Tech upgrade, transformation and relocation for M&A

By Sun Yunzhu and Zou Qing, East & Concord Partners
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In recent years, many high-pollution and hazardous chemical enterprises have been required to eliminate outdated production facilities, change their lines of production or simply close down their business or relocate assets, as required by governmental regulations such as the Notification on Stopping Industries with Overcapacity from Further Blind Expansion, and the Guidelines on Solving the Crisis of Severe Overcapacity, with a view to helping with the national drive for supply-side reform. Local governments have formulated regulations to facilitate gradient industrial transfer and assets relocation to meet the needs of strategic development, environment protection and urbanization.

Sun Yunzhu, Partner, East & Concord Partners
Sun Yunzhu
Partner
East & Concord Partners

Usually, these enterprises need to raise funds to cover the costs associated with land, tax, new plants, new technologies and development of new business lines. Investors, on the other hand, might be interested in their industrial position, technologies and management know-how, and therefore plan to acquire a stake or invest in these enterprises. Some facts about enterprises to be relocated – mostly high-pollution and hazardous chemical enterprises – however, should be noted before any transaction is initiated.

For one thing, these enterprises, especially manufacturers of hazardous chemicals with heavy pollution, might have already closed down their businesses, as required by the government, before such a deal was underway. And their land use rights for an old plant might be terminated, or about to be terminated, while the new plant is still undergoing start-up formalities. What’s more, the production facilities might still be located in the old plant.

Therefore, before acquiring an enterprise to be relocated, investors should consider the following, among other things such as shareholding structure, major creditor rights and liabilities, business model and operating results:

Close-down formalities. In the case of a producing enterprise with mining rights, investors should make sure it has fulfilled obligations for geological environment recovery before closing the pit, and completed the formalities for pit closure and mining permit nullification.

Licences and permits. Generally, a manufacturing enterprise should get: an industrial product manufacture licence; a work safety licence; a water source permit; and a pollutant discharge permit. Most of these licences and permits have an effective term of three or five years. Some of the licences and permits may happen to expire following the close-down of business, and enterprises to be relocated may fail to renew them promptly.

Even if all the licences and permits are still within the effective term, they might also need censoring or reissuance, as production conditions such as location, supporting equipment and production technologies will change after relocation to the new worksite.

Land use rights. Generally, when closing down a business, an enterprise to be relocated needs to sign a State-Owned Land User Right Acquisition Contract with the land authority. Investors should check out the terms of the contract on such an enterprise’s obligations for removal of buildings, structures and installations on, and handover of, the land lot, and the terms regarding penalties. In reality, due to the prolonged process for new factories entering a park to go through land planning and environment impact assessment, and to get the land use rights, there may be delays in
old factory clean-up and vacation, and old land delivery, leading to default under the contract.

Zou Qing, Associate, East & Concord Partners
Zou Qing
Associate
East & Concord Partners

Investors, if not yet in a substantial process, should also understand the nature and intended purpose of the new land lot, as well as the government plan concerning the allocation of the land lot. Where application for a land permit has been made, or the assignment of state-owned land use right has been initiated, investors should keep informed about the progress and follow-up cost. Should the Contract on Assignment of State-Owned Land Use Right have been signed, investors must also study the terms on construction commencement and completion dates, postponements, penalties and liability for land being idle.

According to the Provisions on Idle Land Disposal, where an enterprise fails to commence construction within one year following the deadline, the enterprise shall pay a “land idling fee” and such a fee must not be considered as a production cost; where an enterprise fails to commence construction within two years following the deadline, the enterprise will be deprived of the land use right unconditionally.

In reality, enterprises to be relocated may expose themselves to such risks once signing the Contract on Assignment of State-Owned Land Use Right, for financial problems and failure to commence and complete construction as scheduled.

Value of fixed assets. Usually it takes time to get the new plant ready for production because of such issues as land planning, erection of supporting facilities and financial squeeze. Consequently, enterprises to be relocated may suffer considerable depreciation of fixed assets following a long period of close-down and servicing failure before new plants are put into production. The production equipment of the old factory may also be outdated capacity, or become outdated capacity during this period, and thus be retired as required by the law.

Therefore, the removal of outdated production facilities must also be considered when assessing the value of fixed assets of the target company after relocation to new site.

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Personnel placement. During the close-down and before the new site is put into production, manpower is off work and hence needs placement. When technologies and machines are upgraded, enterprises to be relocated may need downsizing. Consequently, many employees will be laid off. Investors must pay attention to enterprise law compliance status in dissolving and altering labour contracts in situations like this.

Governments must correctly assess the feasibility of transformation through M&A, and the benefit it may result in, and pay close attention to the above-mentioned problems. They must positively solve the problem of “zombie companies” through such approaches as M&A, reorganization, technological upgrades and industrial chain consolidation.

Sun Yunzhu is a partner and Zou Qing is an associate in the Shenzhen office of East & Concord Partners

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