Legal due diligence for acquisitions in the motor vehicle leasing industry

By Li Jie, Concord & Partners
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In the past few years, large quantities of investment have poured into motor vehicle leasing enterprises. An analytical report points out that the top five motor vehicle leasing companies currently account for a mere 9% or so of the total motor vehicle leasing market and it is anticipated that their overall share of the market will reach 10-15% of the market in 2014, still a low level of industrial integration. Great opportunities for industrial mergers and integration lie ahead.

Based on our experience, a brief description of several key points that require attention in legal due diligence for acquisitions in the motor vehicle leasing industry follows.

Evolution of legislation

In August 1997, the Ministry of Internal Trade formulated the Provisional Administrative Measures for the Work Associated with the Pilot Motor Vehicle Leasing Project, specifying that motor vehicle leasing is leasing of physical goods and is a leasing method where the objective is to obtain the right to use a motor vehicle, with the lessor providing such services as motor vehicle use, tax, insurance, maintenance and parts, etc., during the lease term.

李洁 Li Jie 共和律师事务所 高级律师 Senior Associate Concord & Partners
李洁
Li Jie
共和律师事务所
高级律师
Senior Associate
Concord & Partners

In February 1998, the Ministry of Communications and the State Planning Commission issued the Provisional Administrative Provisions for the Motor Vehicle Leasing Industry, specifying that a motor vehicle leasing enterprise is required to secure a Road Transport Operating Permit, and that road transport certificates are to be secured for the vehicles to be leased. The provisions were repealed in December 2007.

In July 2004, the State Council issued the Regulations of the People’s Republic of China for Road Transport, which do not include the motor vehicle leasing industry within the scope of road transport administration.

In April 2011, the Ministry of Transport issued the Notice on Promoting the Healthy Development of the Motor Vehicle Leasing Industry, specifying that the ministry is responsible for guiding the administration of motor vehicle leasing, that relevant qualification certificates need to be secured for the vehicles being leased, and kept with the vehicles at all times, and that motor vehicle leasing enterprises may not engage in passenger road transport operating activities without a permit.

Given that, to date, there are no detailed administrative rules issued at the national level, it is imperative to pay special attention to specific local regulations when carrying out due diligence.

Admission to the industry

The regulations for admission to the motor vehicle leasing industry of different local governments and competent local authorities are not uniform. The first-tier municipalities of Beijing, Shanghai and Guangzhou all implement an operator recordal or permit system. In Shenzhen, motor vehicle leasing enterprises may carry out the procedures for a business licence by the usual procedure with the Market Supervision Administration Bureau of Shenzhen Municipality. Legal due diligence needs to pay attention to which administrative penalties and consequences the target company may face if it has not secured the relevant administrative permission or recordal.

Failure to secure an operating permit may also have an impact on the target company’s lease income. In the Shanghai region, the daily lease rate per motor vehicle for motor vehicles with out of town plates, and those with Shanghai plates, differs by up to RMB100 (US$16).

Modes of leasing

The vehicles that motor vehicle leasing companies put into operation generally fall into the following categories:

Direct purchase. The vehicles are registered in the name of the target company, and the moneys for the purchase of the vehicles are also from the target company;

Direct lease financing. The lessor (the lease financing company) leases the vehicles to the target company, charges the target company rent during the lease term and, upon expiration of the lease term, ownership of the vehicles vests in the target company;

Sale-leaseback. Sale-leaseback is a lease financing method where the lessee and the seller are the same party. The target company sells the purchased vehicles to the lessor (the lease financing company) and then leases the vehicles back from the lessor.

Circumstances also exist where the party that registers the vehicle and the one that uses it are different, e.g. the service vehicles are bought by the target company but registered in the name of another party.

In the review, attention needs to be paid to the integrity of the title to the target company’s vehicles – whether it is impaired by a dispute, mortgage or otherwise – the issue of funnelling of benefits to affiliates and the risk of potentially facing administrative penalties for use in leasing operations of vehicles not owned by the lease operator.

Service or non-service

As to the nature of the vehicles of a motor vehicle leasing company being “service” or “non-service”, national legislation lacks clarity, while local regulations and practice are inconsistent in many cases. Based on our experience, many places maintain the designation of “non-service”.

The period for decommissioning a service vehicle is shorter than that for a non-service vehicle, and insurance premiums and maintenance costs are both higher than those for non-service vehicles. If, in future, laws or regulations are revised and expressly classify motor vehicle leasing as service vehicles, it could result in an increase in insurance premiums for leased vehicles and a reduction in the period before decommissioning, thereby reducing enterprise profits.

Number plate resources

For investors, the number plate resources in a city where there are purchase restrictions are also an integral part of the target company’s assets. Legal due diligence should also look at the number plate resources if the target company is in a city such as Beijing, Shanghai or Guangzhou, where restrictions are placed on motor vehicle purchases, so as to understand the quantity and expiry dates of the number plate resources.

Policy risks

Policy risks are one of the factors that must be considered for an investment, for example the regulatory trend in the legislation of different regions with respect to the motor vehicle leasing industry, and the impacts and opportunities to the motor vehicle leasing industry brought by energy saving and emission reduction measures, as well as reforms on the use of official vehicles.

Legal due diligence of admission to the industry, vehicles and policy directions not only can assist an investor in fully and accurately understanding the actual condition and value of the target company’s assets, but also can provide it with valuable references for its future development plans and investment orientation.

Li Jie is a senior associate at Concord & Partners

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