Digital Issues to Consider Before a Merger or Acquisition, Part 1 of 2: the Due Diligence Phase

Part 1 of 2: the Due Diligence Phase

A critical, but yet surprisingly overlooked, component of a successful merger or acquisition is the dependability and efficiency of the data due diligence undertaken by the companies involved in the transaction. Companies should be cautioned that post-integration success may hinge on the data due diligence efforts undertaken in the pre-merger and acquisition due diligence phase.

The importance of the condition of the target company’s ESI cannot be understated. It is imperative that the acquiring company undertakes a “systems” check to thoroughly review the target company’s existing information systems. Moreover, an evaluation of these systems and processes will assist the parties in identifying critical issues related to integration, data loss and data recovery issues. In light of the burden that the acquiring company assumes respective to ensuring that data related to current or anticipated legal disputes is preserved, along with the high cost of losing or improperly storing such data, mandates that the aforesaid steps be undertaken in some fashion to ensure a thorough evaluation of said company’s ESI.

A second item of particular import in any e-discovery checklist is current existing and anticipated legal holds. An acquiring company succeeds its target in ongoing or anticipated legal disputes; therefore, said company is now responsible for preserving and placing litigation relevant data and metadata under legal hold. The sustainability of any post-integration success will be tested by any number of issues, but arguably none more so than ongoing litigation and the costs associated with such litigation. Companies generally tend to vet current and potential legal disputes of a target company with a “fine-tooth” comb; however, the same critical analysis should also be placed on identifying these litigation or regulatory holds in the pre-acquisition phase.

The cost of preserving data for existing or anticipated legal holds is a significant factor to consider in pre-M&A due diligence. Evaluating the costs of preserving data that is subject to a litigation hold should be accounted for in the pricing of the deal, where appropriate.

Counsel must also consider physically verifying the systems exist and that the systems are operational. An acquiring company should physically verify that the backup tapes operate and contain data. Failing to do so at this phase exposes the acquiring company to unnecessary liabilities and increased costs, because if the data is partially or not at all backed up the acquirer will incur substantial additional costs in order to try and restore the data, which may or may not be possible. Perhaps, even more important, if this issue arises, the acquirer should see it as a red flag because it may indicate possible prior bad acts, senior management is oblivious to the day-to-day operations, existing agreements might be fraudulent, or other possible technology infrastructure issues exist that might not have been identified, which are costly to remedy.

** This is the first part in a two-part series which comprise an abridged version of the article “Digital Issues in Mergers & Acquisitions,” written by Daniel Garrie and published in the Los Angeles Daily Journal. To request a PDF of the complete article, please contact Law and Forensics.