Why Legal Due Diligence Can Change a Deal on Hidden Liabilities, Contracts and Deal Structure
The headline price can look sensible. The growth story can sound convincing. The buyer and seller can even agree the broad commercial terms. Then legal due diligence begins, and the deal starts to move.
That does not always mean the deal is bad. Often, it means the legal review has found issues that were not obvious from the accounts, the pitch deck, or early conversations. Some issues affect risk. Some affect timing. Others affect the price, the payment terms, or whether the buyer wants to acquire shares rather than assets.
In company acquisition & sale, legal due diligence is designed to answer a blunt question: what is the buyer really acquiring, and what obligations come with it?
This article is for general information only and is not legal advice. Specific transactions need advice based on the documents, parties, sector, and jurisdiction involved.
A deal can look right before the liabilities are visible
Early deal discussions often focus on value drivers. Revenue. Margin. Customer relationships. Technology. Market position. Management strength.
Those points matter, but they do not show the whole picture. A business can carry obligations that only become clear once the legal documents are reviewed. These are the risks that sit behind the numbers.
Hidden liabilities may include:
Historic tax, pension, or employment obligations
Unresolved customer claims
Environmental or health and safety exposure
Unpaid bonuses, commissions, or contractor claims
Product warranty issues
Breaches of law or permit conditions
Parent company guarantees
Indemnities given to customers, suppliers, landlords, or lenders
Some liabilities appear in the accounts. Others may be contingent, disputed, or simply undocumented. For example, a seller may say a claim is unlikely to proceed. The buyer’s lawyers may find correspondence showing the issue has been live for months and could become costly after completion.
This is where due diligence changes the conversation. The question stops being “Is the price fair?” and becomes “What should the buyer pay after taking this risk into account?”
That risk may lead to a price reduction. It may also lead to a retention, escrow, specific indemnity, completion condition, or a different transaction structure.
Change-of-control provisions can block or reshape the transaction
A change in ownership can trigger rights for third parties. These rights often sit in contracts that are essential to the target business.
A change-of-control provision may require consent before the deal completes. It may give the other party the right to terminate. It may trigger repayment, renegotiation, or a notice requirement.
These clauses are common in:
Customer contracts
Supplier and distribution agreements
Software licences
Property leases
Franchise or agency arrangements
Banking and finance documents
Joint venture agreements
Public sector contracts
A buyer may think it is acquiring a stable customer base. Legal due diligence may show that several key contracts can be terminated if the shares change hands. That discovery can alter the deal timetable and the buyer’s appetite for risk.
Consent is not always a formality. A key customer may ask for better pricing. A supplier may use the request to renegotiate payment terms. A lender may require refinancing before completion.
If the relevant consent is commercially critical, it may become a condition precedent. That means the buyer does not have to complete unless the consent is obtained first.
Key customer and supplier contracts can change the quality of revenue
Not all revenue is equal. A business may show strong turnover, but the legal review may reveal weak contractual support behind it.
Customer contract due diligence looks at questions such as:
Are the contracts signed and enforceable?
How long is left on the term?
Can the customer terminate for convenience?
Are there minimum purchase commitments?
Are pricing terms fixed, variable, or due for review?
Are service levels realistic?
Are there penalty clauses, credits, or broad liability provisions?
Can the contract be assigned or transferred?
A business with recurring revenue may look attractive until the contracts show that customers can walk away on short notice. By contrast, a business with modest revenue may carry more value if it has long-term contracts with clear obligations and fair termination rights.
Supplier contracts matter just as much. A target may rely on one supplier for a core component, licence, raw material, or logistics route. If that contract is informal, expired, terminable at short notice, or non-transferable, the buyer may inherit a fragile supply chain.
A buyer will also look for unusual terms that affect profit. These might include most-favoured customer clauses, exclusivity rights, rebates, volume discounts, onerous service commitments, or uncapped liability.
The legal review can turn a simple revenue multiple into a more careful assessment of quality, durability, and transferability.
In Company Acquisition & Sale warranties and indemnities are where risk gets allocated
Due diligence does not usually remove every risk. It helps the parties decide who should bear each risk.
Warranties are contractual statements about the business. The seller may warrant that the company owns its assets, has disclosed litigation, complies with laws, has no undisclosed liabilities, and has valid contracts. If a warranty proves false, the buyer may have a claim, subject to the agreed limitations.
Indemnities go further. They deal with specific risks and usually provide pound-for-pound protection if the identified issue causes loss.
For example:
Issue found in due diligence | Possible deal response |
A tax enquiry is ongoing | Specific tax indemnity or escrow |
A customer has threatened proceedings | Litigation indemnity or price reduction |
Key software was built by contractors without clear assignment | Completion condition to obtain assignments |
Change-of-control consent is needed from a major customer | Completion condition or deferred payment |
Historic employment claims are possible | Specific indemnity and disclosure review |
A seller will try to limit liability through caps, time limits, thresholds, exclusions, and disclosure. A buyer will try to keep meaningful protection for matters that are not reflected in the purchase price.
The due diligence findings often decide which side has the stronger argument.
Employment liabilities can follow the buyer after completion
Employment issues are easy to underestimate. They can be sensitive, document-heavy, and expensive to fix.
Legal due diligence will usually examine employment contracts, policies, staff handbooks, bonus plans, commission schemes, consultancy agreements, settlement agreements, immigration checks, disciplinary matters, grievances, and worker status.
Common problems include:
Employees working without signed contracts
Bonus or commission arrangements that differ from management’s explanation
Contractors who may have worker or employee rights
Unpaid holiday pay or overtime claims
Restrictive covenants that are too weak to protect the business
Missing right to work checks
Unresolved grievances or disciplinary disputes
Equal pay, discrimination, or whistleblowing risks
For asset sales in the UK, the Transfer of Undertakings (Protection of Employment) Regulations, often called TUPE, may apply. That can transfer employees and certain liabilities to the buyer by operation of law. This can affect timing, consultation duties, staffing plans, and costs.
Employment findings may change the purchase price if the buyer needs to fund settlements, restructure roles, honour accrued benefits, or accept exposure for historic acts.
IP ownership can decide whether the buyer gets what it thought it was buying
Intellectual property is often central to value, especially in software, life sciences, media, engineering, design, data, and technology-enabled businesses.
The key question is simple: does the target own or control the rights it relies on?
The answer may be less simple.
Due diligence may find that software was created by external developers without proper assignment. A brand may be used by the target but owned by another group company. Product designs may depend on licences that cannot be transferred. Open-source software may have been used without a proper compliance record.
For IP-heavy businesses, the legal review will test:
Ownership of trade marks, patents, copyright, designs, and domain names
Assignments from founders, employees, and contractors
Licence terms and restrictions
Open-source software use
Infringement claims or threats
Security interests over IP
Whether IP sits in the right company within the group
If IP rights are missing or split across entities, the buyer may require assignments before completion. If that cannot be done, the buyer may reduce the price or alter the deal structure.
Regulatory issues can affect value, timing, and even legality
Some businesses cannot operate without licences, permits, registrations, approvals, or ongoing compliance. Legal due diligence should test whether those permissions exist, whether they are current, and whether the transaction affects them.
Regulatory issues may arise in sectors such as financial services, healthcare, education, energy, transport, telecoms, food, chemicals, gambling, and data-heavy businesses.
The key concerns are:
Does the target hold the right licences?
Are the licences held by the correct entity?
Can they be transferred?
Does a change of control require consent or notification?
Has the regulator raised concerns?
Are there past breaches, undertakings, or investigations?
Are compliance policies followed in practice?
Data protection is often part of this review. A buyer may need to know whether the target collects personal data lawfully, has suitable privacy notices, manages processor contracts, handles subject access requests, and reports breaches correctly.
Regulatory findings can delay completion. They can also require a split signing and completion, where the parties sign the agreement first but complete only after approvals or notifications are dealt with.
Corporate structure can hide ownership and transfer problems
A business may look simple from the outside, but the corporate structure can tell another story.
The buyer needs to know what entity owns the assets, employs the staff, holds the contracts, owns the IP, owes the debt, and receives the revenue. If those pieces sit in different companies, the transaction may need restructuring.
Common corporate issues include:
Missing statutory registers
Inconsistent share ownership records
Options or convertible instruments that affect ownership
Minority shareholders with consent or veto rights
Dormant companies that hold key assets
Intercompany balances that need settlement
Assets used by the target but owned elsewhere in the seller’s group
These points can change whether the buyer purchases shares or assets.
A share purchase brings the company with its history, including liabilities. An asset purchase can allow more control over which assets and liabilities transfer, but it may require more third-party consents and more complex transfer steps.
The legal review helps decide which route fits the risk.
Debt and security can control what happens at completion
Debt due diligence checks what money is owed, who it is owed to, and what security has been granted.
A target may have bank debt, shareholder loans, asset finance, invoice finance, landlord deposits, guarantees, or intra-group balances. Some of these may need repayment at completion. Others may remain in place if the lender agrees.
Security matters because lenders may hold charges over assets, shares, bank accounts, receivables, or IP. A buyer will usually require releases for security that should not continue after completion.
Debt documents may also contain change-of-control defaults. If triggered, they may make the debt immediately repayable.
These findings affect the funds flow. They can change the amount paid to the seller on completion, the mechanics for repaying lenders, and the conditions that must be satisfied before ownership changes.
Litigation and disputes change the risk profile
Disputes are not limited to court claims. They can include threatened claims, regulatory investigations, customer complaints, supplier disputes, employee grievances, IP infringement allegations, and insurance notifications.
The buyer will want to know:
What is the claim about?
How much is at stake?
What stage has it reached?
Are lawyers involved?
Has it been notified to insurers?
Has provision been made in the accounts?
Could it affect key contracts, licences, or reputation?
A serious dispute may not stop a deal, but it usually changes the terms. The buyer may ask for a specific indemnity, a price reduction, an escrow, or control over settlement decisions after completion.
If the dispute threatens a core asset or customer relationship, the buyer may decide the deal no longer matches the original commercial case.
Conditions precedent turn findings into completion requirements
A condition precedent is a requirement that must be satisfied before completion. Due diligence often decides what those requirements should be.
Common conditions include:
Obtaining change-of-control consent from key customers, suppliers, landlords, or lenders
Securing regulatory approval or making required filings
Releasing security over assets
Completing IP assignments
Settling specific debt
Reorganising group assets
Resolving a material dispute
Delivering board, shareholder, or third-party approvals
Conditions can protect the buyer, but they also add uncertainty. If too many conditions are required, the seller may push back. If too few are included, the buyer may carry risks it did not price.
The right balance depends on how central the issue is to the business and whether it can be fixed after completion without harming value.
How due diligence changes the purchase price or deal structure
Legal due diligence can affect the deal in several ways. The right response depends on the seriousness of the issue, the likelihood of loss, and whether the problem can be fixed.
Common responses include:
Due diligence finding | Possible impact on the deal |
Hidden liability with likely cost | Price reduction or indemnity |
Uncertain claim with possible future cost | Escrow, retention, or deferred payment |
Missing consent for key contract | Condition precedent |
Weak customer contract terms | Lower valuation multiple |
IP ownership gap | Pre-completion assignment or asset purchase structure |
Regulatory approval needed | Split exchange and completion |
Debt repayable on change of control | Completion repayment mechanics |
Complex group structure | Pre-sale reorganisation |
The deal structure may also change. A buyer may move from a share purchase to an asset purchase. The parties may introduce completion accounts or a locked box adjustment. Part of the consideration may become deferred or contingent. The seller may need to give stronger warranties or specific indemnities.
None of this means due diligence is a search for reasons to kill a deal. Good due diligence gives both sides a clearer basis for agreement. It helps the buyer price real risks and helps the seller understand what must be explained, fixed, or protected through disclosure.
The deal still has to make sense after the documents are read
A deal can look right in principle and still need major changes once the legal review is complete. That is not a failure of the process. It is the point of the process.
The strongest transactions are not the ones with no issues. Most businesses have issues. The strongest transactions are the ones where the parties identify the risks early, decide who should carry them, and reflect that decision clearly in the price, conditions, warranties, indemnities, and completion mechanics.
Legal due diligence changes deals because documents matter. Contracts decide whether revenue stays. Employment records decide what liabilities transfer. IP assignments decide who owns the assets. Finance documents decide what must be repaid. Regulatory rules decide whether completion can happen at all.
The commercial question remains the same: does the deal still work on the facts now known?
If the answer is yes, due diligence helps make the agreement safer and more precise. If the answer is no, it may have saved the buyer from paying the right price for the wrong business.
A successful acquisition is rarely determined by the headline price alone. The legal detail can change the structure, economics and even viability of the transaction.
These are precisely the issues examined in EMG Associates’ London programme, Private Company Acquisition & Sale: Structure, Strategy & Risk Management, designed for lawyers and senior professionals involved in corporate transactions.
About EMG Associates
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