What is legal due diligence? There are numerous forms of due diligence, for instance financial due diligence carried out by accountants to examine a company\’s profits, debts, solvency, financial reporting and tax status. There is also corporate due diligence centering on a company\’s incorporation and board. Investigatory due diligence, that is looking at things such as the personal links of management, is yet another area to take into account specifically in the framework of China. Legal due diligence however targets regardless of whether a company is complying with local and international laws and how the compliance or non-compliance will have an effect on your investment. Carrying out legal due diligence will include looking into a company\’s possession of property both physical and intellectual, contracts along with other agreements, litigation that it has performed or that has been went after against it, as well as overlapping with other types of due diligence in the areas of business licencing, finances, tax, and management. Legal due diligence if properly carried out will also show what kind of company you are working with. Are they highly litigious? Have they been punished by authorities? Or have they outsourced all of their functions and don\’t actually develop anything?
Why carry out legal due diligence? If you are thinking about a transfer to China, be it getting into a cross-border joint venture, merger or acquisition, joining local management, or new international franchisees, partners or investors, it is recommended to know as much as possible before investing. Not taking part in thorough investigation can result in awful surprises on the track. Carrying out due diligence is more than just a hunt for whether or not your preferred company is presently complying with China\’s legal requirements. If done properly, legal due diligence will put your investment into industry context and demonstrate just what kind of business you are dealing with. By employing professionals to perform legal due diligence, you can in turn avoid unwanted risks and confidently take advantage of the rapidly expanding market that is China.
How do you begin it? What areas should you pay attention to? The entire process of legal due diligence is simply a process of gathering information and being able to understand what it tells you and how it fits together. That having been said, understanding what to look for, which things to ask, and where to search are often less than straightforward, especially in China. One thing to do when executing legal due diligence is to talk to a professional, in most cases an expert law firm, and explain to them what you are planning to do, for example are you making an investment in a joint venture, buying a company outright, or establishing a franchise. This will help a firm understand what they need to look for and which laws must be complied with. Then the process will generally move to requesting documents, such as articles of association and business licences, from the company itself as well as China\’s regulatory bodies and courts.
Go Local: Undertaking legal due diligence in China may have the same basic goal as in any other country, that is to understand and assess the investment risk you are about to take, nevertheless the methods differ. Most of the Western world has comparatively centralised and open documentation of the legal particulars of registered companies, in China however you\’ll find much is still done at a provincial level. Therefore the next essential step is to visit the province, and site of the company you are investing in. It may sound ridiculous but an important part of legal due diligence is verifying that the company you plan to contract with actually exists; some western investors have been caught out in the past purchasing non-existent companies. This will also give you a chance to see how the business operates on the ground and speak to management and employees. As stated you will also need to visit local authorities including the local Estate Bureau to verify the land rights you are being sold, and the local Administration of Industry and Commerce (AIC) to evaluate the company\’s incorporation documents and business licence. When it comes to legal due diligence a trip to the local court will also be essential. Important Areas: Legal due diligence will cover many of the elements of financial and corporate due diligence as well as some discrete sections of its own such as intellectual property and the search for past, present, and even pending and future litigation. The following are the main areas to take into account when undertaking legal due diligence.
Real Property: In China a company will have either \’granted\’, being full control, or \’allocated\’, the right to use the land for a particular time and purpose, land rights. These land rights obviously have different values, thus verifying precisely what type of land rights you are getting as part of your deal is vital for checking that the price has not been inflated. It is also essential to determine whether there are any restrictions on a company\’s land use. This can be achieved at the local Estate Bureau by looking for the company\’s land possession certificate/s. 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 move can occur. Also with regards to real property, check the environmental regulations for the region in which the business is located.
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