Reducing the Risk of Post-Merger Discovery Surprises in M&A

As companies are bought and sold, legal obligations may transfer with the acquired entity to the purchaser. The transferred legal obligations typically carry with them the responsibility to preserve and potentially produce electronically stored information (ESI) that may become evidence pursuant to a legal or regulatory proceeding. When this potential evidence is in electronic form, someone unfamiliar with the legal matter may see a hard drive as “just old hardware able to be disposed of during the transition” or “an outdated server that may be a candidate for decommissioning.”

Hard drives, servers, and other storage devices may store potentially relevant data necessary to meet basic preservation requirements and support or refute the allegations in a matter. During an M&A transaction, the resources responsible for the handling of hard drives, servers, and other sources of information may change as departments are reorganized. Legal proceedings often last many years, and the electronic files—now deemed to be evidence—may no longer be needed for any business purpose and may be easily mistaken by a new or transferred employee for expired data that can be discarded.

Evidence handling requires certain protocols be followed that are critically important to establish and maintain a chain of custody and the integrity of the data. Specialized experience and knowledge are required to manage the process of transferring evidence given the associated security, confidentiality, and operational considerations.

Individuals inexperienced in handling evidence may be charged with managing hard drives and other data storage during a transition, and may not yet have the required knowledge to discern when information being moved or removed relates to a legal proceeding. If the data is lost, altered, or otherwise compromised, or if information created after the acquisition relating to the proceeding is not preserved, the ultimate outcome of the proceeding may be negatively affected as a result. Companies that assign trained and knowledgeable personnel to manage electronic evidence as transitional changes are made reduce the risk of impairing a legal or regulatory matter due to spoliation of evidence.

Due Diligence Activities

During mergers and acquisitions, the process of due diligence is used to confirm key value drivers and uncover material facts that could have either a positive or negative impact on valuation and, therefore, expected returns. The due diligence process carries additional significance in that, if performed skillfully, it may offer the buyer support in disputes that can arise over undisclosed information.

A comprehensive due diligence process includes an evaluation of the target company’s financial, legal, and commercial activities (among others), including information technology, to determine points of risk and value prior to the execution of the transaction. This process provides an acquirer with confidence in the value it ascribes to the target, and a basis for asserting its position on key deal terms and conditions such as representations, warranties, and—in certain cases—transition services agreements (TSA).

Assigning a value to the level of risk is complicated because it is based upon subjective assumptions. The financial impact of legal proceedings on assessed value is impacted by, amongst other things, the target’s level of compliance with discovery obligations, which even under normal circumstances can be difficult to achieve. Compliance by employees unfamiliar with the legal system is challenging even in the normal course of business because it requires building a shared understanding of a complex topic among a large number of people with different perspectives. In an M&A environment, this becomes even more difficult because many of the employees who are relied upon for executing discovery responsibilities may have transitioned into new roles post-closing or may have been separated from the company.