Update on due diligence for cross-border M&A

Legal due diligence is a key part of cross-border M&A. It generally covers the organizational form of a target enterprise, its shareholding structure, labour employment, intellectual property rights, environmental protection, significant contracts, government approval, etc.

As the US has many excellent enterprises in the computer, electronic technology and biopharmaceutical industries, it has become one of the best choices for Chinese enterprises in the new wave of cross-border M&A. Considering the increasing law enforcement efforts of the US for trade compliance and anti-commercial bribery compliance, Chinese enterprises should conduct a thorough investigation into target American enterprises in terms of the above-mentioned compliance before acquiring them.

Trade reviews

Most target companies of cross-border M&A by Chinese enterprises operate in the computer, electronic technology and biopharmaceutical industries, and generally the products of relevant target companies only include products for military and civil purposes, and exclude aerospace products and military weapons.

Therefore, an acquirer’s legal team should, mainly under the framework of the Export Control Administration (EAR), conduct an investigation into a target company with regard to at least the following issues: (1) whether its products are subject to the EAR, with a focus on checking whether the products of the target company fall within the category listed in the Commerce Control List, whether it has exported goods via the US, and whether its products contain materials made in the US or incorporate technologies that are protected by registration in the US; (2) whether it discloses controlled and protected technologies to third countries other than the US, orally or by email, fax, telephone and other electronic communication means; (3) whether its foreign employees, overseas subcontractors and others need access to products that are subject to the EAR, and technologies that are protected by registration in the US; (4) whether ultimate users of its exports are listed in the Entity List; (5) whether it exported, or is exporting, goods to countries listed in the embargoed countries list (North Korea, Iran, Cuba, etc.) published by the US Department of the Treasury; (6) whether it has strictly complied with the US export customs clearance procedure, and whether relevant information contains false or misleading information or representations; (7) whether it has a perfect export compliance system; (8) whether it has been subject to investigations and formal punishment by the US Department of Commerce due to illegal exports; and (9) whether it has signed the Commitment to Export Control Compliance with its suppliers and customers.

Since the US export control laws and regulations are very extensive and complicated, a Chinese enterprise should engage an experienced legal team to conduct thorough due diligence on a target company to avoid various adverse consequences arising from violation of US export control laws (hefty fines, criminal charges, inclusion in the “blacklist” of US trade control, etc.).

Anti-commercial bribery compliance review

In order to punish cross-border bribery, the governments of many developed countries have strengthened their legislation and law enforcement efforts against overseas corruption of multinational enterprises. The US published the Foreign Corrupt Practices Act (the FCPA) in 1977. In view of the extensive extraterritorial jurisdiction and severe punishments under the FCPA, if a target company commits multiple FCPA violations before the M&A, and if a Chinese acquirer fails to properly carry out an investigation, it will certainly bear huge legal risks after the M&A is completed.

In order to reduce the transaction risks of cross-border M&A by enterprises, Chinese enterprises should at least pay attention to the following issues of a target company with regard to anti-commercial bribery compliance review: (1) the corruption risks in the region or industry where the target company operates, namely the level of corruption rate of the country, or the business climate in the industry, and whether there were major cross-border commercial corruption cases; (2) business model risks, namely whether commercial bribery can take place easily under the organizational structure of the target company, its models of soliciting for and undertaking businesses, for example, whether the operation of the target company depends on a single customer in a region, or a single type of contract, or whether it is subject to special approval of a government authority, etc.; (3) whether the target company and its employees have been prosecuted or punished for bribery; and (4) whether the target company has established an anti-bribery compliance system, which may include a bribery risk identification and evaluation system, the commitment of senior management to integrity, and the provision of regular anti-bribery compliance training for employees; and (5) whether the target company, its customers or potential customers, and the intermediary agencies engaged by it have any related-party relationship with, or transfer interests to, foreign government officials or managers of state-owned enterprises.

If the acquirer’s legal team identifies relevant illegal acts of the target company during the export control compliance and anti-commercial bribery compliance review of the target company, it shall make suggestions to the acquirer depending on the severity of the violation. If the violation is minor, only resulting in payment of a certain fine, it may suggest that the acquirer should adjust the quote for the acquisition. If the violation is relatively serious and the acquirer concentrates on acquiring the assets or patents and other intangible assets of the target company, it may suggest that the acquirer should acquire the assets instead of the equity.

If the violation can be completely resolved within a short period of time, or the specified compliance monitoring period does not expire in spite of a settlement with the law enforcement department, it may suggest that the acquirer should delay the transaction until the target company completely eliminates relevant adverse impacts. If the violation is serious and there is no possibility of a settlement with the law enforcement department, it may suggest that the acquirer should terminate the transaction.

Yan Xianrui is an associate and Li Huaizhi is an intern at East & Concord Partners

East & Concord Partners
20/F, Landmark Building Tower 1
8 East 3rd Ring Road North
Chaoyang District, Beijing 100004, China
Tel: +86 10 6590 6639
Fax: +86 10 6510 7030
E-mail:
yanxianrui@east-concord.com
lihuaizhi@east-concord.com
www.east-concord.com