Schiff Hardin LLP 150th May 21, 2014
Schiff Hardin Approach

Our Hands Are Tied: Unintended Consequences of Due Diligence Agreements

By: Linda K. Stevens
Schiff Hardin LLP
lstevens@schiffhardin.com

Transactional due diligence is almost always preceded by execution of a due diligence agreement. Such agreements usually include a non-disclosure provision intended to protect confidential information regarding the target business to be shared with the potential buyer as well as restrictions on hiring the target company's personnel. Such provisions may be viewed as routine boilerplate — so uncontroversial that they may be signed without input from the legal team. However, such provisions often restrict a potential buyer's business long after the parties have gone their separate ways. While some restrictions might pose few problems, others can be burdensome and leave the potential buyer regretting its failure to subject the agreement to a more careful review.

Hiring Restrictions:

For example, a typical due diligence agreement will prohibit the prospective buyer from hiring any of the target company's personnel for some period of time. Such restrictions are likely to chafe if the deal fails to happen. Because the target company is often a competitor in the same industry or operates in an area of desired expansion, its workforce is likely to be attractive when the potential buyer needs to scout out new talent. Additionally, turn-over within the target company — a common occurrence in businesses experiencing the various stresses that prompt or result from the posting of a "for sale" sign — means that an increased number of the target company's personnel may be seeking employment with the prospective buyer. That prospective buyer will not want to tie its hands and preclude itself from hiring qualified refugees from the target company. This is particularly true in industries with few employers or other limitations on the supply of appropriately trained talent.

Fortunately, placing the target company's entire workforce off-limits may be unnecessary. A non-hire provision generally is included in due diligence agreements in order to prevent a prospective buyer from exploiting its due diligence entree to identify and recruit the target's personnel. Such a prohibition — for a limited period of time — may seem reasonable. But due diligence agreements are often drafted much more broadly, i.e., purporting to prohibit the prospective buyer from hiring any of the target's personnel for a period of time, even those who have been laid-off by the target company and those who were known to the buyer prior to due diligence. A prospective buyer would do well to question the need and justification for such a provision and consider seeking limitations, such as the following:

  • Limit the restriction to target company employees "to whom Buyer is introduced as a result of the due diligence" and exempt the target company personnel about whom the prospected buyer had knowledge, or with whom it had contact, prior to engaging in due diligence;
  • Further limit the restriction to those whose employment is not terminated by the target company;
  • Shorten the ban on hiring and couple it with a slightly longer ban on solicitation, leaving the prospective buyer free, after a short period of time, to hire target company personnel from whom it receives an unsolicited application.

Obligations Regarding the Sharing and Return of Confidential Information:

Non-disclosure undertakings are another typical feature of due diligence agreements. Such provisions often define the "confidential information" to be shared in potentially problematic ways — or fail to define it at all. Does the agreement say that all information to be shared between the parties is confidential? Does it require that the producing party designate as "confidential" whatever information it desires to protect?

The desirability of a particular non-disclosure provision depends on which side of the transaction table the party is sitting. For example, provisions protecting only those materials designated by the target company as "confidential" (e.g., by stamping documents) generally favor the prospective buyer, since the burden of marking the documents — and the impact of failing to do so — rests with the target company.

Return-of-information clauses also require careful thought. If a target company includes such a provision in its due diligence agreements, it will want to monitor — and demand — compliance, in order to avoid the possibility that a court would deem its rights in that information abandoned. And what exactly does "return" of information mean when the information is stored and shared in electronic format? If "destruction" is offered as an alternative, is there a particular method of destruction specified? Although the use of secure cyberspace "data rooms" for the storage and review of due diligence materials is an effective means for addressing many of these issues, such contemporary practices are often used in tandem with outdated forms. Older-style due diligence agreements remain in use, even though their provisions may not be entirely consistent with current best practices — often creating more problems than they prevent.

For most companies, a twenty-first century "tune-up" of its due diligence forms may be in order, and any agreement pushed across the deal table should be carefully reviewed to ensure that its restrictions are reasonable.

Originally published at InsideCounsel.com.

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