Do the due (diligence, that is)

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This article was first published in the Bay of Plenty Business News

It is a sad fact that the victims of Covid-19 are not just those who contracted the virus. The victims also include – as has been widely publicised – many businesses. From small, home-based businesses to large, international corporates, no-one has escaped unscathed.

As has been often cited in recent weeks, out of adversity comes opportunity. Thus, businesses which have suffered at the hands of Covid-19 may present attractive opportunities to investors, asset hunters or people made redundant looking to resurrect what, in better times, were thriving businesses.

Whichever category interested parties might fall into, the one thing they all must do – and do thoroughly – is comprehensive due diligence on the intended target. No metaphorical stone should be left unturned, everything should be checked.

This is one of the ‘take-homes’ from a recent decision of the High Court of New Zealand concerning a dispute between Bradfields Limited and its directors, the Sullivans, (all together, ‘Bradfields’) on the one side, and Brookwater Investments Limited (formerly called Bradfield Marketing Limited) and its director, Paul Bradfield, on the other. Also identified as a defendant was Christchurch-based law firm, Malley & Co, which had advised Bradfields in the sale process.

The background to this case, in brief, is this: in September 2014, Bradfields purchased a business from Brookwater (then called Bradfield Marketing) which involved the manufacture and sale of natural pet care and air freshener products in New Zealand and Australia. About 18 months after the sale was completed, Bradfields was told by regulators in Australia that most of its pet care products were required to be registered before they could be legally sold in Australia. At around the same time, Bradfields was similarly told by regulators in New Zealand that some of its pet care products needed to be registered before they could be legally sold in New Zealand. Having taken advice on the issue, Bradfields stopped selling all of its pet care products in Australia and most of its pet care products in New Zealand. Bradfields took Brookwater to court to try to claim for their losses.

In the High Court, Bradfields and its directors brought five claims against Brookwater and/or Mr Bradfield, including breach of terms of the Purchase Agreement, misrepresentation and breach of the Fair Trading Act 1986. Bradfields also claimed negligence against Malley & Co. Central to the whole proceeding was Bradfields’ claim that it was a condition of the contract for the sale and purchase of the business, and that it was represented to them throughout the sale process, that the pet care products were being sold legally in Australia and New Zealand and did not require registration under applicable regulations in those countries. Further, it relied on those representations in agreeing to purchase the business.

Standing back, it is clear that the registration status of the pet care products was crucial to the success of the business and therefore was a crucial component of the due diligence phase. Independent enquiries were required to verify the accuracy of the representations made to Bradfields. No such enquiries were seemingly made, however, either by Bradfields or its solicitors.

For this oversight, the court was content to lay the blame at Bradfields’ solicitors’ feet, finding them liable for negligence through failing to advise Bradfields adequately. With all due respect to the court, I think this is harsh: in my view, once the issue of regulatory compliance had been raised, it was incumbent on both Bradfields and their solicitors to ensure due diligence was properly undertaken. Bradfields, then, should have shouldered some of the blame for failing to clearly define with its solicitors who was doing what in the due diligence phase.

To re-state the ‘take-home’: if you or someone you know is considering purchasing a business or a business’s assets, make sure you do your due diligence thoroughly. Draw up a list of every conceivable issue, and do not tick it off until you are 100% confident it has been dealt with. The list should include identifying and verifying ownership of all intellectual property assets, such as registered and unregistered trade marks, domain names, trade secrets/confidential information, copyright and patents, as well as any regulatory matters. Further, when seeking advice from a lawyer, including an IP lawyer if necessary, be sure to allocate responsibility for ticking off the items on the list.