What is a lawyer's due diligence work in China?

What is a lawyer's due diligence work in China?

Lawyer due diligence refers to a legal service in which a lawyer accepts the entrustment of the client and investigates the designated target whom has the business relationship with the entrusted client of the size, assets and liabilities, credit status, social evaluation, and make a professional report to the client.

The significance of hiring Chinese-English speaking lawyers to conduct due diligence work to the target before conducting foreign trade and investment with Chinese partners is to prevent risks for foreign clients. We are taking advantage of bilingual legal services to accept foreign client's entrustment to conduct due diligence works, proceed investigation rights to the domestic target Chinese corporation in China, provide business legal services, and implement effective risk prevention and control for avoiding unnecessary mistakes and losses before you deciding to conduct international trade and investment with Chinese partners.

Main Contents and Scope of Lawyer's Due Diligence work

●The scope of lawyer's due diligence:

1.The main legal statutory status of the company in China; including establishment, registration, shareholder change, company charter, total share capital and change registration, shareholder capital contribution, whether the company has merged, split, reorganized, asset replacement, real estate assets scale, whether there are major problems with the operation records, whether there are restrictions on equity transfer.

2. The status of property and property rights of Chinese Target Company; including of  land use rights and real estate conditions; intangible assets such as trademark rights, patents, copyrights, and franchise rights, and the main production and operation equipment.

3. The recent production and operation situation of the designated target ; the holding of the production license, the occurrence of major creditor's rights and debts, the litigation, arbitration, enforcement, administrative punishment, taxation, environmental protection, product quality, technical standards, etc.,

4. The business reputation of the Chinese side. It mainly includes the quality of its products, the ability to perform contracts, past compliance rates, service quality, product reputation, product sales and service, actual credit status, partner evaluation, industry evaluation, competent department evaluation, major Bad records, etc.

5. the situation of property guarantees of the Chinese side.  It is mainly necessary to investigate whether the enterprise has set a mortgage guarantee for its real estate and fixed assets; whether it has established a guarantor guarantee for other enterprises.

In the market economy environment, the business reputation of enterprises is even more important than the capital situation, business conditions, and organizational forms of enterprises. It is the primary consideration for each other in business communication.

●The main contents of the lawyer's due diligence:

1. Review the legitimate subject qualification of the proposed acquisition company

The subject qualification of the target company is reviewed to ensure that the transaction is legal and valid, that is, the transaction party is legally existing and has the capacity to conduct the transaction. The investigation of the legality of the target company's main body mainly includes two sides: first, its qualification, that is, whether the target company is legally established and legally existing, including its establishment, registration, shareholder status, registered capital payment, annual review, company change, with or without revocation or cancellation. Second, whether it has specific qualifications for specific industries or business projects established by business licenses, such as construction qualifications and real estate qualifications, etc.

2. Review the assets and financial status of the target company

Mainly to verify whether the rights of the target company’s property are flawed, and whether various guarantees have been set.

Whether there are restrictions on the exercise and transfer of rights, etc. the second is to check whether the realization of the various claims of the target company is guaranteed, whether it will become a bad debt, etc., to ensure that the property relationship of the target company obtained by the acquirer is clear, the rights are flawless, and there are no legal obstacles.

3. Review the creditor's rights and debts of the target company

The various liabilities of the target company will increase the liability of the acquirer, as these debts are borne by the target company after the acquisition, except for debt-offset or debts divestiture acquisitions. There are also some disputes due to unclear rights and obligations, and the possibility of filing a lawsuit or being sued in the future will add uncertainty to the acquirer’s liability.

At this time, the lawyer should analyze whether the target company has responsibility and the weighing of responsibility, and study them qualitatively and quantitatively, so as to provide a reasonable basis for the buyer to negotiate.

4. Important trading contracts

Transaction contracts that are important to the company's survival and development are important task for the review by the acquiring party's lawyers. These contracts usually include long-term purchase or supply contracts, technology licensing contracts, large loan contracts, corporate guarantee contracts, agency contracts, and licensing Contracts, related party contracts, etc. The lawyers review these contracts in order to: First, determine that the acquirer will not lose the expected benefits specified in the contract after the completion of the acquisition, because some companies are able to sign some important contracts to take advantage of their company. The relationship of major shareholders, therefore, this kind of contract often stipulates that when the target company changes its control due to reasons such as acquisition, the contract will need to fulfill the payment obligation in advance, or terminate the right to use or related rights. Second, determine whether the rights and obligations in these contracts are balanced and whether the target company is in a materially unfavorable situation.

5. Intellectual property rights

Intangible assets such as intellectual property have important value. Lawyers should review the ownership of intellectual property (owned by itself or through the license agreement), the validity period, whether there is a sub-license, whether there is any infringement lawsuit, etc.

6. Review the arrangement of the management personnel and ordinary employees of the target company

The amount of the hiring staff of the target company, whether the target company has given corresponding incentives to the important personnel, and whether there are labor contracts that hinder the merger, which need to be fully noticed in the due diligence and propose feasible solutions, or circumventive measures. For the ordinary employees of the target company, only the company's labor contract model is generally reviewed, but for the senior management personnel such as directors, the main contents of the service agreement need to be reviewed one by one. This review is based on the level of compensation and the amount of compensation needed to be paid for the dismissing.

7. Investigation of the governance structure, rules and regulations of the target company.

The investigation of the target company's governance structure and rules and regulations is mainly to review the charter of the target company, the resolution of the shareholders' meeting, the rules of the board of directors, the resolutions of the board of directors, and the company's rules and regulations. The review of these documents is mainly to review the company’s shareholders’ meeting, the powers of the board of directors, the voting of major matters of the company, the adoption of relevant information, etc. to determine whether there are procedural obstacles in this acquisition, whether legal authorization has been obtained, etc. Ensure that the acquisition transaction is legal and effective and avoid possible disputes.

8. Whether there is any major lawsuit or arbitration investigation on the target company

The company's litigation or arbitration activities are directly related to the company's responsibilities and the possibility of loss. The lawyer's review will focus on the possibility of winning these litigations or arbitrations, as well as the legal costs and liability expenses that may result from this.

For lawyers’ due diligence investigation objects, their scale and professional fields are different, and the purpose of their lawyers' due diligence investigation reports is different, so each due diligence investigation project has its own unique characteristics. Lawyers should design different investigative documents according to specific circumstances to draw conclusions by industrious, earnest analysis.

The company's litigation or arbitration activities are directly related to the company's responsibilities and the possibility of loss. The lawyer's review will focus on the possibility of winning these litigations or arbitrations, as well as the legal costs and liability expenses that may result from this.

For lawyers' due diligence, the size of the lawyers varies greatly, and the industries they work in are very different. The purpose of the lawyer's due diligence report is different, so each due diligence project has its own characteristics are unique. Lawyers should design different investigation documents according to the specific circumstances.

●Diligent and serious analytical research draws conclusions.

 Lawyers’ due diligence methods

1. Understand the company's specific situation and meet with company representatives to lay a solid foundation for due diligence.

2. Carefully organize the “Deep-Sampling Document Clearance Form”, prepare the “Due Dueance Questionnaire” in detail, and ask relevant documents and materials from the domestic company.

3. Check whether the domestic company provides relevant licenses, resolutions of the shareholders' meeting, resolutions of the board of directors, capital verification reports, major contracts concerning the company, tax payment receipts, and answer sheets according to the list of documents and questionnaires as classification number is used as an attachment.

2. Carefully organize the “Deep-Sampling Document Clearance Form”, prepare the “Due Dueance Questionnaire” in detail, and ask relevant documents and materials from the domestic company.

4. Check the relevant licenses, approval documents and archival materials with the administrative registration authority.

5. Verify the relevant status of company with the local government, competent department and functional agency.

6. The company is required to submit a statement stating that all the materials and materials provided by the company are true, the contents are genuine, and there are no major omissions.

● General Operational Procedures for Lawyers to Conduct Due Diligence Investigations

1. Sign an entrustment contract with the parties on the entrusted project;

2. The lawyer and client's target company sign a confidentiality agreement on due diligence.

3. Prepare a due diligence checklist based on the scope and content of the due diligence and design a due diligence outline;

4. The target company collects all relevant materials under the guidance of a lawyer;

5. The lawyer conducts a specific investigation and issues an investigation report based on the investigation results. The lawyer provides legal opinions on due diligence.

 ●Lawyer’s due diligence fees

According to the implementation of the project and working hours, the billing is based on the lawyer's due diligence work list confirmed by the client.