Due diligence identifies potential risks before closing a deal. The goal is to find problems that may lead to renegotiating, reducing the purchase price, or walking away from a deal.
Yet many issues remain hidden despite rigorous due diligence. Earlier in my career I read about issues that were raised in a bankruptcy asset sale involving two major commercial real estate brokers. However, the issues raised apply to any industry where a years-long effort to poach employees included the unauthorized use of various documents.
The bankruptcy case concerned a large publicly traded firm based in California that was acquired by a New York-based competitor. The Seller’s business was declining although it continued to engage in significant deal flow. The Buyer wanted to acquire the Seller to become one of the industry’s largest brokerage and service companies as one of its acquisitions to achieve this goal.
Despite engaging in due diligence, the Buyer failed to learn that key employees were defecting to a global competitor headquartered in Toronto over a period of several years. Defectors left for a company whose CEO was formerly employed by the Seller in the same role. Post-closing, the Buyer discovered that these key employees had taken Seller’s confidential information, opportunities, templates, and other valuable confidential information to their new employer.
Could the buyer’s due diligence have uncovered these issues before closing? The buyer’s allegations suggest a broad scheme involving numerous employees over several years. If industry rumors hinted at such activities, should a more focused investigation could have warranted?
When the bankruptcy court issued its ruling in February 2024—twelve years after the asset sale closed—it sifted through many issues and documents to reach its rulings. The practical lessons to be learned by prospective acquirors are:
- Determine whether a series of defections to a particular competitor occurred. If so, due diligence through an analysis of the target’s IT systems is imperative.
In 2024, any such analysis must include communications via Slack, text, etc. and not only emails.
- Lists of trade secrets used as schedules or other “definitive” lists of trade secrets should be written expansively to note that other trade secrets may exist within the assets being transferred.
- Public information should be used to a greater degree to infer what is happening internally at a target. Sometimes the most important concerns can be found by simply reading the news. In this case, industry magazines and business journals presumably noted each employee’s move to their common new employer. Ironically, a high school student asked to analyze the situation through reading the first one hundred articles of a Google search may have recommended a more detailed investigation into “what is going on with all of these people leaving for the same place.”
There are many other issues, complexities, and lessons to be gleaned from this ongoing case. But what bothers me most is that the acquiring company and its advisors presumably understood a potential giant concern existed and either (a) acknowledged the issue and stayed willfully ignorant or (b) thought the deal was too good despite an obvious and fundamental issue looking right at it.
David Seidman is the principal and founder of Seidman Law Group, LLC. He serves as outside general counsel for companies which includes negotiating, drafting, and litigating purchase and sale agreements, lease agreements, licensing agreements, and other real estate agreements.
He can be reached at david@seidmanlawgroup.com or 312-399-7390.
This blog post is not legal advice. Please consult an experienced attorney to assist with your legal issues.
Photo: Due diligence by Nick Youngson CC BY-SA 3.0 Pix4free
