An overseas merger and acquisition (M&A) transaction does not only involve two or more countries or regions, but also parties that may differ notably in terms of strategy plan, expertise, financial strengths and human resources.
An overseas merger and acquisition (M&A) transaction does not only involve two or more countries or regions, but also parties that may differ notably in terms of strategy plan, expertise, financial strengths and human resources. In recent years, not a few overseas M&A proposals offered by Chinese companies suffered setback as a direct result of severely asymmetric information in the possession of the parties and lack of effective risk control measures of the Chinese acquirers. In this article we look into the possible issues and risks that legal due diligence (LDD) may address.
Purpose and Effect.
By confirming legal status of significant issues (e.g. legal capacity, business and assets of the seller), identifying potential risks and determining their nature, extent as well as their impact and implications on the proposed transaction, the LDD of an overseas M & A transaction aims at providing basis for pertinent arrangements under the transaction agreement so that legal risks are brought under control. Valuation, design of transaction structure, negotiation of terms and conditions, and development of integration program are based on findings of the LDD. The accuracy and completeness of a LDD report, and quality of relevant analysis contained therein, may have a direct impact on the outcome of an M & A offer.
Preparations.
How to conduct a thorough and intensive LDD on the overseas target in a given time frame? Since an overseas M & A transaction involves at least two jurisdictions, dividing collaborative work between experienced, reliable PRC and local attorneys is crucial for the efficiency and quality of a LDD.
Before conducting the LDD, the LDD team should inform themselves about purpose and background of the transaction, business plan, proposed structure, progress requirements and key concerns, determine subjects and scope of the LDD, search for basic particulars and industry background, and analyze on laws and regulations applicable to the industry of the target. On top of this, they should proceed to design and provide an all-inclusive and feasible list of LDD that covers general issues, reflects industry features and contains a finalized timetable or agenda that is compact and efficient.
Contents of the LDD.
Generally speaking, the LDD of an overseas M & A transaction addresses issues described in the table below. In practice, the scope of LDD conducted by potential Chinese buyer is often restricted by the seller or target, who tends disclose favorable information or have reservations about disclosure out of consideration for transaction strategy. Therefore, instead of relying completely on information received from the target, the LDD team should make best efforts to conduct an all-round investigation using various means.
Investigated Issues |
Contents |
Basic particulars |
Legal capacity and structure of the target, including, among others, incorporation, equity structure, shareholders, capital contribution, pledge of shares, main business, articles of association, shareholders agreement, minutes and resolutions of the board of directors. In view of significance of the target's main subsidiaries around the world, the LDD should also cover these subsidiaries with focus on information about incorporation and valid existence. |
History |
Merger, consolidation, division, reorganization and restructuring of the target, as well as capital contributions, increases or decreases of capital, share issues and transfers. |
Business qualification |
Qualifications, licenses, permits and etc. that are related to business operations of the target. |
Significant claims and debts |
All debt documents should be reviewed to confirm debt relationships, especially significant or potential liabilities and the collaterals and change of control clauses in connection with such liabilities. |
Material contract |
The contractual parties and contents of contracts should be reviewed. The focus should be placed on outstanding material contracts. |
Key assets |
Land use right, real estate (either self-owned or leased), equipment and machinery of production lines, products, raw materials, and inventory; agreements on intangible assets and intellectual property rights, such as copyrights, trademarks, patents, franchises and domains; ownership of the target's significant assets, especially whether any encumbrance exists. |
Labor and employees |
Information about employees and the management, including salaries and benefits, core employees and their employment contracts (particularly confidentiality and non-competition clauses or agreements); stock option program or earnings distribution program; pension, benefits and insurance schemes; whether there are any labor disputes, and whether the proposed transaction involves employee relocation |
Environmental protection |
How do the target and its key subsidiaries comply with laws and regulations concerning environmental protection, and whether there are any significant environmental protection issues |
Administrative penalties, litigation and arbitration |
All documents related to regulation and litigation should be reviewed to sum up significant administrative penalty cases pending against the target and the all disputes in which the target is involved, including any ongoing or threatened litigation, arbitration or government investigation |
Government approval and third party right to consent |
What are the approvals and procedures that need to be obtained from or completed with the foreign government in relation to the proposed transaction, and whether disposal of potential assets or company equity by the seller requires any third party consent, including third party consent necessary for transfer of the underlying asset or related to material contract. |
Other considerations.
Upon collection and rationalization of due diligence data, attorneys should analyze any issues identified. Although the LDD should be treated carefully to prevent omissions, rigid interpretation of facts and laws should be avoided so that there is no exaggeration. More importantly, a lawful and effective solution to the problems should be developed. Besides, communication between the LDD team and the financial and tax due diligence teams should be strengthened.
(The article was translated and first published by China Business Law Journal in its 2017 volume/ issue 6)
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
