Introduction and Overview
The past year has been a difficult time for mergers and acquisitions across the Asia region. Obviously, the impact of COVID-19 (coronavirus) has been profound, with many deals pulled, delayed or put on hold indefinitely as players have struggled to shore up their own positions, gauge the market for valuation purposes or figure out innovative ways of conducting due diligence, management meetings and negotiations. However, it is important to note that even before the outbreak of coronavirus, the outlook was looking far from certain, in particular due to the trade war between the United States and China and the civil unrest in Hong Kong. As a result, we have seen fewer deals being done, generally at a much slower pace, and the market has moved further in favour of buyers (particularly those with immediate access to cash), evidenced by certain more cautious, buyer-friendly deal terms.
2020 marked the fourth year in which Norton Rose Fulbright’s Hong Kong office compiled its Asia M&A deal trends study. The purpose of the study is not so much to analyse sectors or markets which may be “hot” or to perform a “horizon scanning” exercise, but to consider individual clauses (or groups of clauses) in sale and purchase agreements (SPAs), how they vary from jurisdiction to jurisdiction, and how they are evolving through time.
The study demonstrates what a melting pot of cultures and legal practices Asia is – with the traditional influence of English law principles in certain key jurisdictions sometimes being diluted, and even usurped, by U.S., Australian or local influences.
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Pricing and Valuation
Cash is king when it comes to deal consideration in Asian transactions. Indeed, cash was the sole form of consideration in 91% of deals. This is partly due to a cultural preference for hard cash and simple deal terms. However, due to certain jurisdictions’ regulatory hurdles in relation to outbound investment, it is also easier, and therefore quicker, for a regulator to assess, value and approve cash consideration than non-cash consideration.
We are seeing an increased use of completion accounts mechanisms, which now appear in about half of all Asian deals. This still lags some way behind other international markets, but it nevertheless demonstrates an increased willingness to adopt additional complexity from international transaction culture. Earn-out mechanisms are also on the rise, appearing in 26% of deals. The increased popularity of both completion accounts and earn-out mechanisms is indicative of the more cautious, buyer-friendly environment.
The use of locked box mechanisms in around 18% of Asian deals trails many developed Western markets, but its adoption is on the rise; particularly in sell-side auction processes.
Traditionally, the list of conditions precedent (CPs) in Asian deals has been longer than the standard short, legal and regulatory focused, lists of CPs in more developed markets. Since each CP is potentially a walk right, this demonstrates a willingness among Asian parties to accept more execution risk. Recently, we have seen lists of CPs becoming shorter and more precisely drafted, indicating that sellers are taking a tougher stance, and more aligned with international practice. Despite the more uncertain, buyer-friendly environment, we have not seen a material increase in the number of CPs, although there has been considerable interest in the use of material adverse change (MAC) conditions. However, questions remain in relation to their enforceability generally.
The variety of legal influences in Asian dealmaking can be demonstrated by the relatively high proportion (35%) of deals which include a condition precedent that there is no (or no material) breach of warranty pre-closing. An English lawyer would typically resist such a provision, arguing that any loss should be recovered post-closing through a claim for damages, whereas a lawyer from a US background (often the case in Japan) would likely argue that a buyer should not have to complete a transaction where a warranty is inaccurate at the time.
Warranties and Limitations on Liability
Asian SPAs often contain a shorter and less detailed warranty schedule than international equivalents, focusing on fundamental warranties only. This often leads to a shorter disclosure letter, or even no disclosure letter at all. It is also striking how often – particularly on Chinese deals – sellers’ limitations on liability are less extensive than customary or even non-existent.
Despite certain Asian jurisdictions showing favourably in Transparency International’s Corruption Perceptions Index, we would recommend that buyers seek anti-bribery and corruption warranty protection on all Asian deals, regardless of jurisdiction.
Returning to the theme of Asia being a melting pot of legal influences, it is common to see warranties in relation to the accuracy of the information provided to the buyer and warranties in relation to the completeness and adequacy of the information provided. Here, Asia might be seen as a halfway house between Australia (where these warranties are common) and England, where sellers typically resist such warranties. Similarly, there is a fairly even split between warranties given on an indemnity basis (the US model) and warranties where contractual damages based on loss (the English law model) are the prescribed remedy.
Viewed as a whole, the monetary caps on liability and time limits for bringing claims are quite consistent with international standards: 100% of the purchase price and 3 years for title warranties, with approximately 25% of the purchase price and 18 months for general warranties, and 35% of the purchase price and 5 years for tax warranties. Notable, however, is the number of deals (around 20%) which have no financial cap on liability or time limit for bringing claims whatsoever, leaving the seller with unlimited exposure, save perhaps for any statutory limitations. This situation arises mainly on PRC deals. The story is the same with regard to de minimis and aggregate or basket thresholds, which track the internationally accepted rules of thumb of 0.1% of purchase price for de minimis and 1% of purchase price for the basket, although they are often completely absent.
Reliance on general disclosures (in particular, public searches) is not so prevalent in Asian deals (only 48% of deals would feature these). One reason for this is that in certain jurisdictions public searches are not reliable or up-to-date or available online or from a central database. Where disclosure is made, the concept of “fair disclosure”, based on traditional English law principles, is typically applied and defined in the SPA.
The popularity of warranty and indemnity insurance continues to grow steadily in Asia, particularly in the context of private equity driven auction sales. Premiums are generally slightly higher than in Europe (but still less than the United States) but are coming down due to increased competition and underwriters’ greater familiarity with risks in different emerging markets.
Deal protection mechanisms
Interest in the use of escrows is growing, fueled by the current cautious, buyer-friendly M&A environment. Since most international law firms do not offer this service in Asia, banks or corporate service providers are required. However, given the time, effort and expense required to set up an escrow, often the idea is ultimately shelved. Indeed, we only see escrow used in around 10% of Asian deals. Simple purchase price retention mechanisms are even less common.
For cross border deals, it is generally advisable to choose arbitration over court litigation because: (i) the parties can choose a specialist to decide their case rather than risk a non-specialist judge being allocated; (ii) arbitrators may be perceived to be more independent and impartial; (iii) arbitration proceedings are confidential, whereas court proceedings are generally public, and (iv) since the vast majority of countries in Asia are signatories to the New York Convention, arbitral awards are enforceable in most other Asian jurisdictions, which is not the case for all court judgements. The Singapore International Arbitration Centre and Hong Kong International Arbitration Centre are by far the most established and preferred arbitration centres in the region and both have excellent reputations.