What You Should Consider When Divesting Your Business In China.

Divestiture is a key option for many multinational companies looking to restructure their business operations in China. This could be as a result of the economic downturn, change of a group’s global business strategy or in an effort to improve profitability and optimise its investment in China. In this bulletin we look at some key considerations that multinational companies should take into account when divesting their China business.

1. Due diligence

Various elements will need to be taken into account in determining the deal structure, including:

• Whether any businesses or assets of the target should be carved out from the sale from a legal or commercial perspective.
• Whether any pre-sale restructuring is needed to optimise the transaction structure. Where there are multiple targets with different shareholders and the seller is planning a package sale, it may be helpful to simplify the shareholding structure in advance. In this connection, the seller may want to consider how to factor the cost of the restructuring in the transfer price.  
• Whether the transaction will be structured as an asset deal or an equity deal. There are pros and cons to each. An equity deal is generally more straightforward in terms of formalities but the purchaser will inherit the historical liabilities of the target. An asset deal can offer an cleaner option for a purchaser but may result in a potentially higher tax burden, particularly for transfers involving real property. Alternatively, a hybrid structure may be explored to combine the merits of both options.
• Whether the divestiture will be an onshore or offshore sale. For multinational companies, selling an offshore holding company is typically more straightforward and allows greater flexibility. However buyers, in particular Chinese buyers, may resist an offshore sale due to the outbound investment formalities and potential funding difficulties resulting from foreign exchange control. An offshore transaction may only be viable if the Chinese buyer has a readily available offshore vehicle and sufficient offshore funds.
• Whether the transaction will be a package sale or an individual sale. Sellers generally prefer a package sale of all target entities in one transaction. However, depending on the appetite of the bidders, the transaction may also end up as a separate sale of individual targets.
• Whether any regulatory approval is required in China or abroad for a particular deal structure and consider its impact on the deal timetable.
• Input should also be sought on tax, accounting and financial considerations.

3. Regulatory approvals, registrations and filings

Where the target is a joint venture enterprise, challenges often arise in dealing with the joint venture partner. From both a legal and contractual perspective, the joint venture partner will be entitled to pre-emptive rights on the sale of the foreign investor’s shareholding. A waiver of pre-emptive rights and consent to the sale may be needed. Even where the transaction is structured as an offshore transaction, this may not necessarily avoid the pre-emptive rights of the joint venture partner. An unhappy and uncooperative joint venture partner will make life difficult for the seller during the deal process. Therefore it is critical to carefully manage the communications with the joint venture partner.

There may be similar communication issues with the target’s suppliers, customers, lenders and other stakeholders. These commercial relationships are often more than purely contractual relationships and will need to be managed carefully to avoid affecting the value of the target business. The timing of the approach to these third parties is an important commercial decision. Additionally, third party consents, notifications or waivers may be required for a successful completion of the deal.

5. Managing employee relationships

Transaction documents cover a broad range of topics. The following aspects will be important considerations:

• Paperwork structure: Where there are multiple targets being disposed of, the seller will need to decide whether there will be a master framework agreement to govern the transactions, such that each transaction can be interconnected under the same general terms and conditions.
• Consideration: From a seller’s perspective, a price adjustment mechanism may not be desirable. Safeguarding the remittance of the consideration will be important, particularly for cross-border payments. Escrow arrangements or bank guarantees can be used to facilitate payment.
• Buyer’s parent company guarantee: Depending on the identity and the financial standing of the purchaser, a seller may require a member of the purchaser’s group with financial substance to guarantee the obligations under the transaction documents.
• Conditions precedent to completion: The conditions precedent to completion should be limited to those required from a seller’s perspective, such as antitrust filings, setting up escrow arrangements and any formalities needed for the seller to receive consideration.
• Seller representation and warranties: Sellers will always seek to limit the representations and warranties given and also provide for limitation of vendor’s liabilities for breaches. From the seller’s perspective, the ideal position would be that the representations and warranties would not be repeated at completion or, if they are, the seller can update the disclosure letter. This is unlikely, however, to be acceptable to a sophisticated buyer.  
• Termination: Sellers should take care when negotiating the termination mechanism to ensure that the buyer cannot easily walk away from the deal. If the consideration is significant, a seller may seek a reverse break fee for additional protection.

7. Business operations between signing and completion