Legal due diligence for lenders: Free checklist

Legal due diligence for lenders checklist

This checklist covers the key steps a lender should take when performing legal due diligence for a financing transaction. From organizing the due diligence process to reviewing key documents and assessing regulatory compliance, these steps help lenders make informed lending decisions and minimize potential risks.

Using this checklist ensures you conduct a comprehensive review, addressing critical issues that could affect the borrower’s ability to meet their obligations and maintain compliance with legal and regulatory requirements.

How to use this legal due diligence for lenders checklist

Follow these steps to maximize the effectiveness of your due diligence process:

• Work through each section in order: Start by defining the structure and scope of your due diligence, then proceed through document requests, reviews, and any necessary follow-up actions.
• Engage relevant stakeholders: Collaborate with legal, compliance, and finance teams to ensure all aspects are thoroughly reviewed, from borrower obligations to regulatory compliance.
• Keep detailed records: Document each step, from the initial document requests to the final findings. Clear records are essential for transparency and any future audits.
• Adapt to your needs: Customize this checklist to fit the unique aspects of your transaction. For instance, high-risk or complex transactions may require additional steps or specialist input.
• Regularly update procedures: As regulations and best practices evolve, review and adjust your checklist to reflect current standards, ensuring ongoing compliance and thorough due diligence.

Checklist

Organisation of the due diligence process

[ ] Identify team members handling due diligence, outline each person's responsibilities, and establish reporting lines.

[ ] Specify the type and format of the due diligence report.

[ ] Determine who will review the report and make final decisions.

[ ] Confirm any constraints on cost or scope.

[ ] If using prior due diligence, identify areas needing further focus.

[ ] Define how interactions with the borrower will be handled, including any third-party involvement for acquisition financing.

[ ] Decide on a physical data room or online site for document sharing.

Sending due diligence requests

[ ] Send the list to the borrower as early as possible.

[ ] Modify if necessary to avoid duplicate information requests.

[ ] Confirm the borrower’s definition of “material contracts” to align expectations.

Organize information access

[ ] Decide if documents will be shared in a physical data room or online data site.

Documents to review

[ ] If the borrower is a public company:

[ ] Identify the major assets, noting their type and location.

[ ] Confirm if any significant real property or intellectual property requires specialist review.

[ ] Determine if the borrower holds foreign subsidiaries or foreign-based assets.

[ ] Identify any recent or planned changes in the organizational structure.

[ ] Document the types and amounts of existing debt obligations of the borrower.

[ ] Note any other issues in public filings that could affect the transaction or the borrower’s future operations.

[ ] Review foundational documents, including:

[ ] Certificates of incorporation.

[ ] Bylaws.

[ ] Operating agreements for LLCs.

[ ] Certificates of formation.

[ ] Partnership agreements or similar.

[ ] Confirm that the relevant parties to the loan have the legal authority to:

[ ] Incur the loans.

[ ] Provide guarantees.

[ ] Grant liens on assets.

[ ] Execute acquisition or merger agreements or issue securities if applicable.

[ ] Identify authorized signatories for loan documents.

[ ] Check if any special signing procedures apply (e.g., two officers must sign).

[ ] Verify if any specific votes or consents are needed for the transaction, including actions requiring equity holder or board of directors’ consent.

[ ] Identify any limitations on asset transfers that may impact the transaction.

[ ] Look for any clauses in documents that could affect the transaction or future operations.

[ ] Review additional organizational records, such as:

[ ] Organizational charts.

[ ] Board of directors and committee minutes (if accessible).

[ ] Shareholder and voting agreements.

[ ] Communications with shareholders.

[ ] Examine documents related to equity interests (e.g., options, warrants).

Good standing certificates

[ ] Determine which party (lender’s or borrower’s counsel) will be responsible for ordering good standing certificates from the secretaries of state.

[ ] Confirm that good standing certificates will be obtained through a reputable service company.

[ ] Verify that the borrower is in good standing in all states where it must be qualified to conduct business.

Finance documents

[ ] Review all key financial agreements, including:

[ ] Indentures, loan agreements, hedge agreements, and promissory notes.

[ ] Guaranties, agreements for deferred purchase prices, and stock purchase obligations.

[ ] Any other agreements involving borrowed money.

[ ] Discuss internally if a minimum dollar threshold should be set to limit the number of documents requested.

[ ] Identify all parties to each financial agreement.

[ ] Review the terms of the debt, including:

[ ] Total debt amount outstanding.

[ ] Applicable interest rates.

[ ] Loan maturity dates.

[ ] Note any contingent obligations, such as guaranties, especially by third parties (e.g., parent guaranties).

[ ] Identify any existing liens on assets or stock pledges.

[ ] Confirm whether the debt can be prepaid or terminated and note:

[ ] Any penalties or fees for prepayment.

[ ] Notice requirements for prepayment.

[ ] Check for restrictive covenants affecting:

[ ] The borrower's ability to incur additional debt, pledge assets, provide guaranties, or distribute dividends.

[ ] Other limitations that could affect operations or the transaction.

[ ] Look for clauses that require future collateral or guaranties to be shared equally with existing debt holders.

[ ] Review for any change of control clauses and whether the transaction will trigger these provisions.

[ ] Identify any events of default that might be activated by the transaction.

[ ] Note any terms that could impact the transaction or future operations of the borrower or its subsidiaries.

Material contracts

[ ] Work with the borrower to identify “material contracts” and any specific agreements of interest. Generally, include contracts like key licenses, tax-sharing agreements, employment contracts, joint venture agreements, and significant supplier or customer agreements.

[ ] Identify contracts that have substantial economic impact, are critical to the business’s success, or carry significant risk.

[ ] Identify all parties to each material contract.

[ ] Check for change of control clauses and determine if the current transaction will trigger any change of control provisions.

[ ] Confirm whether the contract is assignable and if consent is required.

[ ] Review the definition of “assignment” within the contract.

[ ] Determine if the transaction structure requires assignment or if change of control counts as an assignment.

[ ] Note the contract’s termination conditions, including:

[ ] Scheduled termination date.

[ ] Automatic renewal terms, if applicable.

[ ] Conditions for termination without consent.

[ ] Whether change of control allows either party to terminate.

[ ] Any fees, penalties, or required notices for termination.

[ ] Identify any liabilities that could affect the borrower, such as:

[ ] Significant tax payment obligations.

[ ] Material employee severance packages.

Regulatory matters

[ ] Collect all official documents like orders, opinions, compliance reports, or any correspondence from federal or state authorities about the borrower’s legal or regulatory compliance.

[ ] Check if the borrower is violating any laws, rules, or regulations:

[ ] Assess if the violation is serious or significant.

[ ] Identify any corrective actions required to resolve the issue.

[ ] Review remedial steps the borrower has taken or plans to take.

[ ] Determine the financial effects of any violations, including:

[ ] Possible liabilities the borrower may face.

[ ] The amount of any fines or penalties.

[ ] Decide if consulting with regulatory or legal experts would help in understanding complex compliance issues.

Benefits of using a legal due diligence checklist for lenders

Using a legal due diligence checklist offers significant advantages for lenders during the financing process. Here’s how:

• Minimizes risk: By following a structured checklist, lenders reduce the chances of overlooking critical issues, protecting against unexpected liabilities, compliance issues, or borrower defaults.
• Ensures thorough review: The checklist ensures each essential document and aspect of due diligence is covered, leaving no key area unaddressed.
• Promotes consistency: Using a checklist creates a standardized approach to due diligence across all transactions, helping maintain quality and efficiency regardless of transaction size or complexity.
• Improves decision-making: A comprehensive review of the borrower’s obligations, liabilities, and compliance history helps lenders make more informed, confident lending decisions.
• Simplifies audits and record-keeping: With documented steps and organized records, the checklist simplifies any audits or reviews, providing clear, organized information if issues arise in the future.

Frequently asked questions (FAQs)