White Paper: Acquisitios by Chinese companies in US

By Andrew M. Ross: 0 Comment(s)Print E-mail China.org.cn, February 20, 2012

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Legal Due Diligence

Due diligence, i.e., a detailed examination of one or more prospective target companies, is a critical part of any acquisition for any buyer or investment for any investor and is also relevant, although potentially to a lesser extent, in a joint venture.Because of the U.S. legal structure and typical deal structure and likely lack of pre-existing relationship between the U.S. seller and the Chinese buyer, proper due diligence is essential in seeking to make certain that the buyer obtains what it is paying for and has adequate legal remedies and other protections if a problem arises. Certain due diligence aspects are carried out directly by the buyer and others by its advisors, such as its lawyers conducting due diligence regarding the target company's legal affairs.

Some companies defer much due diligence until they have reached at least an agreement in principle on the terms of the deal. However, due to the possibility of due diligence unearthing problems which can either stop a deal from proceeding or necessitate adjustments in its financial terms or structure, it is generally wise, and often more cost effective to conduct "high level" due diligence as early in the process as possible. Before addressing "legal due diligence" in more detail, note that "business due diligence" is extremely important in assessing whether the potential target does or can meet the business objectives underlying the Chinese company's strategic goals. The prospective buyer often plays a major role in business due diligence, analyzing the target company's business practices, results, relationships, market position and prospects, among other aspects. In other cases a knowledgeable investment banker or other consultant can perform this function, even leading these efforts.

With respect to "legal due diligence," its purpose, as it sounds, is to investigate potential legal issues pertaining to the proposed target. Note that "legal issues" often have financial implications and so ultimately are also business issues. These legal issues can be divided into several categories of which some key ones are discussed below.

First, to investigate whether the target is subject to any current lawsuits, arbitrations, government hearings or other legal proceedings. Then, if this is so, determine whether it is possible to develop a meaningful assessment of the likely outcome and the consequences, and thus the risks involved for the buyer, and then have the parties make an economic allocation of the risks. For example, if the buyer and its advisers conclude that the outcome could be material, a portion of the purchase price could be held back to seek to protect against this.

Second, whether the target company is subject to any contracts which, either on their own terms or as a result of the proposed deal, could have material adverse consequences.For this purpose U.S. legal counsel reviews the target's major agreements.One issue that might arise, for example, is that the target is currently paying a major supplier a specific fee for its goods, which amount is being used in the deal financial projections, but pursuant to the contract with the supplier, for whatever reason, such as the mere passage of time, the increase in volume that is hoped to occur as a result of the transaction or even the occurrence of the deal itself, the unit price will increase, thus adversely affecting the financial projections and potentially the valuation. Without reviewing the agreement, this may not be discovered until too late. In the U.S. it is also not unusual for many contracts, such as supply agreements, leases and licenses, to provide, in the event of a sale of or even a major investment in the customer, tenant or licensee, for a right of termination by the other party. This can result in, at a minimum, a potential renegotiation with the other party, whether a supplier, licensor, landlord or other.

The third aspect of legal due diligence, and often the most difficult, is to determine whether the target seller is conducting its business in a legal manner. One reason this is so important to the buyer is that if prior to the deal the seller is acting in an illegal fashion, even inadvertently, and the buyer is unaware of this, then once the deal closes the buyer's newly acquired business will presumably operate in the same fashion and thus still be violating the law. However, if identified in advance, the buyer can take steps to cause the seller to act properly going forward, and depending upon the nature and magnitude of the illegal act,renegotiate terms if necessary. Common examples can be a workplace environment which violates various laws, illegal gifts to government officials, and pricing strategies for goods or distributor agreements which violate U.S. anti-trust laws.