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2021

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

The content of legal due diligence is closely related to the purpose, mode, and focus of the proposed transaction by the acquiring party. Different types of enterprises have different characteristics, which can become difficulties in due diligence work. However, as the saying goes, every change is inseparable from its root. The conventional investigation content includes the establishment, historical evolution, equity structure, company operation, main assets, debt and debt, taxation, labor and personnel, litigation and arbitration, etc.


After understanding the general steps and main methods of legal due diligence, the next step is to sort out and analyze the main content of legal due diligence one by one.

 

The main content of legal due diligence

 

The content of legal due diligence is closely related to the purpose, mode, and focus of the proposed transaction by the acquiring party. Different types of enterprises have different characteristics, which can become difficulties in due diligence work. However, as the saying goes, every change is inseparable from its root. The conventional investigation content includes the establishment, historical evolution, equity structure, company operation, main assets, debt and debt, taxation, labor and personnel, litigation and arbitration, etc.

 

Company Establishment

 

1. Verification methods and documents

The verification of the establishment of the target company mainly involves reviewing documents, including the relevant shareholder agreements at the time of establishment, approval certificates and documents from the competent department, investment documents, capital verification reports, evaluation reports, and archival documents filed by the market supervision department. The main way to obtain this part of the documents is to request the target company to provide and go to the local market supervision and management department to retrieve complete business records. In addition, for certain enterprises with special establishment methods, relevant establishment background and procedures need to be confirmed through interviews with relevant responsible persons.

 

2. Legal issues to pay attention to

In the merger and acquisition cases handled by the author, there are relatively few issues related to company establishment. For the vast majority of companies, establishment only requires submitting applications, obtaining approvals, and completing registration and filing procedures according to the requirements of the industry and commerce administration department and other competent departments. But we cannot take this part of the content lightly. For the establishment of the company, the following issues need to be paid attention to by the acquiring party and lawyers during the due diligence process.

 

(1) Changes in laws and regulations

For the establishment of a company, the main legal provisions are the Company Law of the People's Republic of China (hereinafter referred to as the "Company Law") and relevant judicial interpretations, as well as the Regulations on the Administration of Company Registration of the People's Republic of China (hereinafter referred to as the "Registration Management Regulations"). When the Company Law was revised in 2013, there was an important adjustment to the establishment of a company by deleting the relevant provisions on the "minimum statutory capital".

 

Based on the above legal modifications, when reviewing the issue of company establishment, attention should be paid to the time of company establishment. If a company was established before the revision of the Company Law in 2013, the registered capital and shareholder contribution issues should be given special attention.

 

(2) Contribution issues

In the establishment of the company, whether the capital contribution is legal and compliant is a key issue that needs to be focused on and reviewed. Unreal investment, withdrawal of investment, false investment, and flaws in investment procedures are common problems.

 

In a real estate merger and acquisition project handled by the author, after reviewing the business records of the target company, we found that the shareholders of the target company contributed at the price of their land use rights. After discovering this issue, we focused on two issues during the review process: firstly, whether the valuation of land use rights for investment has been carried out in accordance with legal procedures such as evaluation; The second is whether there is an encumbrance on the assets used for capital contribution. The first question is that in the business archives of the target company, we have reviewed relevant land valuation reports, capital verification reports, and other documents. After review, we believe that the valuation and investment procedures are legal and compliant. However, for the second issue, in the land registration file retrieved from the local land department, it is shown that before the establishment of the company, a mortgage has been established on the land used for valuation and investment. After analysis, we believe that this physical investment carries the risk of being claimed by the mortgagee, and may even be deemed as a false investment. In this regard, we suggest requesting the target company to release the right burden on the invested assets or make up for the investment in other ways before the project transaction.

 

(3) Establish procedures

The establishment procedures of a company/enterprise include approval and filing for the establishment of special types of companies/enterprises (such as foreign-invested enterprises and Sino foreign joint ventures), as well as legal procedures for the establishment of special procedures (such as mergers/divisions).

 

In a certain merger and acquisition project, we found that the target company was established by the separation of a certain company. When the target company was separated from a certain company and established, it did not fulfill the corresponding creditor announcement procedures in accordance with the law. We believe that the target company has not fulfilled the corresponding procedures for declaring creditors in accordance with Article 175 of the Company Law, and there are flaws in its establishment procedures. If the relevant creditors require the target company to repay its debts in advance or provide guarantees, the financial condition of the target company may be affected as a result.

 

In addition to the above-mentioned issues, there may also be various situations and problems in the establishment of the company, such as the company name, registered capital, capital verification, establishment approval, capital contribution, merger and division, which need to be analyzed specifically in specific projects based on the actual situation of the company. It cannot be generalized or taken lightly.