What is due diligence and why is it required?

Due diligence is the process that a buyer will undertake to obtain information about the dental practice that it is proposing to purchase. It allows the buyer the opportunity to investigate the practice in more detail to ensure that it is a viable practice. It will also highlight any risks of the purchase and seek to draw out any skeletons that may be lurking in the closet!

The due diligence process is usually kick-started by the buyer’s solicitor issuing a due diligence questionnaire to the seller’s solicitor. This generally happens at the outset of the legal work – once the parties have agreed on a deal in principle – but before they sign up to the sale contract. They may have heads of terms in place and are likely to enter into a Confidentiality Agreement (aka Non-Disclosure Agreement) before beginning the due diligence process. This ensures that the buyer keeps confidential any due diligence information disclosed by the seller.

The seller and its advisers will consider the questions and provide responses to the enquiries along with supporting documentation. More often than not, a secure on-line data room is set up so that all of the information can be gathered and accessed by all relevant parties from one place. Based on the information provided, further enquiries are likely to be raised until the buyer is satisfied with the responses received, or, in a worst-case scenario, decides not to proceed with the purchase (either due to a lack of information being provided or of adverse information being disclosed).

Key areas

In terms of legal due diligence, some of the key areas a prudent buyer should cover are as follows:

• Property – how is the property owned/occupied, does it have planning consent to be used as a dental practice (D1 use required), is it in a good state of repair and condition? Who actually owns the premises – is it the seller of the practice or is it a third party?
• Equipment – an inventory will be requested as well as details of ownership of assets and maintenance of dental equipment (e.g. dental chairs, x-ray machines).
• Insurance – copies of all insurances (building, employer’s liability, public liability). Also details of any claims made historically under the insurance.
• Contracts – details of all commercial contracts in place (e.g. third party supplier contracts), the liabilities thereunder and how/if they can be transferred to the buyer.
• Regulatory information – details of CQC inspection reports and CQC registration details.
• Employees – copies of contracts and confirmation of key data such as salaries, years of service and working hours.
• Associates – copies of contracts, details of licence fee amounts, confirmation of self-employed status.
• Litigation – details of any claims or complaints against the practice or employees/associates.

In addition to the above, where the practice is an NHS practice there will be a whole host of further information required in relation to the practice’s NHS dental contract. This will include copies of the contract itself and any variations, vital sign reports, pay and activity statements, breach and remedial notices.

Warranties and disclosures

Warranties are statements of fact about the historical running of the practice. They are given by the seller to the buyer in the sale and purchase agreement. If it turns out that a warranty is untrue, the buyer will have a potential claim against the seller for breach of warranty (subject to any limitations of liability that the seller will have added to the sale and purchase agreement). Generally, the buyer will not be able to make a claim against the seller for a breach of warranty where the seller has disclosed against it, i.e. if the buyer is made aware of something through the due diligence process and still proceeds with the sale, it cannot then make a claim against the seller. Disclosures are made by the seller in the “disclosure letter” – a legally binding document which is essentially a side letter to the sale and purchase agreement.

Results of the due diligence exercise

The due diligence process may draw certain matters to a buyer’s attention which could have an impact on how it views the commercial viability of the practice. If the due diligence process throws up adverse findings, the buyer will need to decide how it wants to deal with such findings before completion. The buyer may do one or more of the following:

• seek a reduction in the purchase price;
• price funds are retained for an agreed period in case of certain liabilities arising post completion. These funds will either be used in the event that the liabilities arise, or if no such liabilities arise, the retention will be released to the seller at the agreed time;
• obtain relevant legal protections in the sale documentation – so that the seller is responsible to reimburse the buyer for specific liabilities if they arise post completion;
• in an extreme scenario, where the risks are too large and difficult to mitigate, the buyer may decide to withdraw from the transaction.

Conclusion

The due diligence process may seem like a daunting stage of a dental practice transaction, but it is an essential one. A seller should, so far as possible, seek to get its paperwork in order when looking to sell to try and speed up the process. The more organised and comprehensive the first set of replies are, the less likely a buyer will come back with lots of further questions. Likewise, in order to ensure that the due diligence process is not unnecessarily drawn out, the buyer should consider the number of questions it asks and the scope of those questions – i.e. is the information it is seeking important and what relevance does it have on the buyer’s investigations?