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Clifford Chance

Clifford Chance

Construction Insights

Borrower/vendor due diligence – when it is not due (or diligent)

We have set out 5 guidelines for when developers/borrowers/vendors produce due diligence reports on their own project contracts alongside a critical glance at this growing trend.

The trend, in certain industry sectors, for project developers to ask their own counsel to produce a due diligence report for their lenders and purchasers/co-investors, shows no sign of abating. This practice is rarely popular with the lenders or purchasers, particularly if their counsel is denied access to the documents being reported upon, but it is increasingly tolerated.

Whilst some sectors are edging towards standardising the required contents for this type of reporting, the outcomes are still ultimately dependent on the quality and experience of the individual lawyers producing the report.

The usual justifications for borrower/vendor due diligence are:

  • a financing or sale process which overlaps with negotiation of project documentation. The theory is that it is more efficient for the developer/borrower counsel to report on a moving picture and comment on risks in the correct context and in an informed and balanced way;
  • a competitive process is under way. For example, if multiple parties are bidding to acquire a stake in a developer, vendor due diligence will avoid the distraction and cost of multiple counsel seeking access to documents and explanations; and/or
  • the transaction is the latest in a line of sales or financings for the same asset where detailed diligence has been provided by borrower's counsel previously and can be usefully recycled and efficiently updated.

A less good reason for this practice is a desire for control over the due diligence product and/or to defend the developer process and documentation product from outside interference. This has always puzzled me as lenders' and purchasers' interests largely overlap with those of the developer and an extra set of eyes is often helpful.

Unfortunately we are increasingly coming across situations where the borrower/vendor due diligence is below basic standards and causes far more trouble (and thus time and cost) than it saves. So here are 5 quick guidelines that may help:

1. Check the market will accept the product before you start. For example, certain institutional financing bodies will typically insist on engaging their own counsel to carry out due diligence anyway.

2. The report should be more than descriptive – good due diligence should be evaluative and reference market standards. This can be awkward for the borrower/vendor counsel as it may feel conflicted in commenting adversely on elements of its own client's documentation. However, most clients will accept that evaluation provided it is placed in the correct context and identifies mitigants.

3. If possible, agree the style of report in advance with beneficiaries. Many lenders and purchasers are only interested in key issues reviews and do not want lengthy reports which can (whether by design or not) obfuscate and obscure issues. We have seen too many reports lately that simply recite or reword at length the drafting from the underlying documents - in which case the purchaser/lender counsel might as well be reading the actual documents. We have also seen reports where the positive aspects of documentation have been so heavily emphasised, in order to balance out other commercial or legal risks, that they create the opposite impression and unnecessarily set hares running.

4. Be aware of the implications that restricting access to project documents can have on developing future precedents and standardisation. We were recently negotiating with a contractor who insisted that a liability limitation it was proposing had been accepted by the financing community and 'banked' on a previous transaction. In fact the wording in question had never been seen by lenders' counsel or reported upon by the borrowers' counsel on that transaction (although it should have been) and so the notion of it being a precedent was incorrect.

5. Counsel appointed to write the report should have both the requisite specialist construction law skills and the commercial nous to understand the perspective and interests of the prospective funders or purchasers who will be relying on it. (Yes, we were always going to blow our own trumpet at some point in this piece). There is a false economy in using generalist legal resource who can summarise the document but not identify specialist legal risks and, as importantly, mitigants or when something is better or worse than market norms or otherwise unusual.

Finally, we do hear anecdotes/tales of the (always hypothetical) developer who pressurises its counsel to change a report to avoid highlighting unusual risks. That is quite different from ensuring a risk is correctly categorised, placed in context and identifying mitigation. Aside from the liability issues that can arise, non-disclosure has a nasty habit of coming home to roost and the reputational impact can stick.