Total Diligence: Are Law Firms Leaving M&A Due Diligence Work (and Money) on the Table?

Written by: David Curle

March 30, 2021
Mergers and Acquisitions Practice Trends

4 minute read

Are law firms putting clients at risk by NOT proposing the use of AI-based contract review tools to more comprehensively provide due diligence in M&A deals? That was a question posed to a group of about 20 partners and firm leaders from large UK-based law firms at two recent Ortus Roundtables, hosted by Kira Systems.

The wide-ranging discussions covered a wide range of topics relating to today’s changing environment for M&A, including the impact of work-from-home on firm management and the impact that a year of uncertainty has had on deal planning, negotiations, and structure.

But the liveliest discussion was reserved for the question of whether the managers of due diligence processes should be encouraged to extend contract reviews beyond what might originally have been defined as “material.” Kira Systems’ CEO Noah Waisberg gave an example of a $400 million deal that might include human review of 50 -100 contracts deemed “material” by the client’s criteria. In a deal that size, the acquired company might actually have thousands of contracts in place - but the limitations of manual review means that most of the company’s contracts lie outside the usual sample set.

What if firms used AI to do an additional, automated review of those remaining contracts? Might the remaining contracts hide risks, including most favored nation clauses, exclusivity terms, or weird indemnity provisions, that could cause downstream problems for an acquirer? What are the risks of not doing that review, compared with the costs of leveraging today’s automated tools?

Raj Panasar, Partner at Hogan Lovells, thinks the typical situation reflects the conservatism that law firms show in advising on what’s a reasonable level of review. “When a client puts documents in a data room, they are taking a view on what’s material, and in general the legal industry has been comfortable with the client making that call,” he says.

Many outside firms won’t question that decision, and won’t suggest an automated review of a larger set of contracts using technology. It’s ultimately a question of risk, and many firms are reluctant to have that discussion with clients.

But as Waisberg put it, shouldn’t the law firm play the role of risk counselor in these situations? Shouldn’t its expertise play a role in decisions on scope? That’s the difference between the law firm as an order-taker, and the law firm as a trusted advisor.

Other participants in the roundtables framed the discussion about “total diligence” not so much as a major discussion about risk, but simply a way for firms to complement and extend their core manual diligence reviews with added services they couldn’t do before. It’s just an extension of what human review can accomplish. And it’s situational; the human review will remain in place for the most important material contracts, but AI can extend the reach of the review to the rest at relatively small cost.

As one of the roundtable participants put it, to extend review to a wider range of contracts is not to claim that ALL risks are eliminated, but where there are large numbers of customer or supplier contracts that could pose risks, the question becomes a more pragmatic one - why not use machines to have a look at those contracts that the human-based review would otherwise not encompass?

What will it take to get firms to expand their review by using AI in this way? Panasar sees a number of patterns:

  • Lawyers are starting to lead with automated AI-based review when scale is an obvious problem. He uses the LIBOR reviews as an example, where there are thousands of documents and the volume is just too great for manual review.
  • The technologists and innovation teams that are developing at law firms understand both the power and the limitations of automated review, but their confidence has not filtered up to the partners driving the deal work. More testing and evaluation on real-world document sets may be necessary.
  • There’s a fair amount of inertia in the market. Some firms are using AI-powered review on some deals, but fewer firms have made the shift to using AI as a matter of course on every deal, in a more expansive manner beyond the normal review scope.
  • In the end it comes to the relationship between firm and client. Recent research has shown that in-house counsel are disappointed in their outside firms’ reluctance to share the technologies they have available to them. One possibility is that the clients will begin to take the initiative to shape their law firms’ approach to expanding AI-based review through outside counsel guidelines or other means.

AI-assisted document review is no longer novel or untested. Whether it’s driven by client demands or by the firms themselves, some firms are beginning to see AI as a way to extend and improve the services they provide in M&A diligence situations.

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