Investors seeking M&As could end with legal entanglements at a time when the country is in the process of making its laws consistent.
Vietnam’s merger and acquisition (M&A) market has seen significant growth over the past decade with a total of 4,353 deals valued at $48.8 billion done.
Last year there was the biggest M&A deal ever when Thaibev Group bought 53.59 percent of the country’s largest brewery Sabeco through its subsidiary.
This interest is expected to spread to other booming sectors like energy and infrastructure, education, pharmaceuticals, and telecoms in the near future aided by the constant efforts by the government to ease the restrictions on foreign investment in several sectors.
In practice, M&A transactions involve guidance from consultants with various kinds of expertise until the deal is closed. The performance of legal due diligence (DD) in conjunction with financial and business DD is the first step in a deal as a pre-contractual investigation before proceeding with any further negotiations between the relevant parties.
In M&A transactions, legal DD serves to collate information and identify legal risks or liabilities and other relevant issues associated with the target company that could arise during the course of the transaction.
The performance of legal DD in Vietnam is often encumbered by several issues unfolding during the deal process due to companies’ lack of organization and/or complexities in the laws.
Given that relevant laws and regulations are sometimes inconsistent, one may be unable to figure out the specific issue or how to handle it for closing the deal.
Certain legal procedures and requirements were neglected or not dealt with care by Vietnamese enterprises during their foregoing operation, causing difficulties to the transacting parties and consultants during the legal DD as to how to fix them.
Charter capital and corporate governance
Under the Law on Enterprises, the charter (or Articles of Association) of a company is one of the most critical corporate documents but is usually not well drafted to reflect the up-to-date legal status of the company.
This is because it is not mandatory to register the charter with competent authorities following an amendment or supplementation save for certain special cases (like increase in charter capital, conversion of company or charter of credit institutions, etc.). Vietnamese companies thus often fail to update their charter regularly since they do not realize the importance of updating.
Together with the charter, the joint venture agreement (JVA) or shareholders’ agreement (SHA) between the parties mainly sets out the organization and management of the target company.
In practice, the JVA and SHA model is not applied to all companies but strikes in for the foreign-invested companies where the interests of the foreign investors are duly protected.
The stated documents must be read and scrutinized with diligence since the investor may assume unfavorable terms and conditions which could materially affect its rights and benefits upon acquiring stakes in the company.
Another customary practice by domestic companies is their registration of numerous business lines at the time of incorporation, which permits them to freely do business in many sectors.
However, this may pose the risk of rendering the company less attractive to foreign investors since, by law, some areas of business have restrictions on foreign investment (i.e. limits on foreign ownership, stringent business conditions for foreign-invested companies).
Consequently, the target company is required to excise unexpected or undesirable lines from their scope of business before the foreign investor buys a stake.
The charter capital, especially in purely domestic companies, is often not contributed in full by the owners or within the statutory time period (i.e. within 90 days from the establishment date).
Upon the lapse of the stated period, the company is required to register a reduced charter capital to reflect the actually paid-in amount. The legal DD is responsible for identifying this non-compliance, which sometimes affects the intention of the buyer since the additional step required may prolong the deal closing and the charter capital of the company could decrease to a figure not originally envisioned.
Joint stock companies’ documents (like shareholder register, share certificate and share transfer agreement of the holders) are usually not well-maintained or up-to-date to reflect the current shareholding structure of the company or sometimes not consistent with each other.
In these cases, it would be very hard to trace the old or current shareholding structure of the target. At some local companies, shareholders contribute their capital to the company but borrow it back from the company right afterwards, and when the M&A transaction occurs these companies are not able to make the required repayments in time, which results in delaying the whole transaction.
For working capital, Vietnamese enterprises often borrow from banks against the mortgage of a portion of or all their assets. In conducting a legal DD, only certain assets which require a mortgage/pledge to be registered with competent authorities is available to be verified (i.e. Department of Natural Resources and Environment with regard to land and assets attached to the land).
Vietnamese laws do not mandate that movable assets must be registered to be effective (save for aircrafts, ships) though the payment priority could be registered with the National Registration Agency for Secured Transactions to ensure the ranking of the secured party when the assets are liquidated to repay liabilities. Thus, it may not be easy to find if any of the movable assets of the target has been taken as security.
Intellectual property rights (IPRs) remain an asset that does not receive adequate attention from Vietnamese companies.
Certain IPR infringements are commonly seen during the course of DD inspection, including the use of software without valid permits or licenses and the use of illegally printed books and documents. In extreme cases, some Vietnamese companies do not even register their trademarks though they are their sole valuable asset with the National Office of Industry Property of Vietnam or use trademarks of others without any authorization from the legal owner. This lack of awareness could lead to unwanted IPR-related disputes which adversely impact the target company’s reputation.
Land and property attached to land
The land laws have kept unchanged the provision that offshore entities cannot be directly allocated or leased land by the state. Alternatively, they must have a presence in Vietnam through the formation of a wholly-owned or joint-venture company to lease land from the government (or from a local landlord who has the right to sub-lease the land) for its investment projects.
In practice, land-related procedures (i.e. land recovery, land clearance, compensation, settlement of residents’ claims), especially for projects subject to the in-principle approval are time-consuming and costly.
Thus, having sufficient documents related to relevant procedures (i.e. minutes, decisions or approvals from competent authorities) has been a challenge for most companies, and escalates issues during the determination of the proper title of a land during the legal DD process.
According to the Land Law, land rents can be paid annually or upfront in one shot. There are limitations on the rights of land users in respect of lands with annual payments as opposed to one-off payments: for instance, the user of land with annual payments cannot transfer, mortgage, sublet or give the land to another entity.
It is routine in Vietnam for companies to lease/ sub-lease part of their land or office to other parties despite the fact they are not licensed to do so. Carrying out real estate business is one of the conditional business lines in Vietnam which require a company to satisfy certain legal requirement.
Some target companies are not aware of the need to have a real estate business license when they lease/sub-lease their land or office to others since they consider such leasing merely an additional source of income. It is however uneasy to early terminate the lease/sub-lease for the M&A closing.
In the case of sale of investment projects using land, the licensing authority shall require the project to satisfy a number of conditions, including, inter alia (i) the land rental must be paid in one shot and (ii) the implementation schedule must be compliant with what is registered in the investment registration certificate issued to the investors. Failure to satisfy either condition means the licensing authority could reject an application to record a new investor for the project.
The issues relating to employment are rather complicated since they are governed by various legal instruments, notably the Labour Code and the others including the Law on Labour Hygiene and Safety, Law on Trade Union, Law on Social Insurance, Law on Unemployment Insurance, and Law on Employment.
Most of the time, the target company may not be able to strictly comply with the relevant laws in every regard (i.e. contribution of compulsory insurance or registration of internal working rules). Especially, the unilateral termination of a labor contract with an employee could easily be a violation of the Labour Code.
Under the law, an employer may only unilaterally terminate a labor contract or dismiss an employee in restricted cases in accordance with the Labour Code. If the illegally terminated or dismissed employee files his/her counterclaim against the decision of the target company, it may trigger an investigation by the labor inspector or, in the worst case, the issue could be taken to a higher dispute settlement body (i.e. the competent local courts).
From practical experience, this latent dispute could be hard to detect if the target intentionally withholds relevant information.
The Law on Enterprises stipulates that transactions with related parties must be approved by the members council of a limited liability company or by the annual general meeting of shareholders (or board of directors, as applicable) of a joint stock company.
However, many Vietnamese companies do not pay attention to this requirement since they are not aware of the fact that without the stated approvals the executed contracts shall be deemed invalid.
A commonly adopted solution to overcome this non-compliance issue is signing backdated approvals. However, from the legal perspective, the validity of such approvals is highly questionable.
Contracts executed with change-of-control or cross-default clauses should also be dealt with care since they may have a great impact on the operation of the target company on acquisition by the investor. These types of clauses normally appear in contracts with substantial value or significant importance.
While the change-of-control clause requires the target company to obtain approval from the counterpart upon any changes to its ownership, assets or projects, the cross-default provisions will trigger the termination of all associated contracts (i.e. loan agreements and security agreements). Prior approval must be sought from all related parties to contracts with a change-of-control clause as a condition precedent.
It is usual practice for Vietnamese companies to assign more than one person with the power to sign contracts on its behalf. This is a totally permissible and widely accepted practice not only in Vietnam but also in other jurisdictions. However as a matter of law, such execution by others, save for the legal representative, must be specifically authorized in writing to ensure the validity of a contract. In case of failure to obtain the said authorization, any contracts executed will be at risk of being declared null and void when challenged in front of competent courts or arbitration.
This seems to be a serious issue yet can be found in most legal DD inspections owing to negligence on the part of target companies. How to assess these potentially invalid contracts and how to continue these contracts after a successful M&A deal is a question for the buyer.
Vietnamese companies often provide unsecured loans to other local companies or individuals (particularly to their members). However, under the law, only credit institutions (i.e. the banks or finance companies) may extend credit secured by assets to other entities.
The provision of such unsecured loans by non-banking entities could entail fines under the law, but in practice rarely are entities giving loans of such nature sanctioned by competent authorities. The authorities could take a lenient view that so long as the provision of unsecured loans is not a regular business activity of the lender it could be disregarded on a case by case basis.
Speaking of loans taken by target companies, credit institutions will require, in addition to collateral, their prior approval for any change in ownership of the borrower through an M&A transaction. In fact, Vietnamese banks are reluctant to grant such permission to the borrower though it is a common practice globally. Thus, approval from banks from which the target company has outstanding loans should always be sought as a condition in the final agreement.
Environment and fire prevention and safety
Environmental protection has attracted more attention from authorities in recent years than before, especially after the occurrence of several environmental disasters. The laws strictly require projects at risk of causing adverse environmental impacts to do an environmental impact assessment report (EIAR) and submit it to relevant authorities for approval. The target is further required to complete the investment project within 24 months from the approval date of the EIAR, failing which it will have to do the EIAR afresh.
But the fact is that investment projects in Vietnam do not properly conform to the registered implementation schedule, which in turn could result in the invalidation of the EIAR, without which the final check and acceptance of construction works could be rejected by competent authorities when applied for, say, the ownership certificate of the construction works.
In recent years the requirement for doing DD with respect to landmine and contamination issues on lands belonging to the target company has been raised, causing problems for the target company to satisfy clearance of such issues.
On the other hand, fire prevention and extinguishment has gradually become an important issue at Vietnamese companies. The recent fire at Carina Plaza apartment and other fatal incidents have made fire safety important precautions to the public and, especially, authorities.
Specifically, subject to their scale and operations, target companies must satisfy certain regulatory requirements such as having approval for their fire prevention and safety design, acceptance of the fire prevention and safety system by the police and purchase of fire and explosion insurance.
However, many target companies still tend to ignore part or all of these requirements or attempt to satisfy the minimum conditions possible (like using outdated or malfunctioning system).
Anti – trust
Anti-trust has always been a remote and improbable issue for Vietnamese companies since they barely have any experience in the field and their business is usually relatively small. The matter in question has only arisen in recent years with the emergence in the market of M&A deals between large enterprises.
Though the legal DD may not be able to firmly explain whether the prospective M&A deal could fall into restricted cases under the laws or not, it could point out a likelihood of its occurrence for the parties’ consideration. Ignoring this issue could cause various problems for the buyer after the deal is concluded.
Subject to the essence and complexity of the transaction, there could be more (or less) categories focusing on other material aspects of the target company (e.g. products of a pharmaceutical company).
A legal DD serves not only as a tool to identify pending legal issues at target companies but also gives the investor remedial measures to overcome risks and achieve its ultimate goals.
With the relentless growth of the M&A market, Vietnam is a promising destination for foreign investment with the government making progress in achieving a fair and level playing ground for foreign investors.
*Dang Duong Anh is managing partner and Luu Quang Anh an associate with the Vietnam International Law Firm (VILAF)