Have You Conducted Due Diligence nvestigations?

Many Chinese enterprises don’t perform comprehensive and full due diligence investigations prior to their investments and acquisitions overseas. Though some do go through this process， their investigations are mostly incomprehensive and even formalistic. The question is， do due diligence investigations really count that much?

Jia Dian’an， a lawyer at the Baker McKenzie Law Firm， told reporters that an often mentioned case about due diligence investigation is TCL’s cross-border merger and acquisition failure. Li Dongsheng， CEO of TCL， regretted very much not having performed a due diligence investigation before the MA transaction. He saved the cost of more than 20 million in this process， but this brought bad consequences to his company. Businesses in any fields should conduct a proper and comprehensive due diligence investigation on the potential target， including such areas as the financial， legal， tax， environment and market situation， and its intellectual property ownership.

Shiwei， from the DLA Piper Law Firm， thinks that before an asset acquisition or a share acquisition， the acquirer should be clear about such questions as whether the target company has a single-asset portfolio or a multi-asset portfolio， how many brands the company has and whether these brands are profit-making， and whether it is necessary to keep its employees. According to the statistics， some acquisitions are conducted through the purchase of the shares of the target company while some are through the obtaining of all the assets of its target. These two acquisition methods both have their pros and cons and due diligence investigation is an effective way to decide which method is better.

He Yuping， a lawyer from the Broad Bright Law Firm， also stressed the importance of due diligence investigation for Chinese companies’ international mergers and acquisitions. He said， there are some clients who may require the acquiring company to simplify or even remove the investigation process and sign the contract directly. The investigation can be conducted after the deal is concealed. In such cases， the acquiring company will take considerable risks. Therefore， a well-established withdrawal mechanism must be in place to ensure that the acquirer can withdraw from the acquisition when risks occur. This is a good way to save time， but a proper due diligence can do a greater good.

How to conduct a due diligence investigation? According to He， the first step is to be well aware of the potential risks. The acquirer should obtain a full knowledge of the target company as the basis for business evaluation. In this process， we may find that the property ownership of the target company is unclear， or the operations of the company are adverse to the environment. For example， the projects the company is undertaking in Kazakhstan may be an environmental hazard. In such cases， we have to consider whether we still offer the same price to acquire the company. When we are confronting with such problems， a proper due diligence investigation is of great help for us to make acquisition decisions.

Second， through a due diligence investigation， we can draft more effective and workable declarations and warranties in contracts. Detailed and well-targeted declaration and warranty items in a contract specify the rights and responsibilities of both parties and these items are always based on a clear understanding of the target company. Legally， declarations and warranties with general and ambiguous items are basically meaningless and inoperable in practice. More importantly， if these items are the only reference， once these items are fraudulent， we can do nothing but take this case to court.

As to risk taking， He said in most cases， risks are taken by the two parties according to the description in the declaration and warranty items. “In the process of the project， the other party may play some tricks. When the due diligence investigation is conducted， the other party only provides a small portion of the material. The majority of the material and documents will usually be provided to you right before the transaction is entered into. The purpose is to leave limited time to read through these materials so that some potential risks may be ignored. Take the petroleum and natural gas exploitation project in Middle Asian for instance. We were given a large pile of materials on the day when the contract was signed. Among these materials， there was a late-taxpayment penalty record that could hardly be noticed. This left us to carry the huge risks. Therefore， it is necessary for us to ask for sufficient time to check and verify the materials disclosed and provided by the other party and be cautious about their tricks.”

Any detail in the investigation should be paid due attention， He emphasized. It is of critical importance to decide the specific precondition items. No one would sign a contract which includes dozens of precondition items. Therefore， we must be clear about what problems can be solved in due diligence investigation， what problems solved during negotiations， what problems must be tackled before the close of the transaction while what problems may be left until the transaction is entered into. We also have to make accurate judgment about those essential problems and come up with effective solutions.

According to Jia Dian’an， the acquisition of listed companies is becoming a development trend. Jia has recently been engaged in several such cases. He said， “Chinese enterprises are usually confronted with special challenges in the acquisition of listed companies because they are unfamiliar with the rules of the listed companies’game. Unlike the acquisition of private companies which can be carried out by offering a high price， the acquisition of listed companies usually requires a due diligence investigation. A listed company often discloses its information in the annual and quarterly reports in a relatively open and transparent manner. However， little information can be gained through a due diligence investigation. We can only do the investigation based on those disclosed materials.”

Jia also particularly pointed out that in some cases， we may get some relevant documents and materials from the top executives of the company. According to the laws of some countries， if the acquirer gets to know some facts in the investigation process that may possibly affect the share price of the company， it should disclose these facts as an acquired company， so as to avoid insider dealing. Therefore， we should be extremely cautious when acquiring a listed company. When doing the due diligence investigation， we have to know what questions could be asked and what materials can be asked for. Some senior executives of small and medium-sized listed companies don’t have such experience. They may provide all the materials to you， just like the private companies do in acquisition.