In the past few years Switzerland, located in the heart of Western Europe and economically integrated with the surrounding EU markets, has become increasingly attractive to Chinese investors due to its leading industries, excellent research and development environment, highly educated and trained workforce, leading financial centres, liberal labour laws, low taxes, low national debt and political stability.
We have had several opportunities in the past few years to provide legal services to Chinese companies bidding for Swiss companies, or parts thereof, and to Swiss groups selling companies or licensing technology to Chinese companies.
As we already featured the technical aspects and particularities of Swiss law on mergers and acquisitions (M&A) and initial public offerings (IPOs) in the March 2013 issue of China Business Law Journal (What are the M&A options for Chinese FDI in Switzerland?, volume 4, issue 3) and the June 2013 issue (Delving into the finer details of Swiss takeover regulation, volume 4, issue 6), we take the occasion of this special overseas M&A issue to feature three obstacles that we have seen typically arise in M&A transactions involving Chinese bidders.
Cost awareness is less a transaction obstacle than a considerable risk factor for Chinese bidders. First timers – meaning Chinese embarking for the first time on an M&A deal in the Western world – usually do not hold consulting in general, and legal consulting in particular, in high esteem. Consequently, they perceive lawyers as interchangeable, which is why they often consider the cheapest one as the best buy and end up being worse off as the effects of lack of expertise, experience and diligence of underemployed lawyers accepting rates, caps or broken deal rebates far below market can have deal-breaking results and end up being more costly in the long run. Although being generally aware that quality has its price, the true problem of the first timers is that they simply cannot see what quality in legal consulting might bring to their business, as their Chinese experience is that the ability to obtain government support and establish excellent relations with the ruling class is much more decisive for success than strict legal compliance and careful contract drafting. As a consequence, they are (as yet) unaware that the exact opposite is true for success in the Western world, as here governments and ruling classes keep out of business and are prevented from having a bearing on justice by the separation of powers doctrine.
Nevertheless, such undervaluation of the quality of legal advice usually happens only to first timers. Chinese experienced in Western M&A usually select their Western law firms without asking for terms below market, attempting, however, to reduce their legal transaction costs by staggering the due diligence process, starting with a non-descriptive high level (red flag) legal due diligence limited to certain data room sectors only (such as, for example, legal existence, title chain, permits, material agreements, insurance, pension funds and litigation), carving out others (such as intellectual property, employment, social security, real estate) and reserving to deepen or extend the limited legal due diligence review should the seller refuse to grant representations and warranties (R&W) bridging the gaps without regard to its relevant data room disclosures.
If the negative findings of the high-level due diligence report cause them to break off the negotiations, the staggered due diligence paid off, but if they continue and finally close the transaction without further examining the target (relying only on representations and warranties) they may bitterly regret it. Deciding whether or not to proceed with a deal on an informed basis, including the knowledge of substantial flaws, may be much better than litigating for years under R&W clauses that may prove to only partly cover the resulting damages and losses. There is quite some truth in the saying that companies rarely fail because they did not do a deal, but often fail because they did the wrong deal.
Chinese investors looking for acquisition financing from Western banks are often surprised to learn that the latter are not at all inclined to accept them as creditors unless their loans are secured by guarantors or assets located in a Western jurisdiction (such as a Bank of China subsidiary). The same is true with respect to the replacement of parent guarantees securing creditors of the target (such as parent guarantees securing the target’s bank loans, performance bonds, lease contracts or customs dues, etc.). Mainland Chinese buyers will learn that security holders usually refuse to turn in the seller’s parent guarantees against their guarantees while financially strong Hong Kong group companies may be acceptable as guarantor. As Chinese investors tend – mostly for cost reasons – to tackle such problems only when the acquisition is imminent, such issues may considera-bly delay the transaction at an advanced stage.
Chinese bidders without a local presence in Europe usually wish to establish a European acquisition vehicle to acquire the target(s). On top of that, larger groups sometimes also wish to edge a Chinese sub-holding in between as the founder of the European acquisition vehicle.
As such acquisition structures are usually set up between the signing and closing of the transaction, transaction documents for Chinese buyers routinely provide for post signing intra-group accessions on the buyer side. Nevertheless, Chinese buyers often delay the start of the preparations for setting up the acquisition structure as they tend to underestimate the time needed for analysing and deciding intra-group tax optimation issues. Therefore, the transaction schedule is sometimes considerably delayed by the protracted set-up of the acquisition structure.
Additional difficulties may arise if the seller insists on keeping the Chinese “deep pocket” parent as a jointly and severally liable obligor rather than accepting it as a guarantor or surety of the ac-quisition vehicle. As Chinese law does not know joint and several debt accession as a security, the Chinese permit situation (under the Ministry of Commerce, National Development and Reform Commission, State-owned Assets Supervision and Administration Commission, State Administration of Foreign Exchange and sector-specific permits, as applicable in the particular case) of the joint and severally liable parent is unclear and may considerably delay the transaction process, and finally still force the seller to accept a guarantee or suretyship.
Felix W. Egli is senior partner and head of China desk, and Wu Fan is a China Desk counsel at VISCHER, Zurich and Basel (www.vischer.com). They can be contacted respectively on +41 58 211 3490 and 3645, or by email at [email protected] and [email protected]