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2022

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Lawyer Wu Jie: How Lawyers Conduct Legal Due Diligence in Enterprise Merger and Acquisition Transactions (7)

In enterprise mergers and acquisitions, whether it is equity or asset mergers and acquisitions, the asset situation of the target company is a top priority for the acquiring party, and it is also a matter that requires special attention and a lot of time and energy to be invested in the due diligence process of lawyers.


In enterprise mergers and acquisitions, whether it is equity or asset mergers and acquisitions, the asset situation of the target company is a top priority for the acquiring party, and it is also a matter that requires special attention and a lot of time and energy to be invested in the due diligence process of lawyers.

 

Main assets

 

1. Verification methods and documents

For the verification of the main assets of the target company, the main verification methods include document review, verification by the competent department, on-site visits, and online verification. If land and property rights are involved, they are supplemented by relevant administrative department inquiries and file retrieval; If intellectual property rights such as patents and trademarks are involved, they will be supplemented by relevant website searches and inspections. The main verification documents include a statistical list of relevant assets, ownership certificates, acquisition documents (transfer, purchase contracts), relevant bills, financial statements, and audit reports.

 

2. Legal issues to pay attention to

For the verification of the main assets of the target company, the main focus is on whether the source of its assets is legal, whether the ownership is clear, and whether there is any burden of rights. Taking the land rights and interests in real estate M&A projects as an example, the following will elaborate on relevant legal issues.

 

(1) There is uncertainty in obtaining land use rights

In a real estate merger and acquisition project handled by the author, the target company has already signed a transaction confirmation letter with the transferor as the bidder through the bidding and listing process. However, six months after the signing of the transaction confirmation letter, the target company has not signed a cooperative development agreement with the economic cooperative in accordance with the requirements of the listing documents, nor has it signed a supplementary agreement to the "Agreement on the Transfer of State owned Land Use Rights" (for limited development), nor has it completed the procedures for the transfer of land use rights and the "State owned Land Use Certificate", thus there is a possibility that the target company cannot obtain the land use rights of the project land, If this is the case, the acquisition goal will not be achieved.

 

(2) The land is idle

In a real estate merger and acquisition project, the target company provided the "Contract for the Transfer of State owned Land Use Rights", which shows that the target company needs to start construction within six months. As of the time of our on-site due diligence, the target company has not yet started construction on the project site, nor has it obtained the approval document for the extension permit from the national land authority, and the land has been idle for three years. According to our interview with the person in charge of the target company, it was found that the reason for the project site's failure to start construction on time was due to the company's insufficient funds.

 

According to the provisions of the "Measures for the Disposal of Idle Land", the project plot may be recognized as idle land by the land administrative department, and once recognized, the target company faces the risk of being expropriated land idle fees or even recovering the use rights of state-owned construction land without compensation. We suggest that the target company communicate with the local land management department in a timely manner to understand the attitude of the local management department towards the idle situation of the project land. If the local management department has no intention of reclaiming the land, the target company should start construction as soon as possible.

 

(3) Failure to complete approval and registration procedures for using rural collective land

In a cooperative real estate development project, we found that the target company signed a "Land Lease Agreement" with a village committee, leasing the land of a certain village for the development of shopping malls. After verification of the "Rural Collective Land Use Certificate" provided by the target company, the project plot is used for collective construction land, and the ownership belongs to a certain village collective. After reviewing the Land Lease Agreement and related documents provided by the target company, and conducting interviews with the person in charge of the target company, we have learned that the target company has not obtained approval from the village assembly for leasing the project land, nor has it gone through the relevant bidding, auction, and registration procedures.

 

We believe that according to the provisions of the Land Management Law of the People's Republic of China, the rental of such collective land use trial rights requires the consent of more than two-thirds of the members of the local collective economic organization's village meeting or two-thirds of the village representatives. According to the provisions of Article 14 and Article 15 of the "Management Measures for the Transfer of Collective Construction Land Use Rights in Guangdong Province", the transfer or rental of collective construction land for commercial, tourism, entertainment and other commercial projects should refer to the procedures and methods of public trading of state-owned land use rights, and be carried out through land trading market bidding, auction, listing, and other methods. The target company has not complied with legal procedures and there is a risk of being invalidated by local villagers or land management departments, which may lead to potential disputes.

 

We suggest that the target company should communicate and negotiate with the local village committee in a timely manner, obtain the consent of the relevant village meeting, promptly complete the relevant bidding, auction, and listing procedures, and apply for land registration and obtain relevant ownership certificates.

 

(4) Soil Environmental Assessment

In a real estate merger and acquisition project, the project site was originally industrial land, and the land use right owner, i.e. the target company, was a chemical enterprise. The target company had been built and put into operation on the project site for many years, and then the land was converted into state-owned construction land through "three old renovations". After verification, we believe that according to the "Notice of the Guangdong Provincial People's Government on Issuing the Implementation Plan for Soil Pollution Prevention and Control Action Plan in Guangdong Province" issued by the Guangdong Provincial People's Government, starting from 2017, the land use rights holder is responsible for conducting soil environment investigation and assessment for chemical and other industry enterprises and public facilities that are intended to be changed to residential, commercial, school, medical, elderly care institutions, and other public facilities. For enterprises in the chemical and other industries that demolish production facilities, equipment, structures, and pollution control facilities, residual pollutant cleaning and safe disposal plans should be formulated as required, and reported to the county-level environmental protection, economic, and information technology departments for record keeping. If the land use right is transferred in accordance with the law, the transferee of the land use right or the responsible person agreed upon by both parties shall bear the relevant responsibilities. Those who cause soil pollution should bear legal responsibility for damage assessment, treatment, and restoration.

 

(5) Planning and approval procedures for construction projects

In real estate M&A projects, the planning and approval procedures for the project site must be a key concern and verification during the due diligence process. The planning and approval procedures for the project site directly affect the development and construction of the project site, as well as the scale and indicators of development and construction. It can be said that they directly affect the transaction purpose of the acquiring party.

 

In this part of the due diligence, common issues include unclear planning conditions for the project site, failure to obtain a construction land planning permit, construction land approval letter, construction project planning permit and other planning approval documents for the construction project, relevant permit certificates exceeding their validity period, and issues related to fire protection and environmental protection of the construction project. For the verification of this part, in addition to reviewing the relevant permits, approvals, certificates and other documents provided by the target company, it is also necessary to log in to the official website of relevant government departments for verification and determination, and go to administrative authorities such as urban and rural planning departments for on-site verification. At the same time, it is necessary to review its legality and compliance in accordance with relevant laws and regulations, and evaluate its potential legal risks.

 

In legal due diligence, the verification of the main assets of the target company involves various types of assets such as land, real estate, other fixed assets, intangible assets, etc. The issues that need to be addressed involve multiple perspectives such as asset acquisition, ownership, and potential risks. Due to space limitations in this article, it is not possible to list the relevant issues of each type of asset. However, for the verification of this part, as long as the logic of discovering and solving problems is followed, the writing method of legal facts+legal provisions+legal evaluation is adopted, and multiple verification methods are comprehensively used to fully reveal risks, achieving diligence, responsibility, rationality, and prudence.