Legal audit: luxury or necessity?

June 4, 2018

Legal audit of a company before its acquisition, known in the business environment as due diligence, is commonly essential condition for making a final decision of the foreign investor on the purchase of shares in Kazakh legal entity. 

Long ago managers worldwide came to conclusion that analysis of current situation in the target of purchase is more advantageous and efficient rather than discovering the necessity to solve certain issues in the future, after signing the sale and purchase agreement.

Similar logic is applicable not only to the companies which are subjects of investments but also to acting enterprises which generate income and do not expect significant problems. The majority of Kazakh companies of medium and large business have in-house legal counsels in their staffs and, consequently, apply to external consultants only for certain project, such as court cases, assistance during important transactions, obtaining permits. Due to that, first managers and in-house counsels of business entities rarely conduct monitoring of current state of legal affairs in the company and do not analyze the job results which may cause negative consequences for this company in the future. 

It is common to apply to external consultants already with existing problem such as withdrawal of license, claim on termination of subsoil contract or application of employee to the conciliation commission. It is obviously clear that in these cases the issue appeared due to improper analysis of the documents related to the commitments of the company’s obligations in front of the third parties. Frequently, the cases aforesaid are solved by external counsels with greater efforts and, as a result, with higher costs rather than preventing these risks by timely legal audit.

Much appreciating the merits of in-house counsels, we see the whole complex of reasons which may cause undesirable aftereffects for business due to the absence of external legal audit. Among them are regular overloading, narrow specialization of certain professionals, absence of wide law enforcement practice, trust to unfair external consultants providing sometimes undue results of their services which are accepted by the clients as appropriate, others reasons.

Within the recent legal audit of industrial company of Astana, the lawyers of Linkage&Mind LLP faced with the situation when actual legal circumstances significantly differed from the information provided by the owner to potential buyers. There were breach of special conditions of three licenses. Besides, the company did not obtain corporate approval of shareholders for entering into long-term major transactions which required such approval in accordance with the charter.

Due to revealing of all risks, foreign investor refused from acquisition of Kazakh company and, by doing so, saved tens of thousands US dollars which might be spent for elimination of legal risks.

We recommend the owners of business, its managers as well as legal directors to prevent timely potential risks by conducting legal audit in the following sectors:

1) corporate affairs. This integral part of any acting legal entity is not limited by the analysis of the charter, registration documents and appointment of the first manager. In fact, every company has certain risky issues which frequently have a lack of attention. Among them are forming of share capital, obligations in relation to sale and purchase of shares, state registration of structural subdivisions in the places of permanent business conduct outside the main legal office

2) permits and licenses. Some business managers consider that a license issued by a governmental body shall be valid till the date of its expiration subject to submission of periodical reports. However, the laws of Kazakhstan stipulate a number of cases when permit or license shall be mandatory re-issued or withdrawn by the competent authority

3) labour relationships. The practice demonstrates that it is inefficient to have only well drafted labour agreement, acts of the employer on hire and dismissal of employees, imposing disciplinary liability. It is also highly important to have proper collective agreement, the mechanism of functioning of conciliation commission as well as the acts of employer on validation of internal policies and procedures to make them mandatory for the execution by employees

4) intellectual property. As we can see, many entrepreneurs do not pay due attention to the objects of intellectual property. The lawyers of Linkage&Mind LLP faced with the situations when market leaders of certain industry continue to work without protection of their trademarks until the appearance of disputable problem. For this reason, we also recommend to carry out regular monitoring of existing patents for inventions, industrial models, utility models and trademarks.

Depending on the type of company’s activities, the useful areas of legal audit can be antitrust and competition, environment, subsoil usage, investment obligations, public purchases, insurance.

Kazakh subsidiaries of foreign companies have common practice of periodical internal legal audits conducted by the parent company (holding). There is no doubt that such practice facilitates well-timed detection and prevention of legal risks.

At the same time, national peculiarities of Kazakh legislation and the practice of law enforcement reveal clear necessity of involvement of external legal consultants for the professional assessment of legal aspects of the company’s activity and potential improvement of existing situation.