The Legal 500

When a company is proposing to apply for admission of its shares to AIM on an initial public offering (IPO), legal due diligence is an integral part of the process required to be carried out by the company. Legal due diligence is primarily designed to help minimise potential liability for the company and its board of directors, who have primary responsibility for the admission document. The nominated adviser to a company, however, is also responsible to the London Stock Exchange for assessing the appropriateness of the company for AIM, and legal due diligence plays a key role in this. Legal due diligence will highlight at an early stage of the process any issues that need to be dealt with to ensure that the company will be suitable for admission to AIM. Through this process, the company will also gather the information required to be included in the admission document.

When a company is proposing to apply for admission of its shares to AIM on an initial public offering (IPO), legal due diligence is an integral part of the process required to be carried out by the company. Legal due diligence is primarily designed to help minimise potential liability for the company and its board of directors, who have primary responsibility for the admission document. The nominated adviser to a company, however, is also responsible to the London Stock Exchange for assessing the appropriateness of the company for AIM, and legal due diligence plays a key role in this. Legal due diligence will highlight at an early stage of the process any issues that need to be dealt with to ensure that the company will be suitable for admission to AIM. Through this process, the company will also gather the information required to be included in the admission document.

RESPONSIBILITIES AND POTENTIAL LIABILITIES OF THE COMPANY AND DIRECTORS

A company that intends to make an application for admission of its share capital to AIM must produce an admission document disclosing the information required by Schedule 2 to the ‘AIM Rules for Companies’ (the AIM Rules). The admission document must include, in addition to a number of specific disclosures, all information reasonably considered necessary for an investor to form a full understanding of the assets and liabilities, financial position, profits and losses, and prospects of the company and its shares.

Rule 31 of the AIM Rules imposes on directors responsibility, both collectively and individually, for the company’s compliance with the AIM Rules. All persons responsible for the admission document must make a declaration that, having taken all reasonable care to ensure that such is the case, the information contained in the admission document is, to the best of their knowledge, in accordance with the facts and contains no omission likely to affect its import (Schedule 2, AIM Rules). If an admission document is inaccurate or incomplete, the company and its directors may be at risk of criminal sanctions. If investors who have relied on the admission document suffer loss as a result of doing so, civil liabilities could also be imposed.

To minimise potential liability the company must:

i) ensure that the admission document contains all of the necessary information and complies with the AIM Rules;

ii) reduce the risk of any material omissions; and

iii) ensure that the admission document informs potential investors of any risks associated with investing in the company.

To achieve this, a comprehensive process of due diligence must be carried out in relation to the company and its business. If a company and its directors have carried out adequate due diligence, it will be more likely that they will be in a position to show that reasonable care was used in the preparation of the admission document, and that it was reasonably believed that the information it contained was true and not misleading or that a matter was properly omitted.

The primary responsibility for adequate due diligence therefore rests with the directors. The nominated adviser for the company, however, also has a responsibility, owed to the London Stock Exchange (set out in Schedule 3 to the ‘AIM Rules for Nominated Advisers’). This responsibility is to oversee the due diligence process and to satisfy itself that any material issues discovered in the process are dealt with or otherwise do not affect the appropriateness of the company for admission to AIM. In relation to mining, oil and gas companies, the London Stock Exchange further confirms this position in the ‘Guidance Note for Mining, Oil and Gas Companies’, which states that the nominated adviser is expected to conduct full due diligence on such companies and their assets.

LEGAL DUE DILIGENCE – STEPS IN THE PROCESS

The overall due diligence process and, particularly, the drafting of the due diligence report(s), is an exercise of investigation into the company, its subsidiaries and their operations, and will consist of financial due diligence, business due diligence and legal due diligence. In the process, the information required to be included in the admission document will be gathered and such information will form the disclosures that must be made to comply with the AIM Rules, in particular Schedule 2. Due diligence carried out on an IPO may be more extensive than that carried out on an acquisition, as a buyer in an acquisition has the ability, and may be willing, to accept certain issues and proceed, provided warranties to a certain level are provided. In the case of an IPO, there is less flexibility as the AIM Rules must be complied with by the company, its directors and the nominated adviser, and therefore a fuller due diligence process must be carried out.

Legal due diligence request list

Although there is no set manner in which legal due diligence must be conducted, the first step in the process will usually be the forwarding of a legal due diligence request list, which will set out a number of questions in relation to the company, its subsidiaries and their operations. The company and its advisers will be asked to provide written responses in relation to the questions set out in the request list and/or copies of documents to substantiate the answers to the questions. The legal due diligence request list will usually be extensive and will cover almost all of the areas of the company’s business. The key matters to be covered would generally be:

• corporate structure and history of the company;
• share capital and the company’s constitutional documents;
• directors (see below);
• business activities of the company and subsidiaries, including material contracts, such as contracts with unusual or onerous terms and/or related party contracts;
• any litigation that the company and its subsidiaries may be involved in;
• investigation of title to any major property and premises, including, in relation to mining, oil and gas companies, the key terms of any licences and their validity and enforceability;
• employees and pension matters;
• environmental issues (particularly relevant for mining, oil and gas companies) and health and safety issues; and
• intellectual property and information technology and the associated rights used by the company and its subsidiaries.

Directors’ questionnaires will also be sent separately to each director and proposed director of the company, requesting, as a minimum, the information required by paragraph g of Schedule 2 to the AIM Rules, which includes information regarding other directorships, unspent convictions, bankruptcies and the like. These questionnaires will form the basis for the disclosures regarding the directors required to be included in the admission document.

Data room

On IPOs of larger trading companies it may prove more convenient for the company to set up an online data room where the key documents requested under the due diligence request list and the company’s material contracts can be made available for review by the company’s advisers.

Legal due diligence reports

A legal due diligence report will then usually be produced from the information gathered in the due diligence process. There will be more than one due diligence report where a company has subsidiaries and/or assets in different jurisdictions and which are material in the context of the IPO. The due diligence reports, prepared in relation to the company, its subsidiaries and their operations, will cover the key areas set out in the legal due diligence request list and will usually be very comprehensive. However, the depth of detail of the reports will depend on the nature of the transaction, including the amount of the fundraising to be undertaken by the company and the level of risk associated with the IPO.

Legal/title opinions

It will often also be necessary for the company to obtain legal opinions in relation to the assets held by the company and its subsidiaries to confirm the ownership of the assets by the company. In the case of mining, oil and gas companies, the ‘AIM Guidance Note for Mining, Oil and Gas Companies’ requires that, where a company’s assets are located outside the UK, in addition to the performance of usual due diligence in relation to the assets, it is mandatory to obtain a formal opinion letter from an appropriate legal adviser authorised to practice in the jurisdiction in which the assets are located and in the law under which the assets are governed. It will often be the case that a company’s assets located outside the UK will be held by several subsidiaries. If so, it will be necessary to obtain legal opinions confirming the chain of title and ownership in relation to both the assets and the subsidiaries. The key points in such opinions would cover:

i) the due incorporation and good standing of any such subsidiaries;

ii) details of the share capital and shareholders of the subsidiaries;

iii) confirmation that there are no charges or mortgages outstanding in relation to the assets or shares of the subsidiaries or, if there are, the disclosure of relevant details; and

iv) confirmation that there is no litigation affecting either the subsidiaries or the assets.

In relation to operating companies and the assets themselves, title opinions will confirm the title to, and the validity or enforceability of, any assets held by the company or the subsidiary, including licences held by such companies that are material to the business being carried out.

LEGAL DUE DILIGENCE – LESSONS LEARNT

It is important for legal due diligence to be started as soon as possible in the IPO process. The extensive investigation in relation to the company and its operations in the context of the AIM Rules will often throw up a number of issues that must be dealt with prior to admission to AIM. Commencing the process early and promptly circulating first drafts of the legal due diligence reports will ensure that there is the maximum amount of time for the company and its advisers to deal with such issues. Several types of issues may arise during the due diligence process:

• Changes to the corporate structure or the company’s constitutional documents may be required to ensure that the company is suitable for admission to AIM. As any changes to the constitutional documents will often require a special resolution of shareholders, this is a case where early identification of such an issue is important.
• The process may bring to light issues such as threatened or pending litigation regarding, for example, challenges to ownership of the company’s assets or environmental claims. Advisers to the company will often recommend that such matters are settled or finalised prior to production of an admission document, as relevant details must be disclosed in the document and uncertainty or potential liabilities might have an effect on investors’ interest in the company’s shares.
• In relation to material contracts of the company and its subsidiaries, the due diligence process will identify whether any third-party consent will be required for the IPO (for example, where change of control provisions will be triggered by the IPO) or for disclosure of third-party details in the admission document where contracts contain confidentiality provisions.
• It may sometimes be the case that the company does not own all of the relevant assets, such as licences or intellectual property rights, and these may be held, for example, by shareholders. Restructuring may be required in such an event.
• The company may not have in place service contracts appropriate for a listed company and these may have to be entered into.
• The board structure may also require change following a review against the guidelines set out in the Combined Code on Corporate Governance (Combined Code). Although compliance with the Combined Code is not obligatory for AIM companies, there is a market expectation that companies will comply to the extent applicable for companies of their size and development. Investors may be more willing to subscribe for shares in a company that complies with industry best practice or is actively working towards compliance with the guidelines set out in the Combined Code, and the nominated adviser to the company should ensure that the company complies to the extent possible.

CONCLUSION

On an IPO, due diligence and, in particular, legal due diligence play an integral part in preparing a company for admission to AIM. The comprehensive investigation involved in carrying out legal due diligence in relation to a company, its subsidiaries and their operations will assist in minimising any potential liability for the company and its directors by helping to ensure that the admission document contains all the relevant details relating to the company and that it complies with the AIM Rules. The process will also highlight any issues with the company’s structure or its appropriateness for AIM, so that these can be resolved or disclosed to prospective investors and the company and its advisers can ensure the company is fit for admission of its shares to AIM.