Challenges and Solutions for a M&A Case in Automotive Industry

Interview of Robert B. Weiss, Co-Chair of International Automotive Legal Team and Chair of Commercial Law, Bankruptcy and Reorganization Department of Honigman Miller Schwartz and Cohn LLP

Gassgoo.com: What are the most important legal matters that the Chinese automotive companies should attach more importance to the M&A due diligence?

Mr. Weiss: I would say that of key importance for Chinese companies doing acquisitions in the US is performing the due diligence on the intellectual property. Because in many cases, one of the primary objectives in the acquisition by a Chinese company is to gain access to the technology. It’s very important because they have to make sure that the company they are acquiring does actually have the ability to allow the Chinese company to use the technology, not only in operating that business but also the ability to take the technology to China. So, I think looking at all the issues I identified, one of the most important is doing your due diligence on intellectual property. That would probably be the No. 1 issue to be concerned about if the reason to buy a company is largely to obtain technology.

Gassgoo.com: In doing the M&A due diligence, what do you think is the most important part for the Chinese government aspect?

Mr. Weiss: We can see this question from both the US and the Chinese aspect. If the seller is a US company dealing with a Chinese company, the US company wants to know two things: is the Chinese company serious about doing the acquisition and does it have the commitment and the financial resources to do it? If a buyer needs the Chinese government’s approval, would it be able to get that approval in a timely manner? From the Chinese company’s standpoint, I don’t think they need to be overly concerned about US government approvals. However, if the buying company is partly owned by a foreign government, then the Committee on Foreign Investment in the US would need to approve the purchase, if there is a relationship between the business of the company to be acquired and national security. To my knowledge, to date transactions have not been hindered or stopped based on this type of government approval.

Gassgoo.com: How do you think of the intellectual property due diligence in a successful automotive M&A case?

Mr. Weiss: I think intellectual property is a very specialized area. For example, in my law firm we have lawyers who do nothing but intellectual property work. In a significant transaction, there may be more than one lawyer needed to complete the due diligence. We have lawyers who specialize in areas of intellectual property, such as patent and trademark lawyers, who understand both the automotive industry and the intellectual property laws to make sure that the due diligence is complete. Then the buyer can be comfortable that its primary objective in getting the intellectual property is met and it will have the authority to use it for their purposes.

Gassgoo.com: What is the key part of the asset evaluation and how to do the overall assets evaluation?

Mr. Weiss: I think intellectual property is the primary component in the evaluation of assets. First, you have to confirm that the intellectual property is available to be used both in the US and China. Once you do that, you can assess the value because you know you will be able to use the technology. You know the value of bringing the intellectual property to China for your business. So understanding what the intellectual property is, and making sure you are able to use it as you intend, is a key issue to ensure that the purchase will progress smoothly and have the appropriate value for you. The other objective is to understand the business of the company that you are acquiring and its potential revenue and profitability for your company over the next 5 years or less. What kind of contracts does the company have with OEMs, how profitable are those contracts and will you have the right to those contracts? And, how does that OEM view this company? Will the OEM continue to do business with this company and help it grow? Be sure the existing contracts depict the business accurately and finding the right person within the OEM to provide straight forward and accurate answers to these questions is very essential, but not necessarily easy to accomplish.

Gassgoo.com: How to avoid violation with the additional use of the intellectual property?

Mr. Weiss: If the company you are acquiring doesn’t own the intellectual property but licenses it from a third party then you need to protect yourself from violating laws governing its use. You have to look at that license. A license can be very restricting because it may allow that company to use it only for specific products. Then, if you take that intellectual property license and manufacture the same product in China, you may be violating that license. There are legal consequences in this which include prohibiting you by court order to produce the product and to pay damages to the license owner. That’s why it’s very important to understand the specifics of the license and possibly negotiate with the third party to broaden that license. It is important to understand if I buy the company and I pay a certain price because I not only want the company but I want to use that technology in China, if that license does not permit me to use the technology, it will be a mistake to buy the company. As for the issue of copying technology, sellers are concerned about foreign companies going through the due diligence process merely to get information about the intellectual property, but they are not serious about purchasing the company. Therefore a US company may ask the Chinese company before they share information to sign a confidentiality agreement, restricting them from using the information they obtain during the due diligence process. The other thing that sellers will do to protect their intellectual property is to limit the access to details about it at least until they get a comfort level that you are a serious buyer. Protecting intellectual property is a big issue for both Chinese and American OEMs and suppliers. Understand who owns the technology, confirm the chain of title, and review licenses to and from third parties. It is also good to confirm that patents and trademarks are valid and understand the companies worldwide IP strategies. All of these are matters to be reviewed during the due diligence process.

Gassgoo.com: What is the difference between the domestic acquisition and the overseas acquisition?

Mr. Weiss: It’s more difficult to represent a Chinese company than to represent a US company during an acquisition. The reason for that is the Chinese companies lack experience in US acquisitions, as well as the languages differences in communicating to the client what is going on and what things need to be done the differences, the distance and the cultural issues are also important. You know if there is not a good line of communication, a large number of misunderstandings will happen. If the US lawyers don’t understand the actual needs of the Chinese company, there is a risk that the acquisition will be rejected. And, similarly, if the Chinese client cannot understand why the US lawyer is taking certain steps to finalize the acquisition, the Chinese client may reject the deal. So it is very important to develop a process to deal with those issues, and also, I think, this is very critical in developing an efficient process. During the decision making process, rapid consideration is especially important when you are competing with another buyer. It’s very important to overcome those obstacles and to have a process where decisions can be made relatively quickly, so that the negotiation process can move forward.

Gassgoo.com: So far as I know several acquisition cases between the Chinese company and the overseas company have failed, could you give your comment on these cases?

Mr. Weiss: First I don’t know exactly what cases you are referring to and who was involved in these cases. But, I think the issues I have mentioned above could explain some of the reasons. If you have handled some of these issues in advance of, and during the acquisition, you can have a relatively smooth and complete transaction. If you don’t do that, the result may be different from what you expected. The responsibility of the lawyer is to sit down with the client and explain the entire process in detail, how much time the process is going to take, and what decisions need to be made. If you can do that up front, the process will be a lot easier from beginning to end. If you don’t do it up front, you will find that half way through the process you and your clients do not have the same understanding of the process and you will have stop the process to educate your client, which wastes time. Then the transaction process will be longer than usual. This is partly because Chinese companies lack experience and knowledge about the transaction process and the US legal system.

Gassgoo.com: As per the time term you’ve just mentioned, could you introduce to us how long will a successful acquisition case last generally?

Mr. Weiss: There are different time frames. For example, the seller will often retain an investment banker, then the investment banker will develop a process for the sale, and as part of that there will be a time line developed. So, the seller will send information about the company to a large number of potential buyers, let’s assume the Chinese buyer was one of those. If you indicate you are interested, you will be asked to sign a confidentiality agreement. Once you sign the agreement, a limited amount of information will be presented and, then, by a certain date you will be asked to sign a “letter of intent,” which is often an outline of each step, the price, the assets to be acquired and liabilities to be assumed, a proposed transaction closing date, and so on. The seller will decide which parties are serious about the purchase, selecting a few potential buyers or maybe even one to work with further. Negotiations will continue back and forth and a new timeline might be set. The bigger the transaction is, the longer it takes. But from beginning to end, especially when it includes the closing, a big transaction could take a year. For example, in a transaction, if there is a need to get the Chinese government’s approval, buyers may have a specified time to get that approval, perhaps 60 or 90 days, or perhaps longer. If they don’t get it within the specified timeline; the seller has the right to walk away, and there might be some penalty that the buyer has to pay. So I think part of the reason for delays in a Chinese transaction is getting the Chinese government’s approval, which is not always easy.

Gassgoo.com: Among all the successful acquisition cases between the Chinese companies and the overseas companies, how to do the complaints management and avoid the violence of the local labor law in handling the employer relations and the employer benefits?

Mr. Weiss: In handling employer relations, a company must have a very strong human resource department, have very clear policies, and a good relationship between the management and the labor union. There must be a complete discussion between the buyer and the US company as to employee benefits and the employer’s funding obligations. It can be a very complicated matter. For example, as I mentioned we engage intellectual property attorneys, who have specialized knowledge. We have other attorneys who only handle labor relations and employee benefits issues. So when we get to that part of the transaction, I will get a labor and employment lawyer involved, who understands the labor laws and regulations. It is a very technical area. For example, retirement benefits can be a complicated issue to understand. There are tests that need to be done periodically to determine whether or not you have sufficient money in the benefit plan to pay benefits over a period of many years. If the money in the fund is not sufficient, the government may give you a limited time to correct the situation, but if it is not corrected there can be serious consequences. So this is another important area where due diligence must be done to avoid major problems in the future. My suggestions in relation to employee issues when Chinese companies are engaged in these transactions are: first, to understand the labor contracts; and second, to find ways, aside from the contract, to develop a better working relationship with labor. There have been a lot of changes in the automotive industry with regard to labor practices, the strength of unions and other labor issues. I think the bottom line is there are a lot of successful companies that have union agreements and union employees. They find a way to work together so that the company prospers. I think a lot of Chinese companies are very concerned about coming to the US and dealing with the US labor needs. I would suggest they take the time and effort to see the successful models of unionized companies and learn from them. And, of course, there are culture and value issues to consider. I think the Japanese had the same problems when they came to the US in the 70s and 80s. They found a way to overcome labor issues and become very successful. They presented their culture and values to their employees and the employees embraced them. It is a good example for Chinese companies to follow.