Legal risks of share acquisitions in liquor makers

By Cai Qixiao and Zhang Jinchao, East & Concord Partners
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in China, the liquor market shows a trend of steady and sound development along with the development and maturity of food industry. The Catalogue for Guiding Industrial Restructuring, which became operative on 1 January 2020, excludes liquor making from restricted industries, releasing active policy guidelines for the liquor making industry.

In order to maintain growth in a highly competitive market, liquor makers mostly expand their production capacity and market shares by mergers and acquisitions (M&A) out of the consideration for raw material supply, sales channels, brand influence, etc. This article summarizes the legal risks common in M&A of liquor makers.

Transaction modes

It is provided in the Provisional Regulations on Consumption Tax that the tax payable by liquor makers shall be 20% × liquor price + RMB0.5 / 500g (500 ml) × weight (volume) of the liquor. In the case of asset acquisition, investors shall pay the consumption tax incurred at the time of transfer of liquor assets. Therefore, out of the consideration for saving tax costs, investors mostly acquire core assets of the target company by share acquisition.

Production and management qualifications

Cai Qixiao
Partner
East & Concord Partners

Giving consideration to tax planning, liquor makers sell their products by setting up sales subsidiaries. It is provided in the Food Safety Law and the Measures for Administration of Food Production Licensing that liquor making companies shall obtain a food production licence and food distribution licence, and liquor selling companies shall obtain the food distribution license.

Liquor makers may also follow the product quality standards set out in the Catalogue of Certification of Alcohol Products, and obtain corresponding certifications in order to cater to market requirements (e.g., their business partners require the corresponding certifications) or enhance product competitiveness. The acquirer may consider the options based on market conditions and competing products.

If the target company is engaged in outsourcing production, the acquirer should also pay attention to whether the contractors obtain the above-mentioned qualifications. No matter whether the target company is the outsourcer or the contractor, it should indicate itself as the outsourcer or the contractor, or only indicate the outsourcer (name, address, and contact information) pursuant to article 8 of the Administrative Provisions on Food Labeling.

Ownership of real property

Zhang Jinchao
Trainee Associate
East & Concord Partners

Due to the special nature of the liquor making process, a liquor maker is required to build a liquor making workshop, packing workshop, ageing cellar and warehouse, which together occupy a large area of land. Therefore, the certificate of land use right and the property ownership certificate (which are consolidated into a real property ownership certificate) are necessary to guarantee continuous production and operation of the liquor maker. If the maker is located in the production area of high-quality liquor, complete and unrestricted ownership of real property is especially important.

If a liquor maker is to occupy agricultural land, the department of land and resources will require that the liquor maker shall not use the land for commercial purposes until it reaches resettlement agreements with households occupying the agricultural land.

Then the department of land and resources may grant the use right to state-owned land through bidding, auction or listing processes. The acquirer should confirm whether the land to which the target company has obtained land use right is completely available, and whether the company is obliged to relocate the affected persons.

If the above-mentioned matters are not properly handled, the acquirer, especially a non-local acquirer, may pay a high cost for communication and settlement of problems.

Environmental protection and production safety

Liquor makers discharge a large amount of waste water and gas during production. They should obtain the pollutant discharge permits pursuant to the Environmental Protection Law and discharge pollutants as per the requirements of the permit.

Meanwhile, the acquirer is advised to fully understand the punishments imposed on the target company in relation to environmental protection and production safety, and the correction requirements the government authorities impose on the target company.

Given that liquors are inflammable, the acquirer should especially focus attention on whether the liquor storage and blending workshops conform to applicable laws and regulations, and affirm whether the target company has potential hazards in environmental protection and production safety.

These matters may directly affect the transaction consideration, therefore it is advised that the representation, warranty and indemnity clauses on such matters be included in the share purchase agreement.

Contract under performance

Where the sales, procurement and project contracts of the target company are underperforming, the acquirer should decide whether it is necessary to continue to perform these contracts based on its specific objectives of acquisition.

If performance of these contracts has a material impact on the business of the target company, the transferor may be requested to make representations and warranties on renewal of contracts in future in the share purchase agreement.

If it is not necessary to continue to perform the contracts, the transferor may be requested to urge the target company and its counterparties to execute termination agreements prior to closing of transaction, so as to prevent dispute over contract performance after closing.

If any project of the target company is not completed or settled, the acquirer is advised to pay attention to that. Accrual of amounts payables may significantly deviate from the actual as-built settlement amount and expose the company to the risk of subsequent high liabilities.

It is advised that, prior to full payment for the share transferred, the transferor should be required to urge the company to complete as-built settlement or execute termination agreements with the construction contractors to specify the amount of liabilities, or issue a letter of commitment by which the transferor undertakes to assume full liability for all losses caused to the acquirer and the target company.

In addition to the above-mentioned legal risks, parties to different transactions may need to pay attention to different matters given the special natures of the transactions. For example, anti-monopoly filing may be required for some highly concentrated liquor makers. Investors should analyze and consider the legal risks based on the characteristics of the transactions.

Cai Qixiao is a partner and Zhang Jinchao is a trainee associate at East & Concord Partners

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East & Concord Partners
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E-mail:
ahawcai@east-concord.com
zhangjinchao@east-concord.com
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