Due diligence is the cornerstone of any successful merger or acquisition. One of the most critical-yet often underestimated-components of the due diligence process is the comprehensive review of contracts. These documents reveal not only the operational structure of the target company, but also its obligations, liabilities, and revenue streams. Overlooking or inadequately reviewing key contracts can lead to post-closing legal exposure, financial losses, or even litigation. Contact us by either using the online form or calling us directly at 414-253-8500 for legal assistance.
Why Contract Review is Critical in M&A Transactions
Contracts serve as the legal foundation of a business. When acquiring or merging with another company, the acquiring party must understand:
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What contractual obligations it may be inheriting
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Whether key relationships are assignable or terminable
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Potential liabilities, breaches, or default risks
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Restrictive covenants that may limit operations post-closing
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Opportunities for renegotiation or termination
In essence, thorough contract review helps identify deal-breaking issues early and informs valuation, negotiation strategy, and post-closing integration.
Categories of Contracts to Prioritize in Due Diligence
Not all contracts carry equal weight. Below are the key categories of contracts that should be reviewed with particular scrutiny:
1. Customer and Client Agreements
These contracts are the backbone of the target company's revenue. During review, attorneys assess:
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Revenue consistency and customer concentration
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Termination clauses and automatic renewal terms
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Assignment and change-of-control provisions
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Volume-based or performance-based pricing structures
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Rights to withhold payment or dispute invoices
If a few customers represent a disproportionate amount of revenue, that concentration risk should be factored into the deal structure or valuation model.
2. Vendor and Supplier Agreements
Vendor contracts may contain exclusivity clauses, minimum purchase commitments, or unfavorable pricing structures. Review should consider:
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Supply chain stability and continuity
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Automatic renewal or long-term lock-in clauses
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Penalties for early termination
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Dependency on sole or limited-source vendors
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Material breach history or pending disputes
These reviews can expose potential supply chain vulnerabilities or hidden liabilities that affect integration plans.
3. Employment Agreements and Independent Contractor Arrangements
These contracts reveal financial obligations beyond just salary-like severance packages, non-competes, or intellectual property rights.
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Are there change-of-control provisions triggering bonuses or automatic termination?
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Are there restrictive covenants enforceable under applicable state law?
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Are key personnel under binding agreements or at-will arrangements?
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Are any independent contractors misclassified?
This review is especially vital when employee retention is key to the success of the transaction.
4. Real Estate Leases and Property Agreements
Real estate contracts often contain clauses that can delay or derail a closing if not addressed early.
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Are leases assignable or do they require landlord consent?
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Are there termination or subleasing rights?
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Are there environmental risks or repair obligations?
Depending on the deal, it may be necessary to initiate negotiations with landlords well in advance of closing.
5. Loan and Financing Agreements
Liabilities associated with debt can dramatically affect the viability of a transaction. Lenders may have:
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Covenants restricting M&A activity
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Prepayment penalties
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Cross-default clauses triggered by other agreements
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Security interests in key assets
Failure to obtain required lender consents or satisfy payoff conditions can delay or scuttle a deal.
6. Licensing and Intellectual Property Agreements
Especially in technology, media, or manufacturing industries, intellectual property (IP) assets and the contracts governing their use are pivotal.
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Are licenses assignable or revocable?
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Do they grant exclusive or non-exclusive rights?
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Are there termination clauses tied to a change in ownership?
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Are royalties or milestone payments involved?
Losing access to critical IP after closing could cripple business operations.
7. Franchise, Distribution, and Reseller Agreements
For businesses that operate under a franchise model or distribute third-party products, these agreements are often tightly regulated and heavily negotiated.
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Are there geographic or territorial restrictions?
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Are there minimum performance requirements?
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Does the franchisor or distributor retain the right to terminate or modify the agreement after a change in control?
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Are the agreements in compliance with federal and state franchise disclosure requirements?
Failing to review these contracts thoroughly can expose the buyer to termination risk or compliance violations that affect continuity.
8. Confidentiality, Non-Disclosure, and Non-Compete Agreements
While these may seem minor compared to other contracts, they can have a significant impact on post-closing operations, particularly if:
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Key employees are subject to restrictive covenants
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The target has agreed to non-competes or non-solicitation clauses that would hinder integration or growth
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Confidentiality terms affect the buyer's access to important third-party data post-acquisition
An experienced M&A attorney can evaluate whether such provisions are enforceable under state law and compatible with the buyer's operational strategy.
9. Litigation Settlement Agreements
If the target company has been involved in litigation, it's critical to review any settlement agreements to assess:
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Ongoing obligations (such as non-disparagement or licensing terms)
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Outstanding payments
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Whether the settlement contains confidentiality clauses or affects third-party relationships
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Indemnification rights and releases
Hidden risks may remain even after litigation is resolved, particularly if settlements included continuing performance or restrictions.
10. Joint Venture or Strategic Alliance Agreements
These often include shared intellectual property, operational responsibilities, or revenue arrangements. Review should consider:
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Exit strategies or buy-sell clauses
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Allocation of profits and losses
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Change-of-control restrictions
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Management and voting rights
Understanding how these agreements operate in practice is essential to ensure alignment post-closing.
11. Government and Regulatory Contracts
For companies operating in regulated industries (e.g., defense, healthcare, transportation), review government or regulatory contracts for:
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Compliance with federal acquisition rules
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Termination for convenience clauses
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Audit or inspection rights
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Flow-down obligations to subcontractors
Failing to meet government compliance requirements can result in contract termination or fines.
Common Red Flags Identified During Contract Review
While not all contract issues are deal-breakers, the following red flags should prompt deeper analysis and potential renegotiation:
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Non-assignable contracts without counterparty consent
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Change-of-control provisions that trigger termination or price increases
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Imbalanced indemnity clauses
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Pending or anticipated breach notices
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Discrepancies between contract terms and actual business practices
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Onerous exclusivity clauses
Identifying and addressing these issues early gives the buyer time to restructure the deal or mitigate risk before closing.
Assignability and Change-of-Control Clauses: The Deal-Makers or Deal-Breakers
One of the most critical provisions attorneys look for is whether a contract can be assigned to the acquiring entity. Many contracts include language that:
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Restricts assignment or requires prior written consent
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Terminates automatically upon a change of control
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Gives the counterparty the right to renegotiate terms post-sale
Failure to secure proper assignment or consent may result in termination of essential contracts, particularly with key customers or suppliers.
Importance of Legal Counsel in Contract Due Diligence
An experienced attorney plays a vital role in identifying, interpreting, and negotiating contract terms during due diligence. Legal counsel can:
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Prioritize which contracts require deeper review
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Analyze high-risk clauses
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Draft assignment agreements, consents, and waivers
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Advise on the need for representations, warranties, and indemnities in the purchase agreement
In complex transactions, your attorney becomes your frontline risk manager.
When to Start Contract Review During Due Diligence
Contract review should begin as early as possible in the due diligence timeline. Delaying contract analysis risks:
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Missing required consent deadlines
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Last-minute deal delays due to unresolved contract issues
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Overpaying for a business with contracts that cannot be transferred
Early review enables more effective negotiation and proactive problem-solving.
Contact an Attorney for Contract Review in M&A Due Diligence
If you're planning a business acquisition, selling your company, or entering a merger, don't underestimate the critical role of contract due diligence. Heritage Law Office provides strategic legal counsel tailored to uncover risk, secure essential consents, and protect your investment throughout the transaction.
Contact us online through our contact form or call us directly at 414-253-8500 to schedule a consultation with a knowledgeable attorney.
Frequently Asked Questions (FAQs)
1. What types of contracts are most important to review during due diligence?
The most important contracts to review include customer agreements, vendor contracts, employment and independent contractor agreements, real estate leases, loan agreements, and intellectual property licenses. These contracts directly affect business operations, revenue, and potential liabilities, and their terms can impact the value and feasibility of a deal.
2. What is a change-of-control clause and why does it matter?
A change-of-control clause gives one party the right to terminate or modify the contract if the other party undergoes a merger, acquisition, or ownership change. These clauses are critical in due diligence because they can result in the loss of essential business relationships if not addressed before closing.
3. Can I assume all contracts will transfer automatically in a merger or acquisition?
No, not all contracts are automatically transferable. Some agreements include anti-assignment provisions that require prior consent from the other party. Failing to obtain these consents can result in unenforceable agreements or loss of business relationships post-closing.
4. How can I tell if a contract contains hidden risks?
Hidden risks often appear in the form of unfavorable termination clauses, automatic renewals, exclusivity provisions, or contingent liabilities. A thorough legal review will identify these issues and assess their impact on the transaction, allowing you to address them before finalizing the deal.
5. Why is legal review necessary even for standard or recurring contracts?
Even standard contracts can contain language that becomes problematic in the context of a business sale or acquisition. Seemingly boilerplate terms can trigger obligations or prevent assignment. Legal review ensures that every contract aligns with your strategic and legal goals during a transaction.