The numbers are good, customers are ordering, and the team knows their job. The company seems ready to change hands.

Then, as you examine the documents, a question arises: Can the owner transfer the lease? Does the software used to prepare quotes really belong to the company? Can the main client terminate their contract upon a change of control?

Legal due diligence is used to answer these questions before the purchase. It allows you to understand the rights, obligations, and risks that come with the company.

The goal is to know what you are actually buying, what could harm operations, and what needs to be settled before closing.

This guide is intended for buyers and owners of Quebec SMEs who are preparing for an acquisition or sale.

In a nutshell: legal due diligence examines the company’s ownership, major contracts, debts and guarantees, litigation, permits, obligations toward employees, and rights to assets. The findings are then used to decide whether to: request a correction, obtain consent, negotiate protection, review terms, or walk away from the acquisition when risks are too high.

Start with the acquisition structure

Before sending a document list to the seller, specify what you intend to purchase.

In a share acquisition, the company generally continues to exist with its assets and obligations. The examination must therefore take its history into account.

In an asset acquisition, it is necessary to identify the assets, contracts, and liabilities being transferred. It is also necessary to determine which steps will allow operations to continue after the sale.

However, buying the assets does not mean that all previous obligations disappear. Certain rules, particularly regarding labor, may apply despite the change of owner. The CNESST reminds us that the sale of a business does not cancel outstanding claims covered by the Act respecting labour standards. CNESST — Sale, merger or acquisition of a business.

The chosen structure therefore determines the questions to ask, without replacing the review of the file.

Confirm who owns the company and who can sell

The owner you are talking to may be the main manager. This alone does not confirm that they hold all the shares or that they can authorize the transaction without the consent of others.

A search in the Enterprise Register is a starting point for consulting information reported on the company. Government of Quebec — Searching for a business in the register.

Then, you must examine the company’s relevant documents, including:

• articles of incorporation and their amendments;

• the share register;

• documents regarding the issuance and transfer of shares;

• shareholders' agreements;

• necessary resolutions and authorizations;

• options or other rights that may affect ownership.

Verify the rights of other shareholders

An agreement may provide for a right of first refusal, prior consent, or other restrictions on transfer.

These elements can influence the timing and the way the sale is carried out. It is better to identify them early than to discover a shareholder who needs to be consulted a few days before closing.

Also ask if any changes need to be made to the structure before the acquisition: removing an asset, repaying an advance, or reorganizing, for example. These operations must be coordinated with legal and tax advisors.

The question to resolve: can the people signing transfer what is being promised, and what authorizations do they need?

Read the contracts that keep the company running

Not all contracts have the same importance. Start with those whose loss or modification could affect revenue or prevent the company from functioning.

These may include the main client, the exclusive supplier, the commercial lease, a franchise, a software license, or a financing agreement.

The BDC recommends verifying whether essential contracts, particularly leases and client contracts, can be transferred when the transaction requires it. BDC — Conducting due diligence.

Examine what happens during the transaction

An assignment clause and a change of control clause do not necessarily cover the same situation.

Ask your advisor to check what each contract provides for the proposed structure: consent, notice, possibility of termination, or other consequences.

Also look at:

• remaining term;

• renewal terms;

• notice periods;

• minimum purchase commitments;

• exclusivity clauses;

• penalties;

• warranties given to the client;

• previously reported defaults.

Read relevant amendments and correspondence

The original contract may no longer reflect the entire agreement.

An amendment, a letter, or an email exchange might change a price, extend a deadline, or confirm a specific commitment. Ask the seller to gather these items and point out important arrangements that are not clearly documented.

Take a manufacturer who claims to have a three-year contract with its biggest client. If a provision allows the client to terminate with short notice, the revenue is not as predictable as the three-year term might suggest.

Verify debts, guarantees, and rights to property

Equipment installed in the factory does not necessarily belong to the company. It may be leased, financed, or subject to rights held by a third party.

The legal review must be cross-referenced with accounting information and the asset list.

Specifically request loan, lease, and credit-lease contracts, as well as documents related to granted guarantees. You must understand which commitments will be maintained, repaid, or released at closing.

In Quebec, the RDPRM allows you to consult certain rights regarding movable property, including hypothecs on movables. These searches must be interpreted in light of the assets and parties involved. RDPRM — Service description.

Plan for closing procedures

If a debt must be repaid at the time of the sale, clearly assign tasks: obtaining the balance, organizing payment, and obtaining the necessary documents to release the relevant guarantees.

If the company owns a building, also provide for an adapted real estate review. Physical inspection, environmental analysis, and title verification answer different questions.

Keep in mind: the presence of an asset on the financial statements is not enough to confirm the rights that will be transferred to the buyer.

Look for litigation and problems that could become litigation

A company might not be the subject of any lawsuits while still having a significant dispute.

A client may be demanding the replacement of an installation. A former employee may be contesting their termination. A supplier may be threatening to suspend deliveries. These situations deserve to be examined even if no judgment has been rendered.

Ask the seller to present:

• ongoing legal proceedings;

• formal notices;

• major claims and complaints;

• reached settlements and remaining obligations;

• notices of default;

• insurance files related to these events.

Searches in relevant registries supplement the seller's documents and explanations. They do not, on their own, allow you to identify all disputes.

Evaluate consequences beyond the amount claimed

A low-value claim can reveal a recurring quality problem. A dispute with a supplier can threaten access to an essential part.

For each file, try to understand the possible costs, effects on operations, and measures already taken. Also ask if insurance could intervene, without assuming coverage will be available.

Exchanges protected by professional privilege must be handled with advisors. Sharing them should not be improvised in a shared file.

Confirm necessary permits and authorizations

The question is not just whether a permit exists. You must verify that it covers the company's actual activities and determine what happens during the transaction.

Depending on the sector, the review may cover professional licenses, municipal authorizations, operating permits, or environmental requirements.

For each important authorization, verify:

• the holder;

• the activities and locations covered;

• the expiration date;

• special conditions;

• inspections or notices received;

• necessary steps after a transfer or change of control.

Do not assume that a permit automatically follows the equipment or shares. Have the applicable process confirmed by your advisor and, if necessary, by the relevant authority.

An administrative delay may be manageable if it is known early. It becomes much more problematic if the buyer discovers after signing that they cannot begin certain activities.

Examine commitments to employees

Employees are not just a line item in expenses. They ensure operations, hold knowledge, and benefit from rights that must be considered.

Gather contracts and relevant information on:

• seniority and compensation;

• vacation and accrued amounts;

• commissions and bonuses;

• benefits and pension plans;

• collective agreements, if any;

• special agreements;

• complaints, grievances, and health and safety records;

• confidentiality and intellectual property commitments.

You must also examine the amounts or obligations that could be triggered by the transaction.

Do not assume that everything starts from zero

The CNESST reminds us that the continuity of labor standards applies to the business and does not disappear simply because the employer changes. CNESST — Effect of a transfer on employee rights.

Therefore, have the consequences of the proposed structure analyzed before making decisions about the team.

Distinguish documents from the reality of work

A job title may have little to do with the responsibilities exercised for several years. An employee may benefit from a special schedule or a method of remuneration that does not appear in the initial contract.

These discrepancies must be noted and understood. The legal review benefits from being coordinated with the retention and transition plan for key employees.

Confirm rights to intellectual property

The trade name, designs, software, and documented methods can represent a significant part of what the buyer is looking for.

Yet, their ownership is sometimes less clear than that of the equipment.

A website may have been created by an agency. Internal software may come from a self-employed worker. A trademark may be registered in the founder's personal name.

Trace the chain of title

For important assets, ask who created them, for whom, and under what agreement.

Examine development contracts, assignments, licenses, and relevant registrations. Payment of an invoice is not, by itself, enough to demonstrate an assignment of copyright. The law provides that an assignment must be in writing and signed by the owner or their authorized representative. Copyright Act, section 13.

Distinguish ownership, license, and access

Having a software password does not mean you own it. Holding a license does not necessarily mean you can transfer it or use it otherwise.

Also check administrator accounts, domain names, renewals, and dependencies on suppliers. The contract and the practical ability to use the tool must be examined together.

Manage data and personal information

Client and employee files may contain personal information. Their examination during an acquisition must be organized, not simply open to everyone participating in the file.

In Quebec, the disclosure of personal information during a commercial transaction is subject to specific conditions. Section 18.4 provides for a prior agreement and usage restrictions in the situations it covers. Act respecting the protection of personal information in the private sector, section 18.4.

Determine the necessary information, authorized access, and protection measures. Where possible, start with aggregated or de-identified data.

The review should also identify the relevant issues for the company itself: known incidents, contracts with suppliers who process data, and retention or access practices.

Turn findings into decisions

A report that lists fifty problems without order of priority does little to help the buyer decide.

For each significant issue, ask for an answer to four questions:

• What did we find?

• What could this change for the acquisition?

• What can we do?

• Who must act and by when?

The answer may be a correction, a consent, a closing condition, contractual protection, or a negotiated modification of the transaction. Depending on the severity and rights provided in the documents, the buyer may also have to reconsider their project.

An indemnity does not solve every problem. If the company cannot use its main premises or its production tool, the possibility of claiming money later does not guarantee business continuity.

An example: buying a workshop with essential software

Let’s take the fictional case of a manufacturing workshop in Quebec City. The buyer is particularly interested in software that allows for the rapid preparation of quotes.

During the due diligence, they discover that the program was developed by an external consultant. The company has the invoices and has been using the software for several years, but the available documents do not allow for the confirmation of all the rights the buyer is looking for.

The agreement with the developer must then be examined: what uses are authorized? Can the company modify the program? Does it possess the source code? What does the agreement provide for in the event of a transaction?

The advisors then determine the necessary steps. This could involve clarifying rights, obtaining an assignment or an adapted license, or revising the buyer's expectations.

This finding does not necessarily lead to abandoning the sale. It allows for addressing an essential element before the buyer discovers its limitations in full operation.

Checklist of documents to gather

This list is a starting point. It must be adapted to the sector, the structure of the purchase, and the risks of the file.

Centralize requests in a secure folder and maintain a list of items received, missing, or requiring clarification. Indicate dates and versions to avoid working from a superseded contract.

Mistakes that leave blind spots

Limiting yourself to available documents. A missing contract or an incomplete response must be followed up.

Presuming that everything used belongs to the company. Equipment, software, and trademarks may be owned by other people.

Waiting until the end to verify consents. Some third parties have their own deadlines.

Confusing the absence of a lawsuit with the absence of a dispute. Complaints and formal notices count too.

Examining each component separately. A legal issue can change financial projections, financing, or the integration plan.

Receiving the report too late to act. Important issues must be flagged during the work, not just in the final document.

Frequently asked questions

What is legal due diligence?

It is the examination of a company’s rights, contracts, and obligations before an acquisition. It helps determine what is transferable, the risks to address, and the protections to negotiate.

Who conducts legal due diligence?

It is generally conducted by the buyer’s legal advisors, according to their expertise and mandate. They work with the professionals responsible for finance, tax, human resources, and other relevant areas.

Which contracts should be examined first?

Those on which the continuity of the company depends: major clients, essential suppliers, premises, financing, licenses, and indispensable tools. Upcoming deadlines also deserve prompt attention.

What to do when an important document is missing?

Ask for explanations and the documents needed to clarify the situation. It will then be necessary to determine whether the document must be recovered, regularized, or replaced, and how to handle the uncertainty before closing.

Does a seller's warranty replace due diligence?

No. A warranty can offer contractual protection, but it does not replace the understanding of risk or the necessary steps to continue operations.

Does legal due diligence replace financial analysis?

No. A contract can be valid while being unprofitable. Conversely, attractive revenue may depend on a fragile contract. The analyses must be pooled.

How much time should be planned?

This depends in particular on the size of the company, its sector, the quality of the documents, and the number of issues to resolve. Agree on a schedule, while planning for quick follow-ups when an important element emerges.

To prepare for the other stages, consult the ultimate guide to buying a business.

This article presents general information and does not constitute legal, tax, or financial advice. Have your advisors adapt the due diligence and contractual protections according to the structure and particularities of your acquisition.