New considerations in acquisitions, Due Diligences and warranties
Today almost all companies and businesses are to some degree computerised and are reliant on computer technology. Accordingly, a prospective purchaser of a target company or business should give careful consideration to this aspect of the target company or business before acquiring it. Indeed, this should form an integral part of any legal due diligence investigation conducted on behalf of a prospective purchaser.
A prospective purchaser should therefore consider the following technology related issues before acquiring a company or business –
software and maintenance agreements. These should be carefully scrutinised to –
– ensure that the software used by the company/business is legitimate. This means that the entity must not only be licensed to use the software but also that it is licensed for the number of users concerned and for the purchase for which it is being used;
– ascertain their duration and the service levels provided for. Service levels include issues such as permissible down-time and disaster recovery;
– ensure that proceedings have not been threatened or initiated in respect of the unauthorised use of software;
whether or not all the computer hardware and software is “year 2000 compliant”;
whether or not the entity has an e-mail policy for its employees;
whether or not the entity has an Internet presence. If it has an Internet presence, then it is important to confirm that –
– the domain name has been registered in the name of the target entity;
– the Internet presence does not infringe any trade marks, copyrights or any other intellectual property rights; and
– the necessary copyright protection is in place in respect of the target entity’s website content;
if the company or business transacts over the Internet, it is important to ensure that the necessary security systems (firewalls and the like) are in place and appropriate disclaimers are in place.
In addition to a due diligence investigation, a prospective purchaser should ensure that the relevant acquisition agreement contains appropriate warranties and indemnities in its favour in respect of these issues.
Given the ever increasing role that technology plays in the operation of a business, a proper legal due diligence investigation should be carried out by a prospective purchaser of a company or business in respect of technology related issues.
Certain technology related warranties and indemnities should be given by the seller in favour of the prospective purchaser.
Failure to provide for the above could result, inter alia, in the prospective purchaser exposing itself to future operational problems and exorbitant costs in updating/replacing systems and claims arising out of Internet transactions.
Public offers and the issue of a prospectus
ON THE INTERNET
Despite being a small New York based company, Spring Street Brewery has generated considerable interest in the US securities industry with its public offering of shares, with the approval of the US Securities and Exchange Commission, through the Internet.
This phenomenon has also reached South Africa, and there appear to be considerable advantages in a public offer of shares through the Internet, including the –
rapid and widespread dissemination of information to a vast number of potential investors;
ability to enhance the value of information so as to enable investors to make more informed investment decisions. This may be done by “hyperlinking” the statutorily required information contained in the prospectus to other relevant commercial information about the company concerned on the Internet;
increased efficiency and cost effectiveness. Potential cost savings include the avoidance of printing, mailing, travel and courier costs associated with the traditional forms of making public offers. Given the enormous potential market provided by the Internet, the advisability of having a public offer underwritten may not be so important.
In principle, there would appear to be no reason why a South African company may not make a public offer through the Internet provided that any such offer complies with the requirements of the Companies Act (“Act”), and the JSE Securities Exchange South Africa listings requirements.
The provisions of the Act regulating offers to the public are essentially disclosure provisions. In other words, their purpose is to ensure that potential investors are provided with at least the minimum of essential information so as to enable them to make an informed decision. As a consequence, the emphasis in the Act is on the content of the relevant documents as opposed to the form they take.
The requirements of the Act are not complete. No offer for the subscription or sale of shares may be made to the public unless it is accompanied by a prospectus which complies with the requirements of the Act and is registered in the Companies Register Office. Furthermore, application forms for the subscription or purchase of shares must be attached to the prospectus.
In the light of the above, it should be relatively easy to set up a website on which an offer to the public is made. The prospectus and application form can be electronically created and should be able to be down-loaded by the user who can print a hard copy for signature. At this stage, one may not be able to complete and return an application form electronically, as the signature of the applicant is required on the form. In addition, it is suggested that the website be created in such a manner that one may only access the application form through the web pages containing the prospectus.
Andrew Klein, the founder of Spring Street Brewery, recently took his initiative further. He set up a “secondary” market where shares in his company can be traded. He has done this through the medium of an electronic bulletin-board. The US Securities and Exchange Commission initially suspended the operation of the bulletin-board, but has since lifted the suspension subject to certain changes being introduced.
South African companies can make a public offer via the Internet, subject to compliance with all relevant rules.
Using this medium, companies can enhance cost effectiveness, increase efficiency and create a dynamic market perception.
This is the first step in a process that may result in the creation of “secondary” markets for the trading of shares.
Year 2000 – are you prepared for the millenium bug?
A considerable amount of computer software developed during the last thirty years recognises only the last two numbers of the year for the purpose of tracking dates. Thus, when “97” is typed into a computer, the computer will automatically register “1997”. Similarly, when “00” is typed into a computer, the programme will register “1900”. The effect of this is that from midnight on 31 December 1999, many computer systems will not be able to store or calculate forward dates after 31 December 1999. For example –
With a system which only recognises the last 2 digits of a year, in 1999 a person’s age will be correctly calculated as 99 – 53=46.
However in the year 2000, an incorrect calculation will occur as 00 – 53=-53.
The effect of this on financial institutions, insurance policies, pension funds, interest payments, transfer of electronic funds, equipment maintenance services, business records, invoice dates and automatic date stamps (to name a few) are calamitous and the problem should not be ignored or underestimated. Although the Year 2000 problem will not necessarily cause a system to terminate, those computer systems which are not Year 2000 compliant, can and in all probability will yield inaccurate or unpredictable results.
What is also important to note is that the Year 2000 problem will not only take effect from 1 January 2000 but problems can and will occur prior to this date. An example of this is with regard to five year fixed deposits or credit cards where the expiry date falls in the Year 2000.
Already in Detroit, USA, the first Year 2000 case has been instituted. A retailer has filed a civil suit against a cash register manufacturer on the grounds that the cash registers used by the claimant cannot recognise credit cards with an expiry date of or after 2000. Problems being experienced by the claimant as a result include significant delays, muddled records and computers constantly crashing. The claimant has sued the manufacturer and supplier for $10 000 plus damages and legal costs.
Existing software licenses, and all networking, hardware, maintenance and other technology contracts must be reviewed to establish whether they are 2000 compliant. For example, if the software is not 2000 compliant, does the contract or license state that the software will become 2000 compliant and if so, when. Existing software licenses with vendors and third parties must be checked for warranties, potential liabilities and other key issues pertaining to 2000 problems.
System vendors that are currently selling systems which are non-compliant face legal risks such as liability for non-disclosure and fraud.
New software licenses and maintenance agreements must provide that the software is programmed to cater for dates from 2000 onwards.
If the software is not 2000 compliant but the vendor undertakes that at some future date the vendor will render the software 2000 compliant (for example, in terms of a maintenance agreement with the vendor), the contract should specify how the software will become 2000 compliant; that this must obviously be effected before 31 December 1999 and that the vendor will be liable for all costs incurred in such conversion. Consideration should be given to testing the system for compliance prior to 31 December 1999.
WARRANTIES AND INDEMNITIES
The representations or warranties regarding 2000 compliance must be drafted in such a way that they are enforceable in a court of law by the party invoking them. Existing warranties relating to “defects” in the software may not be sufficient given that 2000 non-compliance is not a “defect” as such but a material problem in the initial design of the software. Thus, users of software should insist on a specific and well-worded warranty relating to 2000 compliance, as well as a related indemnity provision.
DIRECTORS AND COMPANY OFFICERS
Directors owe a fiduciary duty to a company and are required to meet a certain standard of care and skill when carrying out their duties. Directors should therefore be well appraised of the Year 2000 problem, and should act now to take steps to deal with the problem.
In particular, directors of companies which are highly sensitive to date systems eg, financial services, pension funds and the insurance industry, should be engaged in assessing, and disclosing, the nature and extent of the Year 2000 problem and making provisions therefor.
MERGERS AND ACQUISITIONS
Year 2000 issues should be a key subject in all commercial negotiations and must be considered by all parties when quantifying the value of a target company, especially where the target company relies heavily on date dependant software. If there are serious Year 2000 issues, this may diminish the value of the target company. The cost of remedying the problem (whether it be repairing the software or having to purchase new software) and the potential liabilities that may arise should the software not be 2000 compliant must be assessed and considered when negotiating the purchase price. As outlined above, this aspect should form part of any due diligence investigation into a target company or business. Acquisition agreements should include carefully drafted warranties and indemnities in relation to these issues.
Companies need to timeously implement a conversion strategy which identifies impact, cost and conversion considerations to bring systems in line with 2000. This will involve undertaking a “technology audit” of all software packages and hardware, as well as hardware licenses, contracts and insurance policies to establish and identify non-Year 2000 compliance. Individual programs should then be tested for accuracy and finally, all the programs should be tested to make sure that they are compatible with each other. Suppliers and third parties should also be encouraged to confront the 2000 problem as their failure to act may impact on your business in the future.
The Year 2000 is rapidly approaching. Dates impact on every aspect of commercial business from forecasting, automatic payments and automatic timers on safes and vaults to the calculation of retirement benefits.
Companies need to start strategising how best to counter the 2000 problem now.
Those companies in South Africa which have begun to plan for the next century have amongst other things engaged programmers to develop programs to counter the “millennium bug” and have included the cost of dealing with the 2000 problem in their budgets.
Although dealing with the problem now may seem time consuming and premature, a failure to acknowledge the 2000 problem and to begin making appropriate provisions could have dire and wide ranging consequences for a company.
Electronic data storage and the paperless office
Computerised storage of agreements, records, correspondence and the like provides a great number of advantages, not least among them the massive space savings, greater degree of permanence and easier and quicker access and searching. The question is whether there are legal disadvantages in replacing traditional paper storage systems with computerised ones.
At the outset it must be noted that there are certain circumstances where original documents must be retained by law, for example documents that attract stamp duty. Such documents may not be destroyed for a specified period of time. In assessing whether other documents may be stored electronically and the original destroyed, it is necessary to consider the nature of your use of such stored documents. Generally, stored documents are used for reference either for your own purposes or between the parties to such document. In this case, the use of electronically stored documents will only be constrained by the accuracy of the storage system used and any agreement between you and any other party. Accordingly, if you intend to use an electronic data storage system, it will be useful to agree with the other party that you will be doing so. The other main use of stored documents is in dealings with the state (for example in preparing tax returns and most importantly, litigation) which is a far more complex situation.
The law concerning the admission of electronically stored data as evidence in court is in a state of flux as the Computer Evidence Act, introduced in 1983 to address the issue of computer evidence, has proved inadequate. In fact there is no reported case of the Act ever having been used and it appears likely to be replaced in the near future.
The electronic storage of documents involves the passive use of a computer, as the computer system essentially captures an image of the page to be stored and files that image away, without processing or affecting it in any way other than to give it a label and description to assist in subsequently searching for that image. At present, passive electronically stored data of this nature can be admitted in civil matters, in terms of the Computer Evidence Act, and can also be admitted in court in terms of a number of other laws and legal principles, both in civil and criminal matters. Provided the electronic data storage system that you implement is sufficiently accurate and the procedures that you use to store both existing and new documents on such system are methodical and accurate, there should not be a problem in having passive electronically stored documents admitted as evidence in court.
The situation with regard to “active” information, where the computer is involved in actively generating, processing and changing information (such as a computerised accounting system) differs somewhat from the passive storage referred to above. Despite the uncertainty in this area of law, active computer evidence is currently admissible in terms of the Act and again there are a number of other laws and legal principles which will allow you to admit your business records as evidence.
With regard to financial records, the Income Tax Act provides that certain records must be retained for a period of four years after the income tax return dealing with the documents in question has been received by the Commissioner for Inland Revenue. The Commissioner is entitled to authorise the retention of these documents and records in a form acceptable to him and the Income Tax Act seems to allow for these documents and records to be retained in an electronically stored format with the Commissioner’s consent. In general, with all organs of the state it is preferable to confirm that electronically stored documents will be accepted before destroying the originals.
Assess the current uses to which your archived documents are put and confirm that electronically stored documents may be used for the same purposes before implementing an electronic storage system.
Obtain advice regarding the documents in your business sector that must legally be retained in their original format.
The procedures for scanning and destroying documents must be strictly enforced and accurate logs must be kept.
Insert a provision in your standard agreements advising other parties of your use of such a system and indicating their consent thereto.