Experiences from the completion of buyers' due diligence of single purpose real estate companies
As part of the formalisation of the term sheet or the final share purchase agreement, the buyer will either as a condition for further negotiations or as a condition precedent to the completion of the transaction, require that the buyer is given the opportunity to complete an adequate due diligence of the company and the property. Typically, the buyer’s due diligence encompass a review of financial and legal matters concerning the company, including tax and VAT matters, and a review of technical and environmental issues regarding the property as such. Thus, the implementation of the buyer’s due diligence is often dependent on different service providers.
Risk factors revealed in a delimited part of the due diligence is often relevant to other sections of the due diligence process. However, without the sufficient planning and management of the due diligence process there is an increased risk that each of the involved professions sit on each side, without a constructive dialogue taking place during the process. The result is often increased costs on the hand of the buyer, and an increased risk that factual circumstance or other risk factors within the individual service disciplines remain undetected.
Thus, the completion of a reassuring due diligence process is dependent upon a close collaboration between the various service areas – both with regard to consecutive exchange of information and teamwork on overlapping matters. This is ensured by good planning of the due diligence process, among other things by determining a detailed scope for each of the service areas, common request lists, pre-determined status meetings between the various service areas, common milestones etc. It is often advisable to have a dedicated resource that ensures coordination between the service areas. We regularly assume this role.
Our experience is that a well-functioning collaboration across the service areas is an important premise in order to provide the best possible basis the buyer’s decisions. At the same time, the fulfillment of this premise will in itself, and almost without exception, create added value for the buyer. This in the form of uncovering and quantifying the risk factors associated with the target company, verifying the factual and legal basis of the buyer’s plans for the property etc.
When conducting legal due diligence assignments, we are therefore particularly concerned with ensuring a good collaboration across the involved service areas. This enables us to provide a precise and complete risk assessment as possible, but is also essential to ensure the overlap between the service providers.
Furthermore, there are a number of recurring risk factors in these transactions. Risks exposed in the due diligence, will often give reason for the buyer to reduce his risk exposure beyond the regulation in the standard agreements. The elimination or reduction of risk exposures can be achieved by requiring additional guarantees, indemnification, price reductions etc., for the revealed circumstances.
From a legal perspective, it is our experience that the buyer should pay particular attention to the following matters:
- Tax depreciations – Investigations regarding the historical allocation of cost price between the plot and balance depreciations, and allocation between the respective balance depreciation groups, have both significance for verifying that the historical tax reporting is correct, and for verifying any (agreed) tax discount.
- Tax depreciations vs. direct cost accounting – We often reveal that the target company has made direct cost accounting of various costs that should have been the subject to capitalization and thereby tax depreciation.
- Historical tenant adjustments – In such cases, it is particularly relevant to investigate the lease agreement’s regulation regarding the legal status of such tenant adjustments at termination, and whether such adjustments are handled correct in the historic tax reporting.
- VAT – Reoccurring matters are assessments regarding i) historical reporting of VAT when the target company lease the property to mixed businesses (leasing to both VAT-liable and VAT-exempted activities), ii) cases where the target company historically have been part of events subject to VAT-adjustment, iii) status regarding registration in the VAT-register etc.
- Transactions with related parties – This is often relevant where the property company has concluded management agreements with related companies. In such cases, the key is to investigate whether the agreements, as well as the terms of the agreement as such, are in accordance with the provisions in the Norwegian Company law and Tax law, including procedural requirements, pricing etc.
- Implemented reorganizations – Because of the potential joint and several tax liability that may incur as a result of implemented reorganizations, it is particularly important to check that all the conditions for tax exemption have been fulfilled in reorganizations (demerger, merger, etc.) implemented the last 10 years. Often, we reveal both minor and substantial errors in the tax and accounting implementation, which actualize the need for specific indemnification on the part of the buyer.
- Legal protection – It is essential to verify that the target company has legal protection for its legal acquisition of the property, which often require further investigation. For example, this particularly applies where the target company has participated in previous reorganizations as mentioned above.
- Lease agreements – In several relations it is important to get an overview of significant commitments, such as the risk of paying for and carrying out maintenance and replacements, change of control clauses, termination clauses etc. This is also important in order to verify whether the parties have complied with their obligations. In addition, it is important to clarify whether the lease agreements are in line with the current standard agreements/industry conditions, or whether there are deviations.
- «Showstoppers» – It is essential to identify risk factors that are able to obstruct the execution of the transaction, for example pre-emptive rights, restrictive clauses, or other restrictions in the right to dispose the property or shares.
- The range of registered and unregistered liens – The information contained in the land register is often limited, which requires thorough review of the underlying registered documents.
- Certificates of completion/provisional permissions to use – It is essential to make factual assessments of the existing certificates of completion and the property’s actual nature, including whether the condition of the property is in accordance with available permits.
- Planning regulations – Current municipal sector plans and zoning plans should be compared with the existing utilization of the property, including the buyer’s further plans for use/utilization of the property.
The awareness of these conditions are also important from the seller’s perspective, prior to the transaction-process. In many cases, it may be appropriate for the seller to perform a vendor’s due diligence prior to the process.
Simonsen Vogt Wiig has extensive experience in assisting the parties at all stages of a sales process – from planning to completion and implementation of the transaction – and can offer services in all legal fields. Please contact our lawyers if you have general or specific questions in this regard.