Read more Legal Due Diligence in China articles below >>
If you are considering a move into China, be it entering into a cross-border joint venture, merger or acquisition, engaging local management, or new international franchisees, partners or investors, it is important to know as much as possible before investing. Not partaking in thorough investigation can lead to nasty surprises down the track.
The requirements for due diligence in China are not that dissimilar to the Australian requirements. Obviously for foreign investors there is the issue of the language barrier, and unfamiliarity with specific government processes or the proverbial ‘red tape’. However the aim of due diligence in any country is to understand exactly what it is you are investing in, make sure that all local laws are being complied with, and know how to structure a deal to make sure your investment is maximised.
The most authentic way to verify businesses in China is to undertake a site visit. It is important to have people on the ground who understand, obviously the local language, but also the business culture of China. It should also be noted that much administration in China is governed on a provincial level, thus a visit to the provincial authorities is worth your while. A place to start is the local Administration of Industry and Commerce (AIC). Most AIC websites offer a company search for a fee which should at least show some information about a company’s incorporation, location, contact people, and legal representatives.
There are many areas to consider when undertaking legal due diligence, listed below are some of the major areas in which to pursue investigations.
Assets
A site visit is probably the best way to verify that a factory, or other business, exists where it is said to. What should also be obtained is documentation showing the ownership and current value of a company’s assets. Valuations, like many other things in China, may vary depending on whether or not the valuer is a friend of the company. Thus it is advisable to have an independent valuation of the company’s assets undertaken. Most of the large real estate firms in China have a valuations department.
Business Licensing
It is imperative to check that a business has all the licenses required to carry out its current operations, and to check that the scope of these licenses will cover any new operations that might be undertaken along with foreign investment. Business licenses in China need regular renewal so the expiry date of licenses should also be checked. Finally the name on the license should be that of the person you are dealing with, if it not find out why.
Also check for a company’s articles of association, something an AIC inquiry should reveal.
Finances
While financial reporting is not as transparent in China as it is in Australia the financial statements of a company can usually be obtained through the local AIC if they are not forthcoming from the company itself.
Land Rights
China has two types of land use rights, Granted and Allocated. Granted rights are full ownership of land, while Allocated rights are the right to use the land or a long term lease. These land rights obviously have different values, thus verifying exactly what type of land rights you are getting as part of your deal is important for checking that the price has not been inflated. it is also important to find out if there are any restrictions on a company’s land use.
The local land bureau is the source for verifying land rights. It should also be noted that in some rural areas land rights are held by a ‘village collective’, and the head of the collective needs to sign their approval before any transfer can take place.
Environmental Regulations
Check the environmental regulations for the area in which the business is located. It may also be wise to undertake an environmental audit of the business’s operations. It should be noted that much of the industrial land in China is polluted so checking the extent to which future clean-up of a site will be necessary may allow you to negotiate a lower land value.
Intellectual Property
This includes trademarks, patents, copyright, and technology licensing. Also check that the company is not infringing anyone else’s intellectual property rights.
Management
What is meant by ‘management’ is an investigation of the directors and other key office holders of any company you are intending to invest in or purchase. Check for records of their appointment. In China, as the rule of law is not known to predominate, it is more crucial than in the West to know the status of management’s relationships with other organisations.
Tax
You should be looking at annual audits and tax returns. It is also important to consider the implications of stamp duty, import and export duties, any tax incentives that are available in the relevant industry, and the tariff rebate program.
Employees
Check that employee information is known and is correct. Look at copies of current employee contracts.
Debts and other liabilities
Obviously it is important in terms of risk management to know what debts and liabilities a Chinese company has both short and long term. This includes any pending litigation. While it is often difficult to anticipate future litigation a finding that there isn’t any may provide leverage for guarantees to be included in any agreement. Also look at any material ongoing contracts a business has, be they with employees, suppliers, or anyone else.
Insurance
Just like in any other country insurance documents should be checked.
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