Learn from spectacular failures in foreign resource sector acquisitions

By Xu Bin and Christina Dong, Concord & Partners
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It has been calculated that, since the beginning of this century, the rate of successful acquisitions in the foreign resource sector by PRC enterprises has been only about 30 percent. In addition to those failed acquisitions by large state-owned enterprises that have been reported in the media, the number of private enterprises that have lost their shirts is also quite numerous. The reasons for their failures are primarily that they did not understand the foreign laws or their target enterprises, and they failed to make good use of domestic and foreign lawyers, and investment advisors.

Xu Bin Concord & Partners
Xu Bin
Concord & Partners

Key legal issues

Even within the PRC, investment in the resource sector is complex and risky. But when carrying out an acquisition in a foreign resource sector, an enterprise has a greater need to understand relevant laws in detail.

Diplomatic relations. When investing abroad, security of the person and property are of utmost importance. The Ministry of Commerce has formulated the Catalogue for Guiding Outbound Investment in Countries and Industries, and in the Measures for the Administration of Investment Abroad has specially provided that investment in countries that do not have diplomatic relations with the PRC is directly subject to its approval.

Investment restrictions. Many countries place restrictions on foreign investment, and in particular on the development of strategic mining resources. Before investing, it is imperative to extensively understand relevant laws. All the unsuccessful foreign acquisitions by PRC enterprises in recent years can be said to have been due to their hitting the sensitive nerve of target countries with respect to resource security.

Customs and legal systems. “Courtesy calls for reciprocity” has become customary in the PRC, and the success of many PRC enterprises has more or less relied on this ‘custom’. When abroad, PRC enterprises will often mechanically copy this custom, using a ‘sugar-coated bullet’ to establish relations, but then be unwilling to use funds to engage legal counsel, their reasoning being that lawyers cannot create wealth.

What they need to realise is that in countries with sound legal systems the ‘sugar-coated bullet’ is unacceptable, and in countries with weak or inoperative legal system, the acceptance of bribes is a bottomless pit.

Christina Dong Concord & Partners
Christina Dong
Concord & Partners

Mining rights. Many countries have mining rights systems, with some being similar to that of the PRC and others taking such forms as state concessions, contractual co-operation, leases and so on. Mining rights are the most important intangible assets when investing in resources.

Land use rights. As resources are buried in the earth, the development of the resources and use of the land are inseparable. Enterprises need, with the assistance of lawyers, to familiarise themselves with the land use laws of the country of investment.

Environmental protection. The price for developing resources in the PRC in recent years has been environmental degradation. In contrast, foreign developed countries have established strict environmental protection philosophies, and many underdeveloped countries, after falling victim to the environmentally destructive development of resources by developed countries, have learned the lessons and formulated strict environmental protection laws.

Labour laws. Foreign countries ruled by law have sound labour laws and labour union systems. Labour unions are often independent nationwide organisations with great power. If a PRC enterprise that invests abroad violates the labour laws of the country in question, or if its working conditions are harsh, a strike by a labour union organisation in that country could have crippling consequences. Peru-based Chinese mining company Shougang Hierro Peru S.A.A. has been unable to extract itself from the mire of labour disputes for close to 20 years.

Taxes. PRC enterprises have a weak tax awareness and punishment of tax evasion by the PRC government is mild, with prison for tax evasion almost unheard of. However, in countries ruled by law, tax evasion is a serious criminal offense, and once proved, a perpetrator will usually face crushing fines and a prison sentence.

Taking countermeasures

PRC enterprises intending to carry out foreign resource acquisitions need to know themselves and their targets. When PRC enterprises invest abroad, it is very necessary for them to engage PRC lawyers and lawyers of the investment country with extensive experience in the mining field, in particular having a full understanding of relevant laws to issue legal opinions for their investment projects and carry out detailed due diligence of their target companies.

In 2011, a CITIC group consortium acquired a 15% equity interest in Companhia Brasileira de Metalurgia e Mineração (CBMM) for US$1.95 billion. The CITIC consortium retained Concord & Partners, an international law firm from Hong Kong and a local Brazilian law firm to jointly provide comprehensive and integrated legal services, thus manifesting the importance that large PRC enterprises should attach to controlling legal risks in overseas acquisitions.

A legal opinion is a professional confirmation document prepared by a lawyer as to whether an offshore acquisition is legally feasible, and enables the parties to the acquisition to understand whether any major legal obstacles to the transaction exist, and the plan for resolving any issues.

A due diligence report is the report submitted by a lawyer after conducting an investigation of the lawfulness of the operations of the acquisition target, and the genuineness and lawfulness of its assets. The things that the lawyer needs to verify include whether the target company was legally established and is lawfully existing, that it has secured all necessary business permits, that its mining rights are free of defects, that it lawfully occupies its land, that it meets environmental standards, that it uses labour in a lawful manner, pays taxes in accordance with the law, and that its material contracts are free from operating risks, or whether such risks are controllable, etc.

When an acquisition is being effected, if there is an asymmetry in the information of the two parties, the acquirer bears a greater risk. Accordingly, the engagement of a lawyer by the acquirer to issue legal opinions, carry out due diligence on and issue an investigation report on the target company is an important step crucial to the success or failure of the entire acquisition.

Xu Bin is a partner of Concord & Partners, and Christina Dong is the firm’s paralegal

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