AI: Conducting legal due diligence

As AI develops and more companies seek to incorporate AI into their operations, products and services, interest in companies using AI is expected to increase and consequently the need to consider AI and AI-related issues in M&A transactions is also likely to increase.

The novelty of AI, its power, rapid development and general lack of regulation present some challenges that justify specific AI-related due diligence issues to be considered by buyers.

In brief:

• As AI grows and more companies are keen to integrate AI into their businesses, buyer’s appetite to target companies developing or using AI is expected to increase.
• While many of the issues brought up by AI might seem similar to those associated with any emerging technology, the unique aspects of AI pose some challenges which demand specialized AI-related due diligence considerations.
• This article provides an overview on some key issues a buyer should consider when conducting legal due diligence on AI businesses and companies using AI.

Algorithmic advances and increases in computing power and data availability have led to unprecedented developments in artificial intelligence (AI).

As AI has developed and the use cases for AI have increased, more companies have sought to incorporate AI into their operations, products and services. This has led to a substantial increase in investments in companies using AI and consequently an increased need to consider AI and AI-related issues in M&A transactions – particularly in relation to due diligence.

As professionals with deep experience in technology transactions, we have prepared this article to provide clients with guidance on conducting legal due diligence on businesses that use AI.

If you have any questions in relation to this article, please contact Steve Johns at steve.johns@au.ey.com or on +61 402 793 004 and Emma Maconick at emma.maconick@nz.ey.com or on +64 9 348 6604.

Introduction

As AI has developed and the use cases for AI have increased, more companies have sought to incorporate AI into their operations, products and services.

Uses of AI by companies include:

• Strategic level: assisting in data-driven decision-making and by informing long-term business strategies.
• Operational level: optimising supply chains, managing inventory through predictive analytics, automating routine tasks, and improving efficiency in production and delivery.
• Functional level: providing tailored applications, such as virtual assistants and chatbots for customer service and AI tools for financial analysis and risk management.
• Product and service level: embedding in a company’s products and services, enhancing their functionality and creating new customer experiences.
• Employee level: assisting employees with tasks such as scheduling, communication and information retrieval.

Given the wide range of uses of AI, it is increasingly likely that buyers will need to consider AI and AI-related issues in M&A transactions – particularly in due diligence.

AI: the key legal issues

From a legal perspective, AI and its use pose a range of concerns for buyers, including:

• Use of AI: that the company has the right to use AI and for the purposes for which it is used.
• Development and supply of AI (including AI work products and services): that the extent to which the company supplies products and services using or incorporating AI is known and consistent with any applicable agreements or limitations on use.
• Safeguards: that the company has in place robust processes and safeguards to avoid any misuse of AI and to protect the company’s rights.
• Intellectual property rights – data and content: that the company’s access to and use of any information is permitted by the owner of such information and that the work product does not infringe any rights of any person.
  
• Privacy: that the company’s collection and use of any personal and sensitive information complies with all applicable laws.
• Compliance: that the company complies with all applicable laws (if any) regarding the use of AI.
• Disputes: that there are no disputes affecting the company with regards to the use, development or supply of AI.
• Insurance: that the company holds adequate insurance against any AI-associated risks.

Superficially, these concerns appear similar to those associated with any new technology. Consequently, there is often a temptation for these concerns to be addressed in a generic way and without particular reference to AI.

Privacy

It is important for buyers to ensure that the use, development and supply of AI and any products or services using or incorporating AI comply with all laws regarding the collection and use of personal data and sensitive information.

• Please provide details of all policies and procedures regarding the collection and use of any personal data or sensitive information (a) used to develop and train (and re-train) AI, and (b) provided by third parties when using AI.
• Does the company have in place policies and procedures for the destruction of personal information used to train (or re-train) AI? If so, please provide details and copies of all such agreements.

Compliance

The buyer should ensure that the company complies with all applicable laws regarding the use of AI.

As at the date of this article there are no specific laws dealing with the use of AI in most jurisdictions (though it is expected that the European Union will adopt a regulatory framework in the near future). However, like with all new and disruptive technologies, we expect this will change.

• Please provide a list and copies of all authorisations, licences, certifications, permits, registrations, consents and approvals required for the use of AI by the company or the development or supply of any products or services (a) using AI or (b) which incorporate, or make use of, AI.
• Have there been any actual or claimed breaches or non-compliance by the company or any of its related bodies corporate, officers, or employees, with any of the above authorisations, licences, certifications, permits, registrations, consents and approvals?

Disputes

As previously stated, AI is a novel, powerful and rapidly developing technology with an increasing range of use cases. These factors, combined with a current lack of specific regulation regarding its development and use, increase the likelihood that disputes will arise in relation to AI.

As a result, buyers should carefully review the claims history of the company to ensure that it has not been the subject of any claims or disputes in relation to its use of AI or the supply of products and services using or incorporating AI.

• Please provide details of any breach or non-compliance, or claimed breach or non-compliance, of any agreement to which the company is a party in connection with, or relation to, AI or the supply of products and services using or incorporating AI.
• Has any AI developed, created, produced, manufactured or supplied by the company been the subject of any pending or threatened complaint, prosecution, litigation, arbitration, mediation or investigation?
• Have any products and services developed, created, produced, manufactured or supplied by the company (a) using AI or (b) which incorporate, or make use of, AI, been the subject of any pending or threatened complaint, prosecution, litigation, arbitration, mediation or investigation?
• Are there any circumstances of which the company is aware which may lead to the company or its officers to become involved in any of the above, or related, complaints or proceedings?
• Please confirm whether there are pending or threatened government or other investigations involving the company’s use, development or supply of AI or the supply of products and services using or incorporating AI.

Insurance

The buyer should confirm that the company holds adequate insurance against any insurable risks specifically relating to AI.

• Does the company have any insurance for AI-related risks (including the sale of products and services developed, created, produced, manufactured or supplied using, or which incorporate, AI)? If so, please specify the types of insurance and the specific risks insured against.

Further developments will bring new legal challenges

As AI further develops, use cases increase, and more decision-making is devolved to AI, we expect that the issues that need to be considered by a buyer during legal due diligence will significantly increase.

We also expect increased focus on compliance during legal due diligence. Although, as at the date of this article, AI and its use is not the subject of specific regulation in most jurisdictions, we expect this to change - similar to data and privacy which led to the General Data Protection Regulation (GDPR) and its equivalents in each major economic block. We also expect ethical considerations, such as algorithmic biases and transparency, will gain more attention and potentially lead to additional regulations.

For the above reasons, it is essential for buyers to keep up to date in relation to AI and its regulation. Failure to do so could result in unforeseen business and transaction risks and post transaction compliance challenges.

If you would like to discuss this article or learn more about mitigating risks posed by AI from a transactional perspective, please contact Steve Johns at steve.johns@au.ey.com or on +61 402 793 004 and Emma Maconick at emma.maconick@nz.ey.com or on +64 9 348 6604.

About the authors

Steve Johns is an M&A partner at Ernst & Young, Australia, providing M&A and corporate law advice to clients. He has a focus on technology transactions and has over 20 years of experience. He has worked on transactions throughout the US, Asia and Australia.

Emma Maconick is Data and Technology partner at EY Law Ltd (New Zealand). She has over 20 years of experience in tech and data intensive industries and has worked extensively in the US, UK, New Zealand and Australia.

Steve and Emma were assisted in the preparation of this article by Gonzalo Castro and Eliza Unger, senior associate and associate, respectively, of the M&A team at EY Australia. Both Gonzalo and Eliza have extensive experience in advising clients on M&A transactions in Australia, Europe and the US.