As this month marks the tenth anniversary of my career in Asia, I thought I would look back again on some of the interesting transactions from earlier in my time in Vietnam. In particular, I am thinking of an acquisition on which I worked that involved a rushed tax deadline, two parties who claimed they knew each other well, and an investor with a huge risk appetite.
The foreign investor had worked with the local target for some time, apparently long enough to build up a good relationship. They had done business deals together and imported restricted goods that required major dealings with the regulatory authorities. They had built up a trust that gave the foreign investor a rosy picture of the management of the target.
Now, before I move on, I want to state a piece of advice that I heard recently that originated with an investor who has worked in Indochina for decades. In essence, when looking to acquire or invest in a project in Vietnam, you do not worry about the sector, you worry about the management. If the management is with it, and enthused, and capable, then that’s the indicator you use in determining whether to advance with the investment.
That in mind, I’ll continue. The foreign investor, a European company, was interested in the target company because it allowed the foreign company a share of a restricted business sector, one that wasn’t much regulated yet, but that was limited by Vietnam’s WTO accession. So the interest existed. The foreign company would benefit from a successful acquisition in import, manufacturing, and market access. It was a no-brainer deal for the foreign company, but it also benefited the target because of the increased capital the acquisition would bring.
So they got together and developed a term sheet. That’s when they came to us and when they stated something that was very much a problem. There was a new tax law coming into effect in the very near future, far too soon to complete a full M&A deal beforehand, and they wanted to close the deal before that deadline so they could avoid thousands in taxes.
Great. You can pay more for your legal counsel to work around the clock, or you can buckle down and agree to pay the taxes, at least if you want a proper transaction to occur.
This odd couple, the foreign investor and the target, decided to take a different route. Instead of doing something reasonable, they decided to skip the due diligence in favor of a timely closing. I shouldn’t say skip. They postponed the due diligence. And this fell on us as lawyers. We had to draft documents that allowed for the due diligence to occur after closing, and should it result in negative feedback, include a clause which allowed that foreign investor to escape the transaction.
We very much objected to this state of affairs. Regardless of our arguments, the odd couple insisted that they continue with the acquisition and that they do so in a rapid way. They cited the trust they had built up over the last couple of years, the relationship the two CEOs maintained, the fact that they had talked about the transaction and knew what to expect from the due diligence.
And yet they proceeded to exchange millions of dollars without the security of actual investigation in order to save a haircut’s worth of money on taxes.
Before I rant, I want to explain that as far as I know the acquisition was a success and the two companies remained in their cozy relationship. I don’t know if it lasted, though, for sure as this was ten years ago, but I do remember reading a newspaper article that suggested they may not have been so cozy after the passage of some time.
Now to the moral of the lesson.
Do not use trust in a relationship to justify circumventing legal and financial precautions. This is simply something you don’t do. Yes, if you talk to most people with experience in East Asia they’ll tell you that the most important thing is the relationship, that negotiations are fluid, that prices can fluctuate but so long as the relationship is solid, then things will be okay.
This is not an acceptable reason to skip a due diligence. You can have all the trust in management of the target, but you can’t risk your investment without checking the documents. Your relationship with the CEO may extend to his testimony of a perfect paper trail, the proper financials, the exact procedure for incorporation and corporate governance, but in most cases, the CEO is not an experienced corporate lawyer and accountant. He may think he’s right, but in reality, he probably doesn’t know. You can’t trust his representations without backup, and that means fulfilling the formalities of the contract, of the proper procedure, of the due diligence.
Furthermore, in the above example, the due diligence wasn’t skipped entirely, but it was postponed until after closing. This may fly in some jurisdictions, but not in Indochina. In these countries the courts are still fledgling. They are still learning how to interpret the law. These are Civil Law systems without a large base of jurisprudence and academic analysis upon which to draw. The courts don’t do innovation. And trying to close and then perform a due diligence is certainly an innovation.
Without a court capable of interpreting a contract according to the demands of the parties, especially when that contract is in opposition to the common practice of M&A and the legal definitions provided by the National Assembly, then enforcement of such a deal would be practically impossible. That means that, should there be a problem with the due diligence and the target refuses to give back the money, the foreign investor is left with a millions of dollars loss and a handful of stock that is worthless. Not only can’t he retrieve his investment, but once he realizes this, he no longer has a good relationship with the target’s CEO and cannot enforce the original contract to perform the acquisition.
In other words, don’t do what this odd couple did.