Abstract: In corporate mergers and acquisitions, the debt and debt situation of the target company is a concern for the vast majority of acquirers, and it is also a top priority that lawyers must pay attention to in their due diligence. The nature and amount of debt and creditor's rights are likely to affect the transaction method and consideration.

 

Debt and debt

 

1. Verification methods and documents

The debt and debt situation of the target company is a concern for the vast majority of acquirers, and the nature and amount of debt and debt are likely to affect the transaction method and consideration. As a lawyer, the focus of verifying creditor's rights and debts is not only on the amount of the debt, but also on the nature of the debt and its potential legal risks. The verification methods in this section mainly include document review, online verification, verification with other intermediary agencies, and interviews. Especially, verification with other intermediary agencies such as accountants, auditors, tax agents, assessors, etc. is particularly important because this section involves a lot of professional knowledge in finance and accounting, and lawyers always have limitations in these professional fields. During the due diligence process, timely communication with other professional intermediary agencies is necessary Information sharing is an effective supplement and improvement to legal due diligence. The verification documents include major contracts, audit reports, financial statements, relevant litigation, arbitration and other judicial documents of the target company.

 

2. Legal issues to pay attention to

In this part of the due diligence, we need to verify the type, quantity, legality, compliance, performance status of the target company's creditor's rights and debts, as well as whether there is a guarantee for the relevant creditor's rights and debts, and the legality and effectiveness of the guarantee. At the same time, we also need to verify whether there are restrictions or accompanying obligations for the relevant creditor's rights and debts. In addition, the target company's off balance sheet liabilities also require verification and attention. Here are a few examples.

 

(1) Defects in the effectiveness of guarantees

In a due diligence investigation of a certain project, after reviewing the significant contracts of the target company, we found that the target company signed a "loan contract" with Company A, providing a loan of 10 million yuan to Company A. Company C, an affiliated company of Company A, provided a mortgage guarantee with its land use rights and signed a mortgage guarantee contract. However, when reviewing the relevant guarantee documents, we did not find any internal approval documents such as the shareholder meeting resolution and board resolution of Company C regarding this mortgage guarantee matter. After interviewing the person in charge of the target company, it was stated that C company was not required to provide the aforementioned internal approval documents when signing the mortgage guarantee contract.

 

We believe that in accordance with the provisions of the Company Law and the Interpretation of the Supreme People's Court on Several Issues Concerning the Application of the Guarantee Law of the People's Republic of China, in terms of this guarantee, if Company C claims that such guarantee behavior violates the mandatory provisions of the Company Law and is invalid on the grounds that the mortgage guarantee contract signed by Company C has not been approved internally or the guarantee amount exceeds the limit of the articles of association, There may be a risk that the target company may not be able to obtain full collateral guarantee for this loan.

 

① Note: As the project cited in the case was handled before the implementation of the Civil Code, the relevant laws and regulations in effect at that time shall prevail. After the implementation of the Civil Code and related judicial interpretations, the corresponding judicial interpretation should be the "Interpretation on the Application of the Guarantee System in the Civil Code of the People's Republic of China" (Fa Shi [2020] No. 28).

 

Regarding company guarantees, in accordance with the Notice of the Supreme People's Court on Issuing the Minutes of the National Court Civil and Commercial Trial Work Conference (hereinafter referred to as the "Nine People's Minutes"), there are relatively clear and detailed provisions on the rules for determining the effectiveness of contracts for companies to provide guarantees to others. The newly implemented Civil Code and the Interpretation on the Application of the Guarantee System in the Civil Code of the People's Republic of China (Fa Shi [2020] No. 28) have also made some amendments to the guarantee system. These regulations require lawyers to pay special attention to the review of company guarantees in future due diligence.

 

(2) Limitation of Litigation for Major Contracts

During the due diligence process of a certain project, during the verification of the target company's major contracts, after reviewing the target company's sales and purchase contracts and conducting interviews with the target company's responsible persons, we found that the target company has creditor's rights against Company A due to the sales and purchase contract, but these creditor's rights have not been recovered after three years, and the target company is also unable to provide written documents related to claiming creditor's rights against Company A during this period.

 

We believe that according to the relevant provisions of the General Principles of the Civil Law, the creditor's rights of the target company have exceeded the legal statute of limitations, and the target company has lost its right to win the lawsuit against Company A's creditor's rights by suing the people's court. The target company may therefore face the risk of not being able to recover its debt.

 

② Note: As the project cited in the case was handled before the implementation of the Civil Code, the relevant laws and regulations in effect at that time shall prevail. The future legal basis should be the Civil Code.

 

(3) Defects in shareholder loan procedures

In the process of due diligence, companies with non-standard corporate governance or financial management are often encountered. When reviewing their financial statements, it is found that there are large amounts of payables, but there are no corresponding written documents such as contracts for verification. After interviews, it is often informed that these payables are shareholder loans or shareholder transactions, but no written agreements have been signed or corresponding internal resolution procedures have been followed.

 

We believe that according to Article 12 of the "Provisions of the Supreme People's Court on Several Issues Concerning the Application of the Company Law of the People's Republic of China (III)", if the target company is unable to supplement the corresponding written agreement and internal resolution documents for shareholder loans or transactions, such funds may be sued by other shareholders and creditors of the company on the grounds of shareholder withdrawal of capital contribution, The financial situation of the target company may be affected as a result.

 

We suggest that for shareholder loans, the target company needs to ensure that the borrowing relationship between the company and shareholders is legal from both physical and procedural aspects. The so-called "legality" should refer to the legality of the loan procedure, loan content, loan purpose, and debt relationship. For example, shareholder loans, provided that they do not violate the company's articles of association, should be approved by all shareholders and legal procedures should be followed. Shareholders should sign a loan agreement with the company and fulfill the borrower's rights and obligations in accordance with the law, repay the principal and interest on time. The amount of shareholder loans should not exceed the amount of their shares, and the borrowing period should not exceed one year. Necessary financial accounting treatment should be carried out for the loans, Shareholders' loans should not engage in behaviors that harm the interests of other shareholders, the company, and creditors.