This article forms part of our guide to corporate simplification and legal entity reduction projects. Links to the other parts of the guide are at the end of this article.
The ’corporate memory’ issue is often one of the most difficult hurdles to overcome when implementing a legal entity reduction project. This is the problem that a group’s records as to individual companies’ activities and assets may be incomplete, and the people with personal knowledge about those companies may have left the group. This can make it difficult to get comfortable that removing any given company will have no negative consequences.
In some cases, concerns about this issue means that a proposed corporate simplification project never gets off the ground, or is shelved part-way through. But unfortunately the problem does not get easier over time.
So what’s the solution?
Refocussing on the objectives of due diligence investigations
As a starting point, it’s helpful to remind yourself of the objectives of due diligence in corporate simplification projects. In general, the main objectives are to:
- Preserve assets;
- Avoid triggering liabilities; and
- Ensure that the proposed corporate actions are implemented validly.
When information is scarce, it’s even more important than usual to follow a consistent methodology for due diligence. This does not have to be complicated, but by documenting and following a consistent methodology, it’s less likely that issues will be missed, and easier to satisfy the relevant directors and others that the necessary actions can properly be approved.
The approach taken will need to be appropriate in the context of the project and the group concerned. Typically it may involve:
- Setting a materiality threshold for due diligence issues
- Preliminary ‘desktop’ research on the companies involved
- Detailed due diligence, including issuing due diligence questionnaires
The subject of due diligence is covered in more detail in later parts of this guide. For now, it’s worth emphasizing the value of being explicit about materiality thresholds – in other words, what value of assets or liabilities should be regarded as material in the context of the project. This can avoid significant resource being invested in chasing down details which are ultimately not material for the group.
Hidden assets and hidden liabilities
One of the challenges of due diligence is that some assets and liabilities may not appear on any given company’s balance sheet, and may also not appear on any public register. Such assets may include:
- Assets held on trust or as nominee (for example, shares held in other group companies)
- Contractual rights
- Unregistered land
- Unregistered intellectual property
- The benefit of restrictive covenants
Similarly, hidden liabilities may include:
- Contractual obligations
- Contingent liabilities such as guarantees
- The burden of restrictive covenants
- Environmental liabilities relating to historic assets or activities
Where there is considered to be material risk that hidden assets or liabilities may be present, then additional investigations should be considered as part of the detailed due diligence process.
Depending on the circumstances, those additional due diligence measures may include:
- Reviewing historic financial records for e.g. rents received and paid
- Reviewing historic board minutes or other corporate approval documents
- Reviewing internal announcements
- Reviewing registers of sealings (if applicable)
- Reviewing deeds packets
Read the other parts of this guide to corporate simplification projects: