Introduction and overview
2019 marked the third 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 to analyze sectors or markets which may be “hot” or to perform a “horizon scanning” exercise (although clearly in 2020 COVID-19 (coronavirus) will have an impact on the volume of global M&A and, separately, it is noteworthy how China’s influence has declined in recent years), 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 US, Australian or local influences.
A copy of the full report can be found here: Asia M&A Deal Points Study
Pricing and valuation
It is said that cash is king, and that is certainly true for deal consideration in Asian transactions. Indeed, cash was the sole form of consideration in 86 percent of deals. This may be put down to a cultural preference for hard cash or Asian parties’ preference for simple deal terms. However, another more practical reason may be that, due to certain jurisdictions’ (e.g. mainland China) regulatory hurdles in relation to outbound investment, it is easier, and therefore quicker, for a regulator to understand and approve cash consideration than non-cash consideration, which the regulator would have to value.Despite many deals still having a fixed price hardwired into the SPA at signing, and despite the risks this represents to both buyer and seller in relation to the period up to closing, we are seeing an increased use of completion accounts mechanisms, which now appear in about half of all Asian deals. This still lags somewhat behind more established markets, where usage stands at more than 70 percent of deals, but it nevertheless shows an increase in sophistication and a willingness to embrace more complex concepts from international transactional culture.
The use of the locked box mechanism in around 19 percent of Asian deals trails many developed Western markets, but its adoption is on the rise; particularly in higher value, private equity 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. Over the years, however, we have seen lists of CPs becoming shorter and more precisely drafted, indicating that sellers are taking a tougher stance, more in step with international practice. That said, we still see occasionally – particularly on Chinese deals – a vaguely worded condition precedent about obtaining “all necessary” regulatory approvals or similar. Whilst this may simply be reflective of poor drafting or a lack of sophistication, the parties may have elected to include such a vague provision due to the fact that sometimes regulatory approval processes are not prescribed and are rather opaque so that it is not certain at the outset what specific approvals may ultimately be required.
The variety of legal influences in Asian dealmaking can be demonstrated by the relatively high proportion (31 percent) 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 would likely argue that a buyer should not have to complete a transaction where a warranty is inaccurate at the time. The fact that CPs of this type appear most commonly in Japanese deals indicates that Japanese M&A professionals take their lead from the US.
Similarly, we still occasionally see CPs making completion conditional on a buyer completing due diligence to its satisfaction or arranging its financing. For lawyers from an English law background (less so US), this is most unsatisfactory as it is accepted practice that these matters should be concluded before an SPA is entered into. However, culturally clients in Asia are often very eager to sign an agreement – even a highly conditional one – despite there being a substantial risk that it may need to be renegotiated if circumstances change or the conditions are not satisfied.
Warranties and limitations on liability
Asian SPAs often contain a shorter and less detailed warranty schedule than international standards, 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 – seller’s limitations on liability are less extensive than normal or even non-existent. Nevertheless, we have noticed a trend over time whereby sellers are including increasingly detailed and robust limitations on liability, consistent with international practice.
Anti-bribery and corruption warranties should be considered the norm on Asian deals. Indeed, despite certain Asian jurisdictions showing favorably in Transparency International’s Corruption Perceptions Index, we would recommend that purchasers seek “ABC” warranty protection on all Asian deals, regardless of jurisdiction.
There can be considerable variety in the standard to which management accounts warranties in Asian deals are given, with “true and fair view” (the audit standard) commonly seen. It seems unlikely that this can be correct.
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 (we saw this warranty in 47 percent of deals) and warranties in relation to the completeness and adequacy of the information provided (we saw this in 36 percent of deals). Indeed, so far as this type of warranty is concerned, Asia might be seen as a halfway house between Australia (where these warranties are common, featuring in around 70 percent of deals) and England, where sellers typically resist such warranties. Similarly, there is a 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. Japan leads the way among Asian jurisdictions in the adoption of indemnity backing for warranties, again indicating that Japan takes its lead from the US where M&A practice is concerned.
Viewed as a whole, the monetary caps on liability and time limits for bringing claims are quite consistent with international standards: 100 percent of the purchase price and 3 years for title warranties, 30 percent of the purchase price and 18 months for general warranties, and 30 percent of the purchase price and 3-7 years for tax warranties. However, analyzing median or mode numbers fails to show the considerable disparity between caps and time limits across Asian deals, some of which fall well outside international norms. Also notable is the number of deals (around 20-30 percent) which have no financial cap on liability or time limit for bringing claims whatsoever, leaving the seller with unlimited exposure save perhaps for statutory limitations, if available. This situation arises mainly on PRC deals. The story is the same with regard to de minimis and basket thresholds, which vary greatly in reality (and often do not exist at all), although when the mode number is taken, they track the internationally accepted rules of thumb of 0.1 percent of purchase price for de minimis and 1 percent of purchase price for the basket, which in over 80 percent of cases is a tipping basket enabling a buyer to claim “from the ground up” provided the basket threshold is satisfied.
Reliance on general disclosures (in particular, public searches) is not so prevalent in Asian deals (only 44 percent of deals). One reason for this is that in certain jurisdictions, public searches are not terribly reliable or up-to-date. Surprisingly however, even in developed jurisdictions such as Hong Kong, where public searches are available online and updated regularly, sellers are failing to push for simple general disclosures to reduce their exposure. Where disclosure is made, the concept of “fair disclosure”, based on traditional English law principles, is typically applied and defined in the SPA.
Deal protection mechanisms
Deposits are relatively seldom seen on Asian deals, although they are commonly used where a real estate holding company is sold, as the parties tend to replicate the periodic payments that would occur if the asset alone were acquired.
Interest in the use of escrows is growing. Since most international law firms do not offer this service in Asia, banks or corporate service providers are required. However, the time and effort required to satisfy these service providers’ KYC requirements, as well as the substantial cost of the escrow itself, often mean that the escrow idea is ultimately shelved. Indeed, we only see escrow used in around 14 percent of Asian deals. Simple purchase price retention mechanisms are seen even less frequently.
The choice of dispute resolution forum is extremely important in Asian transactions. 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 being at the mercy of whichever non-specialist judge is allocated; (ii) judges in some Asian jurisdictions are not as independent or impartial as they should be; (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 cannot be said for court judgements. The Singapore International Arbitration Centre and Hong Kong International Arbitration Centre are by far the most established and preferred arbitration centers in the region and both have excellent reputations.