Sharp spike in China outbound deals
Chinese companies continue to develop a voracious appetite for offshore deals. The value of China's outbound M&A deals reached $32.1 billion in the first 6 months of 2014, up 40% on the previous half. And Australia remains a key destination for Chinese investment. The value of China's announced outbound deals in Australia during the first half of 2014 was $2.4 billion, up 42% on the previous six months. Privately owned enterprises in China are taking an ever increasing share of the outbound deal pie, experiencing a triple-fold increase in deal value during the same period. This trend is set to continue as Chinese companies seek diversified investment opportunities and stable destinations for their capital, and as they look offshore for new growth potential, new technologies, reliable products and sustainable supply chains.
Where deals are done, disputes will arise
The sharp jump in Chinese investment in Australia has inevitably resulted in an increase in shareholder disputes. This comes as no surprise and replicates what has been experienced in the growth of disputes between Chinese parties investing offshore through, for example, the British Virgin Islands and Hong Kong. Already, in the first two months since I have returned from Shanghai to work in Australia, I have been involved in several shareholder disputes between and/or involving Chinese shareholders in Australian companies. Disputes tend to involve concerns over access to information and dissatisfaction with decisions at the board level, including in respect of dealings with shares in the company and company assets. Unfortunately, many Chinese investors fail to consider appropriate (if any) risk abatement strategies when making investments in Australia, and this greatly limits their ability to resolve successfully their grievances as shareholders.
The importance of smart structuring
Chinese investors often find themselves as minority investors in Australian entities, frequently alongside other Chinese investors. Sometimes there are strategic, commercial and financial reasons for opting for a minority stake, but there are many instances where a lack of awareness on the part of Chinese investors has impeded their ability to ameliorate the risks doing business in Australia. Confucius once stated with consummate wisdom, "real knowledge is to know the extent of one's ignorance". Many Chinese investors have simply not understood, for example, that overseas companies wishing to carry on business in Australia may elect either to register a subsidiary or establish a branch office by registering themselves as a foreign company in Australia.
It is a truism that we view our world based largely on our own perspective and experience. As a matter of Chinese law, foreign companies cannot own and operate assets in China without first establishing a subsidiary in China. Therefore, many Chinese businesspeople automatically, but wrongfully, assume that they must set up a subsidiary in Australia to do business in Australia, even if it requires them taking a minority position with other investors.
Another example is to do with failures to understand the role of government in Australia. In China, government is pervasive and is involved in most aspects of business. In Australia, although business lobby groups are capable of influencing government, there is a clear demarcation between business and government. It will not simply be the case that good government relationships will provide a cure for poor commercial and legal preparation in making investments in Australia.
Prevention is better than cure
Indeed, prevention is usually more effective and certainly cheaper than a cure. Chinese investors in Australia would do well to seek professional advice on how they can, for instance, buttress the protection of minority parties and how they can best structure their Australian investments. If Chinese investors do set up subsidiaries in Australia (and especially where they do so as minority investors), they would be prudent to do the simple things well, such as:
- ensuring that they negotiate contractual arrangements which protect their rights and interests
- agreeing upon the operation and governance of the Australian company in constitutional documents, whose binding effect is recognised and enforceable in both Australia and China
- negotiating clear and strong safeguards in the relevant documents
- maintaining a copy of the relevant contracts and documents (Australian corporations law does provide a shareholder's right to obtain a copy of an Australian company's constitution, but it is always easier if the shareholder protects their own right upfront by keeping a copy in their possession).
To the extent possible, Chinese investors would also be wise to:
- seek representation on the board of directors of the Australian company (in Australia, company directors have the power to manage the business of the company. Subject to specific requirements of the company's constitution, directors are not required to consult with shareholders or obtain the consent of shareholders before making decisions about the company which the directors are empowered to make, including – for instance - the issue of shares in the company or the sale of company assets)
- adopt a structure that allows for a degree of disproportionality between decision-making powers and equity involvement
- include in the shareholders' agreement and the Australian company's constitution explicit "information rights" as to ensure the investor has unobstructed access to the company's financial, operational and other important information (depending on the type of company, Australian corporations law provides shareholders with limited rights to inspect the books and records of the company, but this may require the shareholder to apply to the court for an order authorising the shareholder (or another person on the shareholder's behalf) to inspect the books of the company)
- provide for protections in the company's decision-making procedures, as set forth in the shareholder's agreement and the company's constitution (e.g., specify a right to, and proceedings for, summoning regular and interim board and/or shareholders' meetings, ensure that the quorum of any board meeting consists of at least one director appointed by the minority shareholder, and make sure that sufficient notice is given to directors before board meetings, etc)
- provide for anti-dilution controls in the in the shareholder's agreement and the company's constitution
- specify certain "reserve powers" of the board/shareholders' meetings which require unanimous or special majority approval, or include veto rights over reserved matters so that the minority shareholder can block undesirable resolutions in respect of material transactions or company changes
- include in the relevant documents exit mechanisms (e.g. put options, tag along rights) or similar arrangements (e.g., buy-out option, Russian roulette) so that the minority investor has a way out of a bad business or a soured relationship, or a way to squeeze out an uncooperative partner
- include in the relevant documents a termination right which captures deal-specific circumstances in addition to statutory termination events
- play an active role in the management of the company or place appropriate limits on the authority of management if it is not possible to play an active role in the management or appointment of management.
Although Australian law does provide mechanisms for upholding the rights and interests of shareholders (and minority shareholders in particular), it is much easier for Chinese investors to take smart precautions when making an investment and during the lifetime of the investment than it is to rely on Australian law to protect such rights and interests when a shareholders' dispute arises. Furthermore, if a shareholders' matter does become contentious, courts and arbitration tribunals are more inclined to support the rights and interests of minority shareholders who have taken steps to protect their rights and interests when documenting and implementing the investment. As another famous Chinese saying goes, "preparation forestalls calamities".
This publication does not deal with every important topic or change in law and is not intended to be relied upon as a substitute for legal or other advice that may be relevant to the reader's specific circumstances. If you have found this publication of interest and would like to know more or wish to obtain legal advice relevant to your circumstances please contact one of the named individuals listed.