if the contract is beneficial to the incoming buyer or new shareholders
Example contract review
Let's apply the above guide to review a customer contract
Overview and agreement details
- Identify the parties involved (and their relationship, if any);
- Specify the nature of the agreement (ie that the target company is supplying goods and/or services to the counterparty.
Commercial details
- Indicates whether there is a minimum contractual quantity the Customer agreed to purchase;
- Approximate annual contract value or pricing (revenue);
- Approximate annual contract value or pricing (revenue);
Term and termination rights
- Outlines the initial term of the contract;
- Identifies an option to extend the term for a further term(s);
- Notes whether the Customer has the right to terminate the contract early for their convenience and whether there is an early termination payment (refer to the article on termination rights in commercial contracts).
Transfer restrictions
- Identify any transfer or assignment restrictions, and restrictions on a change of control of the target company (refer to the article on contract assignment in M&A (ensuring smooth transfer of material contracts))
- This is particularly relevant in M&A as if the incoming buyer can't get the benefit of the contract due to the transfer restrictions, then this may affect the purchase price for the asset or company.
Liability regime
- Whether the target company indemnifies the other party and in what circumstances;
- Whether the target company’s liability is limited and if there are any exclusions from this limit (eg for fraud or wilful misconduct on part of the target company);
- Whether the target company is liable for consequential loss and what is the meaning of consequential loss in this contract
- Refer to the article on how to analyse liability regimes in commercial contracts
Security
- Whether the target company is required to provide security;
- What type of security is required (e.g. bank guarantee or guarantor);
- What recourse does the counterparty have to the security.
Miscellaneous
- Identify the governing law;
- Check the contract has been duly signed by all parties in accordance with the relevant laws, ensuring enforceability;
- Any other onerous or unusual provisions identified.