HOW TO CARRY OUT EFFECTIVE ESG DUE DILIGENCE

A core principal of common law is caveat emptor, and as Lord Atkin, Bell v Lever Bros (1932) stated “Ordinarily the failure to disclose a material fact which might influence the mind of a prudent contractor does not give the right to avoid the contract.” The idea behind this rule is to deliberately put the buyer ‘on guard’ and induce them to make appropriate enquiries into the worthwhile nature of the transaction writes Professor Robert Lee, Landmark Information Group.

If a vendor can stay entirely silent during the course of a transaction, however bad the bargain, there is no legal recourse against that vendor. From the purchaser’s point of view, this creates an imperative to uncover any sort of information, through preliminary enquiries, to begin the process of due diligence.

Due diligence aims to isolate areas of concern and to put these to the vendor, so they are induced to make representations in the course of negotiations. Many lawyers have experience of delving through hundreds of documents that put into disclosure, which eats up a great deal of time and human resource; but this is undergoing rapid change both in process and content.

Today, our capacity to search across data is immense – not only in terms of the data put into disclosure but also across the wider public domain. Data – and digitised data – growth has been phenomenal over the last two decades, as trends such as corporate reporting add yet more sources of data.

The due diligence process remains crucial; in purchasing the shares of a company and acquiring that company, one not only acquires its assets but also its liabilities. The due diligence process was therefore driven by a desire to avoid that liability risk.

Financial and reputational risk have overtaken, to some degree, the historic emphasis on liability risk – and due diligence has become much wider ranging in its scope. For example, as firms grapple with their understanding of ESG and managing climate change adaptation and mitigation, financial risk goes beyond the current financial worth of the company and entails far more holistic questions concerning the future capacity of the company to attract investment.

Similarly, with reputational risk, in the past this may have attached to liability risks, but now, it goes much further. In acquiring a company, worries attach to ESG considerations such as the impact on the reputation and share value of the group of companies if it transpires, post-completion, that the acquired company is the subject of a major scandal in relation to, e.g., bribery or corruption. So we see a change of emphasis in due diligence, centring on the three Vs: of Verification, Value and the Vagaries of unforeseen elements that have the potential to come back and bite us.

Another trend is the merger of legal and business due diligence. The growth of ESG leads to due diligence enquiries that may have previously been managed by other professionals including issues such as supply chain contracts or the handling of employee relations. The ESG agenda is wide and lawyers are drawn into new routes of enquiry.

Lawyers are focusing much less on the negatives and beginning to instead to concentrate more on the evaluation of the positives, which are represented in the longer-term value of the company as judged by a range of factors, all of which speak to sustainability.

This creates an integrated agenda, with a cross-disciplinary approach. So, for example, narrower concerns of a company’s historic record in waste management now include much wider ranging questions of product stewardship. Across many legal disciplines, we see a widening of the agenda so that contract lawyers engage with supply chain policing, environmental lawyers with climate change resilience, employment lawyers with whistle-blowing policies and so on.

Indeed the barriers between many of these traditional legal specialisms erode as lawyers engage with an integrated ESG agenda.

Importantly, the end product of this work this is not just about some price adjustment on the deal or the negotiation of an indemnity to cover areas of future uncertainty. The significance attached to ESG may well mean that the results of due diligence put an early end to the transaction as companies decide that the acquisition is not a good fit.

In an era of big data, there is so much data out there that they are a powerful tool if employed effectively. But how do we combine it and analyse the data to make conclusions about the value of a company? Increasingly, it will be algorithms rather than lawyers that bear this hard work, speedily and efficiently.

Lawyers will always have the task of exercising judgement on issues central to the transaction but solutions such as RiskHorizon, will offer a quick and inexpensive fix on what these core issues are.

Use of this tool allows you, at the early stage of due diligence, to risk profile, in a sector-specific way, so lawyers know where to begin serious enquiry and highlight initial areas of concern and, indeed, of value.

Due diligence, then, is changing rapidly, under pressures of ESG in terms of both process and content. Data driven tools are there to allow us to add real value to the deal, and to focus on positive attributes, rather than pursuing a narrowly drawn approach to due diligence based on negative downsides.

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Contact us now for a demo and let us show you how RiskHorizon works, and how easy it is to incorporate into your existing workflow.