Articles & Resources
The Importance Of Due Diligence Searches
What does it mean when your lawyer tells you they need to conduct “due diligence” searches when you are buying a business? It means that they need to run certain searches against the business to ensure that you can run it without issue.
There are two types of searches: 1) Title Searches, and 2) Off-Title Searches.
We will first start with Title Searches. To understand what they are, we need to look at what is a Work Order. A Work Order is an enforceable requirement by a governmental authority requiring a property owner to comply with rules governing building standards, zoning, health, fire code and other similar rules. If unresolved, there will be fines and penalties levied.
Now generally, most people buying businesses will be leasing the premises instead of owning it, so why does it concern you as a tenant when it seems to be the landlord’s problem? Well, for one, your lease will outline who is responsible for what, and generally most leases allocate the responsibility to the tenant to ensure that they can run their business on the landlord’s property.
Imagine a scenario where you want to start a dine-in restaurant, and you find a spot where a take-out restaurant was run previously. One would think hey a restaurant was here already, so the zoning should be fine! WRONG! It is actually a different type of zoning and different type of municipal licence.
If you had already signed a binding lease contract, and invested in renovating the place, and then realize this error, it will be even more expensive restoring the place back to its original condition, and the cost of breaking a contract, which could lead to thousands of dollars in loss for you! A simple ~$100-$200 could save this headache, so we highly recommend you do not skim on this minimal cost.
Below are some of the title searches that should be conducted. Each business is unique, so the searches differ, but let’s assume a client is purchasing an existing business.
Zoning Search - the Building and Zoning Department of a municipality typically provide a Property Information Report/Compliance Letter with details on active building permits, violations, work orders and the zoning designation. This will tell you: 1) if your restaurant can operate in this area for the use you want, either take-out or dine-in, and 2) if there are on-going renovation permits or violations that haven’t been resolved yet. A clear report is what you want before moving forward. Sometimes, there are permits that have not been closed yet because work is still ongoing by the property owner or city, or an error in the city’s system did not remove the violation that has been fixed. Your lawyer will sort this out for you.
Fire - Municipal Fire Services Department of a municipality will provide a Compliance letter regarding the fire safety of the property and whether there remain any outstanding work orders. A client may also opt for a fire safety inspection, where the Fire Services Department will enter the premises to inspect head to toe. While this is more thorough, it does take longer and is more expensive than requesting a Compliance Letter. We recommend the fire safety inspection route, for peace of mind.
Health & Safety - Municipal Health Department of a municipality will verify whether there are any health or occupational work hazards or outstanding work orders.
Now on to Off-Title Searches. Let’s continue under the context that a client is purchasing an existing business.
Lien Search/Personal Property Security Act Search
This search determines whether the personal property being purchased has any liens registered against it by creditors (banks, private lenders). A search will usually reveal the debtor name (borrower), secured party (lender), length of the lien, the specific collateral that the lien is on (inventory, assets) and amount secured. When buying a business, you want to ensure the assets being purchased are being transferred to you free and clear of any liens, otherwise creditors can pursue you for the purchased assets.
Bankruptcy and Insolvency Act
This search determines whether there is a record of any bankruptcy/insolvency proceedings involving the seller. If a search reveals there is indeed a proceeding against the seller, the creditors have rights over these assets you are paying money for, so the deal should be suspended until this is resolved.
Bulk Sales Act
In the past, a lawyer would have to file something called a bulk sales affidavit with the courts which makes the sale of business official with the courts. This search used to make sure the seller wasn’t trying to resell what was already sold.
This search determines whether there are any enforced but unpaid judgments that have already been decided against the seller. We generally conduct searches in the sheriff’s office in the municipality where it does its business. For example, if the landlord has sued the seller as a tenant for unpaid rent, and won in court, the seller has an outstanding payment to the landlord which needs to be resolved
This search determines whether there is any pending lawsuits against the seller. If there is, the lawsuit may affect the assets being purchased. We generally conduct searches in the municipality where the seller carries on its business.
Please note the content on this web site is provided for general information purposes only and does not constitute legal or other professional advice of any kind.