Hong Kong

4 Chapter M&A

    • NTRODUCTION

       The terms “merger” and “acquisition” have no legislative interpretation or meaning in Hong Kong. While defined by statute in a number of jurisdictions, “merger” is not a legal term of art in Hong Kong and, used generically, is often indistinguishable from acquisitions and amalgamations.  “Acquisition” has a more generally accepted meaning and can encompass a number of methods by which a party acquires whole or partial ownership of  a business enterprise or shares in a target company. “Amalgamation” is a legal process by which the undertaking, property and liabilities of two or more companies merge and are brought under one of the original companies or a newly formed company and their shareholders become the shareholders of the new or amalgamated company.  The new Companies Ordinance, which became effective on 3 March 2014, introduced a court-free regime for amalgamations of wholly-owned companies incorporated in Hong Kong within the same group.   Mergers and acquisitions in Hong Kong are typically structured through the transfer of the target company’s shares, or the target company’s assets, to the purchaser. The detailed discussion in this guide is mostly focused on share transfers. In addition, it should be noted that much M&A activity in Hong Kong involves public (and, in which case, almost invariably listed) companies, in which case the relevant listing and takeover rules will be applicable.

    • a. Shares Transfer

       Normally, this does not involve transfer of employees.

    • b. Assets Transfer

       Employees of the target company will not be automatically transferred to the purchaser. All existing contracts of employment have to be terminated and, if it is desired to retain employees, new contracts of employment would be offerred to those employees who are being transferred.  

    • c. Transfer of Liabilities

       The Transfer of Businesses (Protection of Creditors) Ordinance provides that whenever a business is transferred, the purchaser shall, notwithstanding any agreement to the contrary, become liable for all the debts and obligations arising out of  the carrying on of  business by the seller, unless the procedures set down in that ordinance are followed. These procedures require the parties to publish a notice of transfer (setting out prescribed particulars of the transfer) not more than four months and not less than one month before the date the transfer takes place.  The purchaser ceases to be liable for all obligations of  the seller with effect from the date on which the  notice of transfer becomes complete, which occurs upon the expiration of one month after the date of the last publication of the notice, unless within that period a creditor commences proceedings against the seller in respect of any liability of the seller arising out of its carrying on of the business. Under the Transfer of Businesses (Protection of Creditors) Ordinance, the purchaser is entitled to be indemnified by the seller for all amounts for which the purchaser is made liable under that ordinance and for which it would not otherwise be liable. In most cases an express indemnity provision in favour of the purchaser would be included in the contractual documents between the parties.

    • a. Joint Venture Corporation

       The term joint venture does not carry a specific legal meaning under Hong Kong law. It is commonly used as a generic term to describe a variety of situations in which two or more parties co-operate with one another by pooling resources (such as capital, know-how, marketing and management) together in a mutual business endeavour with a view to achieving certain business goals or to achieve a commercial objective (HKSAR v Gammon [2003] 3 H.K.C. 276 at para.14).

       

      The exact legal relationship between the joint venturers is determined by the agreement between the parties. As is the case in England and other common law jurisdictions, the relationship between the parties is subject to a combination of common law and legislation (for example, company and partnership law, the newly gazetted competition law in Hong Kong, and laws governing intellectual property, commercial, trade and tax).

       

      Types of Joint Ventures

      The following types of Joint Ventures are allowed in Hong Kong:

        -Incorporated

        -Unincorporated (or contractual)

        -Partnerships

       

      Corporate Joint Ventures

      Corporate Joint Ventures are very often formed using limited liability companies. The company may be a limited liability company formed under the Companies Ordinance (Cap. 622 of The Laws of Hong Kong) but it is very common in Hong Kong for the corporate vehicle to be incorporated in the British Virgin Islands (BVI) or the Cayman Islands, both British overseas territories located in the Caribbean Sea. BVI and Cayman companies are very commonly used in Hong Kong as investment vehicles and for JVs. The reasons for this are somewhat historic, but there are stamp duty savings and the BVI and Cayman rules in relation to statutory reporting are more favourable to shareholders.

       

      Principally, the documents regulating an equity Joint Venture in Hong Kong are the articles of association (which may be modified to include rights in relation to share transfers, pre-emption rights, voting, appointment of directors, remedies for breach and so on, tailored to the specific terms of the JV) and a shareholders' agreement. There will also likely be ancillary documentation that would reflect the parties' intended relationship, such as loan documentation, technology transfer agreements, supply or distribution agreements, and licensing agreements regulating intellectual property rights.

       

      Corporate Joint Ventures provide a flexible method of regulating a number of different Joint Venture relationships. For example the Joint Venture may be a 50/50 arrangement between two entities or groups, or one party may hold a majority (in which case the rights of the minority can be protected) or there may be a number of partners with different rights protected by using different classes of shares. Given the use of limited liability companies, the Joint Venture parties can be protected from liabilities arising from the business (perhaps by bringing in a private equity investor), the structure may facilitate financing the Joint Venture project or business, the Joint Venture may more easily be sold, and the parties can build in mechanisms to deal with changes in control and rights in the event of breaches of the Joint Venture agreements.

       

       

       

      Contractual Joint Ventures

       

      Contractual Joint Ventures are known by a variety of names, most notably consortia, strategic alliances, collaboration agreements, joint operating agreements and of course, joint ventures. Where the Joint Venture involves a single undertaking or a project of relatively short duration, a contractual Joint Venture may be appropriate without the need for a Joint Venture based on a limited company. The contractual Joint Venture offers several advantages, namely the absence of public filing requirements and ongoing compliance requirements such as financial reporting and other requirements of the Companies Ordinance relevant to an incorporated JV. Each party in a contractual JV may give the other an indemnity in respect of loss caused by his failure or of defective performance on the part of his employees or subcontractor and the contractual terms of the relationship may preclude it from being a partnership with its ancillary duties. A contractual JV can also maintain a greater degree of privacy compared with corporate JVs. Apart from registering with the Inland Revenue Department under the Business Registration Ordinance (Cap. 310 of The Laws of Hong Kong), no other filing requirements apply for contractual JVs. Finally, depending on the parties' circumstances, certain tax advantages may be gained from the business structure as the JV is not taxed separately from the parties.

    • REGULATIONS INVOLVING MERGERS AND ACQUISITIONS

       Company law in Hong Kong has developed through the interaction and interdependence of case and statute law. The Companies Ordinance, which forms the core of the regulation of companies in Hong Kong, has been substantially re-written recently. The new Companies Ordinance, which came into effect on 3 March 2014, introduces extensive changes and repeals most of the core provisions under the former Companies Ordinance (except for those provisions relating to:

       (i) winding up and insolvency and

      (ii) the public offer / prospectus regime).

       

      Broadly speaking,  the new Companies Ordinance sets out the general rules and regulations governing  Hong Kong companies  (with certain provisions applying to overseas companies having a place of business in Hong Kong)  and contains a number of specific provisions relating to matters which may impact upon mergers and acquisitions and how they can be structured, including the following:

       

      • the giving of financial assistance by a company for the purchase of its own shares is subject to certain procedural requirements, including the satisfaction of a solvency test and board and shareholder approval (albeit that there is also a de minimis  threshold in lieu of obtaining shareholder approval)  

       

      • Restrictions on the methods whereby a company can reduce its share capital or vary the rights attaching to  a  particular class of  shares. The new Companies Ordinance introduces a court-free procedure for capital reduction.  The requirements under this new procedure include the satisfaction of a solvency test and the passing of a special resolution by disinterested shareholders. This court-fee procedure will likely be faster and cheaper than the alternative court-sanctioned procedure which existed under the former Companies Ordinance and which has been retained in the new Companies Ordinance

       

      • Restrictions on the amounts which can be distributed by way of dividend

       

      Under the former Companies Ordinance, companies could only resort to a court-sanctioned scheme of arrangement to effect an amalgamation. The new Companies Ordinance, while retaining such procedure, introduces a new court-free procedure for two categories of intra-group amalgamations:  vertical amalgamations (meaning amalgamations between a holding company with one or more of its wholly-owned subsidiaries) and horizontal amalgamations (meaning amalgamations between two or more wholly-owned subsidiaries of the same company).

       

      Certain requirements will have to be complied with under the new court-free procedure. These include requiring the directors of each amalgamating company to make a solvency statement, issue a certificate on the solvency statement, give written notice of the proposed amalgamation to every secured creditor and publish the proposal in newspaper. The members of each amalgamating company must approve the amalgamation by a special resolution, which must also be registered with the Companies Registry.  The effect of an amalgamation is that the amalgamating companies form one company. On the effective date of such amalgamation, each amalgamating company ceases to exist as an entity separate from  the amalgamated company, and the amalgamated company succeeds to all the property, rights and privileges, and all the liabilities and obligations, of each amalgamating company.

       

      Private and public companies

       

      An important distinction is drawn in Hong Kong between private and public companies. The Companies Ordinance prescribes that a company is a “private company” if its articles of association restrict the right to transfer shares; limit the number of its members to no more than 50; and prohibit any invitation to the public to subscribe for shares in or debentures of the company. The term “public companies” is defined in the new Companies Ordinance as companies other than private companies and companies limited by guarantee.

       

      (h) Listing Rules and Takeovers Code

       

      Companies listed in Hong Kong are also subject to the Rules Governing the Listing of Securities on The Stock  Exchange  of  Hong Kong Limited or the Rules Governing the Listing of  Securities on the Growth Enterprise Market of  The Stock  Exchange of  Hong Kong Limited  (as the case  may be),  as  well as  The Codes on Takeovers and Mergers and Share Repurchases (which apply to public companies). 

       

      (i) Use of offshore companies

       

      One factor which is quickly apparent to those conducting business in Hong Kong is the common use of offshore companies, incorporated in jurisdictions such as the British Virgin Islands. These companies are used for a number of reasons, including the relative simplicity of maintenance, and the avoidance of Hong Kong stamp duty on share transfers (save as regards shares traded on The Stock  Exchange of Hong Kong Limited, which are required to be registered on a Hong Kong branch register). It is also important to note that, on occasion, use of such companies can mitigate the application of some of the provisions of  the Companies Ordinance.

    • SPECIFIC INDUSTRY

       The Competition Ordinance only regulates mergers involving holders of carrier licences in the telecommunications sector[1].

    • a. Overview

       The tax regime local tax considerations play a subsidiary role in the structuring of mergers and acquisitions in Hong Kong, due to the simplicity and transparency of the tax regime. Some of the principal features of the Hong Kong tax regime are:

      • Hong Kong does not recognize the concept of taxing capital gains on the  disposal of  assets (including property and shares)

      • There is no withholding tax payable in respect of distributions to shareholders by way of dividend

      • Dividends are not taxable income

      • There is no concept of group taxation

    • b. Stamp duty

       Stamp duty is charged on the sale of shares of Hong Kong incorporated companies. Currently the rate is calculated at 0.2% on the higher of the amount of the consideration paid and the value of the shares being transferred. It is normally paid in equal proportions by the seller and the purchaser, although there is no hard and fast rule in this regard. Relief is available (subject to certain conditions) in respect of intra-group share transfers between associated companies (90% ownership is the applicable threshold).  For acquisitions where the stamp duty payable is substantial, techniques such as "swamping" allotment of shares or the reclassification of existing shares may sometimes be adopted to minimise the duty. There may also be other methods that can be used to minimise (and sometimes even eliminate) the stamp duty charge, but there may be uncertainty as to the effectiveness of some of these methods, in particular those involving non-commercial steps which may be disregarded as a result of application of anti-avoidance provisions. Capital duty, which was previously levied for increases in the authorised share capital of the Hong Kong companies, has been abolished with effect from 1 June 2012.

    • (a) Typical Documentation

       Core documentation involved in a sale and purchase of a company or a business in Hong Kong is similar to that used in many international jurisdictions and typically includes the following: 

      • a confidentiality letter in which the parties undertake to keep confidential the actual transaction and any information they may obtain during the due diligence process. In some cases, it may include a provision for exclusive negotiations for a particular period so that the purchaser knows that there will be no dual negotiations or auction type process

      • a due diligence questionnaire and report in relation to the business or company

      • a sale and purchase agreement that specifies the obligations and liabilities of each party in relation to the sale. This normally includes detailed representations and warranties regarding  the business or company.  In a share transfer, all the company’s obligations and liabilities remain in the company whereas in a business sale, subject to the Transfer of Businesses  (Protection of Creditors) Ordinance, the purchaser  will normally be able to pick and choose which assets it wishes to purchase and which liabilities it wishes to acquire

      • a disclosure letter in which the seller makes disclosures against the representations and warranties in the sale and purchase agreement

      • share transfer forms where the sale and purchase involves the sale of shares, and bought and sold notes if these are shares in a Hong Kong company

      • A notice under the Transfer of Businesses (Protection of  Creditors) Ordinance in  the case of  the sale of a business

      • With respect to public companies, any documentation specifically required by relevant listing or takeover rules 

    • (b) Letter of Intent / Memorandum of Understanding

       The process for a merger and acquisition transaction in Hong Kong is similar to typical international practices. The parties will initiate discussions to reach a preliminary agreement on the key commercial terms. Having reached an agreement in principle and before the due diligence and documentation drafting process, which can be  time consuming and costly, the  parties may want to  record the principal terms of the transaction in writing, which may be referred to as a letter of intent, a memorandum  of understanding, a term sheet or heads of terms.

       

      A letter of intent / memorandum of understanding may or may not be legally binding and the parties should specify this clearly in the relevant documentation. Normally a letter of intent/ memorandum of understanding would not be expressed to be legally binding except for certain specific provisions, such as those relating to confidentiality, exclusivity, and liability for costs in the event of an unsuccessful transaction. In relation to those parts of the document which are to be legally binding, the legal requirement for the creation of a valid contract must be satisfied.  

    • (c) Confidentiality Agreement

       Where the seller is prepared to provide commercially sensitive or confidential information before a legally binding sale and purchase agreement is entered into, the seller would typically require the purchaser to enter into a confidentiality agreement which may contain the following:

       

      • a definition of the confidential information

      • an obligation on the purchaser not to disclose or use such information except for the purpose of evaluating the acquisition

      • restrictions on the purchaser from  soliciting customers, suppliers and/or employees of the target company 

      • an undertaking  by the  purchaser to  return or destroy such information (including copies  and documents prepared on the basis of information provided) 

      • an agreement that the parties will not, without the written consent of the other party, make any announcement or disclosure of the fact that negotiations are taking place The undertakings of the purchaser may be contained in a separate agreement between the parties (which may be in the form of a letter to the seller) or in the letter of intent / memorandum of understanding  

    • (d) Exclusivity Agreement

       While an agreement which purports to commit the parties to enter into a definitive sale and purchase agreement would be unenforceable under Hong Kong law on the basis that it is an agreement to agree, the seller may commit that it will not enter into negotiations for a sale with other parties. Such a commitment would be enforceable provided that it is sufficiently certain. Consideration should be provided for the commitment to be enforceable, which is often drafted as the incurring of fees by the potential purchaser in the due diligence investigation of the target company. Again the commitment may be contained in a separate agreement between the parties or in the letter of intent / memorandum of understanding or the confidentiality agreement.

    • (e) Due Diligence

       Matters investigated In any merger and acquisition transaction, in addition to financial and business due diligence, legal due diligence in some form is normally undertaken by the purchaser. Reports on title are sometimes prepared in relation to properties owned by the target company.  Other items commonly investigated in a legal due diligence include, the statutory books, major contracts, plant and machinery leases, service agreements, loan details, licences/permits and particulars of litigation.

       

      Extent of legal due diligence

       

      The due diligence process usually involves the following steps:

       

      1.    A questionnaire is submitted to the target company

      2.    Teams of lawyers review documents and a legal due diligence report is prepared. The report may be a comprehensive one or simply reporting on disclosures made against warranties given in the contractual documentation. In answering due diligence enquiries, the seller must be careful to avoid any misrepresentation which may subsequently be relied upon by the purchaser to rescind the agreement and claim damages.  

       

      As part of the legal due diligence, searches of publicly available information may be made at the relevant government authorities (e.g. the Hong Kong Companies Registry, the Hong Kong Land Registry, the Trade Marks Registry, the Official Receiver's Office and the Hong Kong Courts in respect of litigation and winding-up proceedings) to serve as an independent check against the information provided by the seller. When the target company has operations or assets in mainland China, a greater degree of proactivity in due diligence is usual and prudent.

       

      Exemption to privacy law for due diligence exercise

       

      The Personal Data (Privacy) Ordinance (the primary piece of legislation in Hong Kong aimed at protecting the privacy of individuals in relation to personal data) includes an exemption which allows personal data to be transferred or disclosed by a data user (defined to mean a person who controls the collection, holding, processing or use of the personal data) for the purpose of a due diligence exercise to be conducted in:

      (i)            a transfer of the business or property of, or any shares in, the data user;

      (ii)           a change in the shareholdings of the data user; or

      (iii)          an amalgamation of the data user with another body, even  though such purpose was not provided for at the time of collection of the personal data. 

       

      Certain conditions will have to be fulfilled for this exemption to apply.  These include:

       

      • the personal data transferred or disclosed are not more than necessary for the purpose of the due diligence exercise

       

       • goods, facilities or services which are the same as or similar to those provided by the data user to the data subject (defined to mean the individual who is the subject of the personal data) are to be provided to the data subject, on completion of the proposed business transaction, by a party to the transaction or a new body formed as a result of the transaction

       

      • it is not practicable to obtain the prescribed consent of the data subject for the transfer or disclosure

       

      This exemption does not apply if the primary purpose of the proposed business transaction is the transfer, disclosure or provision for gain of the personal data. Further, if a data user transfers or discloses personal data to a person for such due diligence exercise, that person (which arguably may include a professional adviser such as a lawyer or an accountant) must

       

      (i)            only use the personal data for that purpose; and

      (ii)       as soon  as  practicable after completing  the  due diligence exercise,  return  the  personal  data to the data user, and destroy any record of the personal data kept by him.