Vietnam has recently become one of the favoured destinations for mergers and acquisitions (M&A) for foreign investors, particularly from Japan, Korea and Singapore. Key sectors of interest include real estate, food and beverage, retail, and to a lesser extent, manufacturing. However, the Vietnamese government has yet to consolidate the laws governing M&A to streamline capital flow from foreign countries while counterbalancing the protection of local business, as it planned. Vietnam’s local enterprises have yet to develop a win-win mentality when approaching M&A. As a consequence, many M&A negotiations take too long and closing can be difficult to achieve. This article discusses some of the major obstacles and pitfalls in the M&A process, as well as solutions to overcome them in Vietnam’s legal environment.
M&A in Vietnam – overlapping laws under the Enterprise Law and the Investment Law
Both the Law on Enterprise (LOE) and the Law on Investment (LOI) are a major source of regulations related to M&A. The scope of regulations under both laws overlaps, as they govern the establishment and capital transfer of an enterprise. At the same time, the requirements under both laws are not consistent, causing confusion for investors.
For example, while the process of establishing a company under the LOE and obtaining a business registration certificate (BRC) is straightforward, it only applies to local investors. Foreign investors who invest for the first time into Vietnam would need to receive an investment certificate (IC) before they can establish their project companies. To receive the IC, investors need to submit more documents, including those that may not have a realistic impact but do take time to prepare, such as a feasibility study. Then, the IC application dossiers need to be approved by the municipal People’s Committee (PC), whereas the BRC registry merely requires endorsement from the head of the business registry unit. In order for the PC to issue the IC, the local department of planning and investment (DPI) needs to crosscheck the HS Code of the businesses, and eliminate the businesses that may restrict foreign investors from investing. The DPI then needs to send letters to various ministries to obtain an answer as to whether market entry is open to investment. The DPI does not use a system of precedent, where previously asked questions would not be asked again, and therefore the bureaucracy may drag on up to six months or even a year before a company may be established, if a sector for investment is sought. Currently, there are more than 300 sectors that are classified as ‘conditional investment sections’, meaning that a business established in these areas would be scrutinised and reviewed carefully before an IC is issued. This mentality of protectionism can give rise to harassment.
To the disappointment of investors, there have been recent movements to change the LOI so that, before the IC is issued, an approval in principle must be obtained from the local PC. Therefore, the applicants would need to submit the application twice: once for the in principle approval and once for the IC issuance. The government has made great efforts to attract foreign investors only to find its bureaucracy discourages them from investing in Vietnam, since the time and cost involved in establishing a company quickly mounts up.
The difficulties in establishing a foreign direct investment enterprise (FDI) apply in a similar way to M&A activities whereby one of the parties (often the buyer) is a foreign investor. Although some regulations state that an enterprise in which foreigners hold no more than 49 percent of the capital would be considered a local enterprise, other regulations require that foreigners first need to receive an IC before investing in a company. Contradictory regulations lead investors to a safe but inefficient solution: to obtain an IC anyway, facing all the requirements and strict regulations in the same way as they would if establishing an FDI vehicle from scratch.
Impact of the laws on closing conditions
Under the LOE, completion of an equity acquisition occurs when the investor receives share certificates and his name is entered into the Shareholder Registry. Under the LOI, a foreign investor is officially (under the definition of FDI) allowed to manage a local company only when he has been issued an IC. As highlighted above, the process of obtaining an IC is often far more cumbersome and requires the signature of a province leader. This process usually takes a few months and needs to be well planned by good advisers to avoid delay. That is one reason why Vietnam remains behind other countries in terms of competitiveness. It is also why major M&A transactions take place offshore – i.e., the investors acquires the holding company in the BVI or Singapore, rather directly acquires the shares of the Vietnam company – and the Vietnamese government loses the tax revenue. That structure, however, is effective when the target is already an FDI company.
When the target is a local company, an offshore transaction does not avoid the requirement of obtaining an IC in order to complete the transaction. One solution would be to use a local holding company. Recently, however, the government issued regulations prohibiting the establishment of a local ‘holding company’. However, without an official definition of ‘holding’, to establish a parent company in Vietnam in an area where there are no restrictions on foreigners holding an operating company would be considered an efficient solution.
Pitfalls during legal due diligence
Legal due diligence (LDD) in Vietnam differs from other countries in the restriction on foreign investment in the business lines of the target company. The starting point of an LDD process is to check whether the buyer would be excluded from market entry. If so, the recommendation is to clean up those sections or to use a holding structure as described above.
Another issue is the nature of the target company. Family businesses may use double book transactions and not have their books audited before a transaction. The buyer should only trust the audited statements and be sceptical about any ‘profit’ shown in non-audited books.
There are two risks that may not be remedied via LDD in Vietnam. The first is the ‘non litigation’ risk. There is no central database in Vietnam allowing a buyer to determine who is suing whom. Therefore, in this regard, most LDD confirms that “the target is not aware of any legal action pending”, which is a weaker representation and warranty. The second risk is tax risk. Under the Law on Tax Management, there is no time limitation on tax recovery. That means, in theory, a target company could be subject to tax recovery indefinitely. In fact, it has been the case that some unresolved issues that were pending with the tax authority when the LDD took place surfaced a few years later. Further, the tax liabilities of the seller could exceed the purchase price. A tax indemnity clause may help if the seller is still around and solvent. But if the seller withdrew from Vietnam, then the target company would be at risk, which ultimately affects the buyer. The solution to this would be to request the tax authority to conduct a tax finalisation as soon as possible, or at least withhold part of the purchase price until the end of a tax finalisation. That said, this risk can never be fully remedied, which is why many buyers opt for an asset deal rather than equity deal. This may be more practical with pure M&A than private equity, where an asset deal is not an option.
Pitfalls during contract negotiation
Contract negotiation may be long or short depending on how skilful the lawyers of both parties are, and how detailed the memorandum of understanding (MOU) or term sheet is. Often, negotiation is tiring because the MOU or term-sheet was not drafted or is not sufficiently detailed. Setting aside the setting of transaction price, these preliminary documents are very important to limit the expectations of both parties and make them familiar with all pertinent concepts, such as first right of refusal, drag-along or tag-along rights, non-compete clauses, or reserved matters, which are often a source of tension.
Cooperation between lawyers from both sides striving for good faith and a win-win solution is important. We have encountered rare occasions where lawyers from the buyer and seller meet to share champagne over the success of the deal, but that is not in every case. There is nothing more frustrating than a non-cooperative negotiation, where one party has a presumed feeling that he was abused by the other party and the lawyers are doing nothing to promote fairness, and are instead only pushing their client’s interests. If lawyers implant into their clients such a mentality, then both parties lose, and the only winner is the lawyer.
During contract negotiation, it is standard that both sides must have lawyers. Where only one side has lawyers, the other side may not understand basic concepts such as representations and warranties, put options, etc., and grow concerned about every clause. However, many sellers still hesitate to engage lawyers to save costs – which actually prolongs negotiations and leads to frustration. In this case, it is necessary that the buyer’s lawyers use plain English to tone down the language so that their client achieves their objectives. But it is still better to advise the seller to use a capable lawyer or stop negotiating until a lawyer is appointed, or until the buyer’s lawyer can explain all contentious points to the seller.
Often foreign lawyers blame local lawyers for a lack of cooperation or for not understanding the basics of M&A. But, more often, we encounter foreign lawyers who underestimate local lawyers or hold colonial attitudes. Such attitudes or bullying tactics might be useful in some frontier markets, but not in Vietnam, and especially not when the other side are prominent local lawyers who have worked on many international transactions. Both side have to be realistic and adopt a win-win mentality. It is easier said than done, but small steps, such as not arguing about ‘face-saving’ issues or making threats, helps to build a trusting relationship between lawyers and between the parties.
Closing does not mark the complete success of the transaction. When a put option or a convertible bond applies, there is some guarantee for the implementation of this clause. There is a case pending in the Vietnam International Arbitration Centre (VIAC) between a buyer seeking to enforce a put option and a seller who denies the validity of the put option. The war of interpretation occurs between one side who relies on strict interpretation of the language of the Shareholder Agreement, and the other side who relies on the intention of the parties before the M&A transaction completes. The solution, either way, is avoidable if the contract is well-drafted – but more importantly, each party should have a red line to its interest, and build up some hedging or insurance around that red line.
There are obstacles and pitfalls in M&A in Vietnam, as there are in other emerging countries. However, with an experienced M&A advisory team that has worked on many transactions in the past, and has a good working relationship with the authorities, it is easier to build trust with the counterparty to sign the share purchase agreement and shareholder agreement, as well as to obtain an IC to complete the transaction.