Issues during the due diligence process in M&A transactions

In recent years, thanks to progressive diplomatic policies and robust economic development strategies, Vietnam has emerged as a prominent destination for attracting investment capital from both domestic and international investors.  

Apart from contributing capital to establish new economic entities, a process that often entails multiple stages and approvals from state agencies, Mergers And Acquisitions (M&A) have increasingly become the preferred route for investors. Through M&A, investors can efficiently gain control and leverage the business potential of the Target Company.  

To ensure the success of an M&A transaction and the sustainable growth of the Target Company, investors must carefully evaluate not only financial and operational aspects but also critical legal considerations. This article provides an in-depth analysis of the regulatory framework and shares practical insights into due diligence for key legal issues that investors should address before executing an M&A transaction in Vietnam. 

I. Transferred Shares In The Target Company  

In this Part 1, Apolat Legal focuses on legal due diligence pertaining to the transferred shares in the Target Company.  

1. Ownership Status of the Seller’s Shares 

Under applicable regulations, a shareholder is recognized as the rightful owner of the transferred shares in the Target Company (“Transferred Shares”) only if they satisfy two conditions (i) Full payment for the Transferred Shares has been made, and (ii) The shareholder is properly recorded in the Register of Shareholders. 

The due diligence process should verify whether the Seller has fully fulfilled their payment obligations for the purchase or transfer of the Transferred Shares and holds complete ownership rights. This assessment may rely on the following documents: 

• Payment receipts, documentation of contributed assets, or records of bank transfers.

• Certification of full capital contribution or payment issued by the Target Company. 

• The Shareholder Register, Financial Statements, and Articles of Association of the Target Company. 

• Agreements or contracts governing the purchase or transfer of the Transferred Shares. 

Key considerations during due diligence: 

• The shareholder has not completed the required capital contribution and instead uses a nominee to hold shares. 

• The company has failed to issue certificates of capital contribution or share certificates to shareholders. 

• The company does not maintain or update the Register of Shareholders as required by law. 

• The Shareholder Register lacks critical details, including the list of shareholders, share quantities, share types, and timelines for contributions or transfers. 

2. Restrictions on Share Transfers 

Transferred Shares may be subject to restrictions imposed by law, the company’s charter, or shareholder agreements.  

Key scenarios where Transferred Shares may be restricted include:  

• Ordinary shares held by founding shareholders: Within three years from the issuance of the Enterprise Registration Certificate, ordinary shares held by founding shareholders may only be transferred freely among founding shareholders. Transfers to non-founding shareholders require approval from the General Meeting of Shareholders.

• Charter-based restrictions: Restrictions outlined in the company’s charter are enforceable only if explicitly stated on the relevant share certificates.

• Shareholder agreements: Shareholder agreements may impose absolute or conditional restrictions on share transfers. While the legal enforceability of such agreements remains contentious, violating these restrictions may lead to the invalidation of the transfer. 

Key considerations during due diligence: 

• Are the Transferred Shares ordinary shares held by founding shareholders and subject to the three-year restriction period?

• Does the company’s charter contain legally valid restrictions on share transfers? 

• Have the shareholders entered into binding agreements imposing restrictions on the transfer of Transferred Shares?

3. Disputes Involving Transferred Shares  

Disputes among shareholders or between shareholders and the company present significant risks in M&A transactions. Such disputes may compromise both the transaction’s legality and the valuation of the Target Company. 

Key considerations during due diligence: 

• Are there any ongoing disputes, lawsuits, or claims involving the shares?

• Are there unresolved decisions or judgments related to the shares that remain unenforced? 

Conducting due diligence on the Transferred Shares in an M&A transaction is essential not only for ensuring the transaction’s legal validity but also for safeguarding the interests of all stakeholders. Investors should collaborate closely with legal counsel to comprehensively review all legal aspects, ensuring that any issues related to the Transferred Shares in the Target Company are transparently resolved before finalizing the transaction. 

II. Corporate Legal Compliance of the Target Company

In this Part 2, Apolat Legal focuses on legal due diligence pertaining to the corporate legal compliance at the Target Company. 

In the process of M&A transactions, due diligence plays a crucial role, helping the parties involved in the transaction assess the Target Company’s level of compliance with current legal regulations. This due diligence ensures that the Target Company operates legally, fully complies with legal requirements, and avoids from potential risks related to legal issues. It is a decisive factor in the success of the transaction and the protection of the interests of all stakeholders.  

1. About the Charter of Target Company 

The Charter of the Target Company must be prepared and comply with the provisions of Article 24 of the Law on Enterprises 2020. It must include mandatory contents such as the name of the Target Company, business lines, charter capital, governance structure, and the rights and obligations of shareholders.  

During the due diligence process, it is necessary to check whether the charter of the Target Company has been prepared and fully updated with the required information and whether there are any contents contrary to the law. Additionally, it is important to verify that the Charter contains special provisions on the rights of the buyer based on the number of shares and charter capital, the structure of power division among shareholders, and whether there are any regulations restricting the transfer or disposition of shares.  

Key considerations during due diligence:   

• The charter is not in accordance with the provisions of the law.

• The Charter stipulates issues restricting the transfer of shares, which is not in accordance with Article 127.2 of the Law on Enterprises 2020. 

• The charter includes mechanisms for adopting adverse decisions, requires excessively high voting rates, or grants veto power to a group of minority shareholders, affecting the buyer’s control. 

2. About Target Company’s License 

The operating license is an important legal basis for determining the legal status and scope of business activities of the Target Company. Due diligence will include verifying the legal establishment and existence of the Target Company in Vietnam, including its head office, branches, representative offices, and business locations. 

During the due diligence process, investors need to check the validity, expiration, and maintenance conditions of the licenses, including business registration certificates, investment registration certificates, and sub-licenses (if any), to ensure that the Target Company is eligible to establish and operate for the licensed purpose. 

Key considerations during due diligence:  

• The license has expired or has not been renewed on time. 

• The Target Company’s business activities exceed the scope of the license. 

• Permits are issued based on inaccurate information or have illegal grounds or are in danger of being revoked. 

• The Target Company does not meet the conditions of licensed business. 

3. About the Management Structure of the Target Company  

The organizational structure of the Joint Stock Target Company must comply with the provisions of Article 137 of the Law on Enterprises 2020, with three main bodies: the General Meeting of Shareholders, the Board of Directors, and the Supervisory Board (in some specific cases).  

The due diligence should determine whether the Target Company’s organizational model complies with the law. Additionally, another important factor to consider is the decision-making mechanism within the Target Company, such as voting rights, the approval rate of resolutions at the General Meeting of Shareholders, and the powers of the Board of Directors, all of which will directly affect the buyer’s ability to control the company after the completion of the transaction.   

Documents to consider during the due diligence may include: 

• Charter of Target Company and operating regulations of the Board of Directors and the Supervisory Board.  

• Minutes and resolutions of the General Meeting of Shareholders and the Board of Directors. 

• Documents related to the appointment or dismissal of members of the Board of Directors, the Control Board, and the Director/General Director. 

Key considerations during due diligence:  

• The organizational model does not meet the provisions of the law, or lacks the Supervisory Board in case of compulsory establishment. 

• Lack of internal operating regulations or unclear regulations, causing conflicts in decentralization and decision-making. 

• Control is limited due to unfavorable regulations on voting rates or the mechanism for electing management members. 

4. About the Target Company’s business scope 

According to regulations, the Target Company is free to engage in industries and trades that are not prohibited by law. Therefore, the Target Company in Vietnam often registers multiple business lines; however, the primary business line of the Target Company is an important factor to understand. This not only affects the sub-licenses that need to be obtained but also determines key contracts and assets that must be considered during the due diligence process. 

Additionally, if the buyer is a foreign investor, the Target Company’s business lines need to be carefully considered. Vietnamese law and international commitments to which Vietnam is a party may impose restrictions and conditions on foreign investors, depending on the Target Company’s business lines. 

Documents to consider during the due diligence may include: 

• Business Registration Certificate.

• Confirmation of notification of changes in business registration contents.

• Charter and Financial Statements of the Target Company. 

• Important Commercial Contracts. 

• Brochure about the Target Company 

Key considerations during due diligence: 

• The Target Company does not properly implement the registered business lines. 

• The Target Company does not fully meet the conditions for regulated industries. 

• The activities of the Target Company will be limited when it becomes a foreign-invested enterprise. 

• Foreign investors must meet the legal conditions according to Vietnamese regulations and international commitments to participate in the purchase of shares of the Target Company.

The Due diligence related to corporate legal compliance at the Target Company not only helps investors identify and manage risks but also supports the establishment of mechanisms to protect the interests of the buyer after the transaction. This is a critical step to ensure that the M&A transaction proceeds successfully and that the Target Company operates stably under the control of the new investor. 

III. Labor Compliance of the Target Company

In this Part 3, Apolat Legal focuses on legal due diligence pertaining to the labor compliance at the Target Company. 

In the process of implementing an M&A transaction, conducting labor compliance due diligence at the Target Company is crucial. It enables investors to evaluate whether the Target Company has properly fulfilled its legal obligations toward employees. This process helps identify potential legal risks and disputes that may arise during the course of the M&A transaction 

1. Issues Requiring Due Diligence 

a. Labor Contracts:  

The Target Company must review the labor contracts signed with employees to ensure that the terms comply with legal provisions and do not contain terms that may pose risks or be detrimental to the Target Company. The labor contracts must be in writing and include the essential information required by law. 

Legal basis: Article 21 of the Labor Code 2019 

b. Labor Regulations  

Internal labor regulations are essential for governing employee conduct in the workplace. The Target Company should ensure that its labor regulations fully comply with the law and have been registered with the relevant authorities. 

Legal basis: Article 118 of the Labor Code 2019. 

c. Financial Obligations to Employees 

It is necessary to verify whether the Target Company has fulfilled its financial obligations to employees, including salaries, bonuses, insurance, and other benefits, on time and in full. Additionally, any commitments the Target Company makes to employees regarding wages and benefits should be clearly defined in the employment contracts or collective bargaining agreements. This ensures the protection of employees’ legitimate interests and minimizes the risk of potential disputes. 

d. Work permits for Foreign Workers 

If the Target Company employs foreign workers, it must ensure that work permits are obtained before hiring foreign employees, and comply with all reporting obligations as required by law. This aspect requires careful due diligence to avoid violations of the law concerning the employment of foreign workers. 

Legal basis: Article 151 of the Labor Code 2019  

e. Mandatory obligations as an Employer 

In addition to basic obligations such as salary payment and social insurance, the Target Company has various other mandatory legal obligations to ensure the protection of employees’ rights and interests. These include: 

• The obligation to establish and make public salary and bonus regulations in the workplace. 

• Organizing regular dialogues with employees. 

• Conducting periodic health checks for employees.

• Fully fulfilling obligations when terminating labor contracts with employees. 

2. Key considerations during due diligence: 

During the due diligence process, the Target Company may encounter the following issues: 

• Failure to apply for work permits for foreign workers may result in administrative sanctions and the requirement for foreign workers to leave Vietnam. 

• Labor contracts containing illegal clauses: If the terms of the labor contract do not comply with legal requirements, they may be deemed invalid or lead to disputes. 

• Internal labor regulations with illegal provisions, which may create a lack of basis for resolving disputes with employees. 

• Failure to register internal labor regulations with the competent authorities. 

• Collective labor agreements containing illegal clauses. 

• Failure to fulfill obligations related to salaries, insurance, severance pay, and job-loss allowances for employees, or failure to meet other labor-related financial obligations (such as trade union dues or health insurance for foreign workers). 

• The Target Company organizing overtime beyond the maximum limits permitted by law.

The due diligence on labor issues at the Target Company helps investors identify and manage legal risks while also safeguarding the buyer’s interests post-transaction. It ensures that the Target Company operates stably and legally under the control of the new investor after the completion of the transaction. 

IV. Due Diligence Of Business Activities At The Target Company 

In this Part 4, Apolat Legal focuses on legal due diligence pertaining to the business activities at the Target Company. 

In parallel with the thorough due diligence of the Target Company’s finances, assets, and business situation, it is crucial to conduct a legal review of these factors before proceeding with an M&A transaction. Legal risks and implications may arise for the Target Company in terms of finance, assets, and operations, ensuring both compliance and the ability to maintain stable operations moving forward. Below are the legal issues to address, key documents to consider, and common legal challenges. 

1. Important Contracts 

Contracts are essential tools for the Target Company in conducting its business operations. Therefore, reviewing important contracts allows investors to assess the obligations and interests of the Target Company in various transactions, as well as evaluate commitments that may have an impact on the Company. 

Given the variety of contracts the Target Company may enter into, due diligence should focus on the contracts that are most significant to the Target Company, which may include: 

• High-value contracts or contracts with major customers and partners;

• Contracts related to the sale of goods and provision of services; 

• Investment-related contracts, such as joint venture agreements, business cooperation agreements, shareholder agreements, commercial franchising agreements, and public-private partnership contracts; 

• Loan agreements, credit agreements, and financial lease agreements; 

• Contracts related to the purchase or sale of the Target Company’s assets; 

• Contracts with stakeholders and management of the Target Company; 

Key considerations during due diligence: 

• The contract includes a clause that allows the counterparty to terminate or accelerate payments due to a change in control;

• An important contract in the Target Company’s business is nearing expiration; 

• The contract contains clauses that restrict business activities or the disposition of the Target Company’s assets; 

• The contract includes provisions that may not comply with the law, potentially leading to disputes and litigation. 

2. Important Assets 

Assets are a core element of the Target Company’s operations. Due diligence on important assets allows investors to understand the status of assets owned or used by the Target Company. Assets to be appraised include: 

• Land, factories, machinery, equipment, other real estate, and intellectual property rights.

• Leased or borrowed assets: Assets that the Target Company uses but does not directly own, including leased or borrowed items. 

• Collateral: Assets pledged by the Target Company to secure loans or other financial obligations. 

• High-value or essential assets: Assets that are crucial for the business operations of the Target Company.

Key considerations during due diligence:  

• The property lacks clear legal ownership. 

• Ownership of the property is disputed or the right to use is restricted.

• Assets are pledged, mortgaged, or tied to unresolved obligations.

3. Loans and Financial Obligations 

Investors should examine the Target Company’s loans and financial obligations, particularly those linked to collateral. This due diligence helps investors assess the financial status and obligations of the Target Company, enabling informed decisions regarding the transaction’s value. Documents to consider: 

• Loan, pledge, and mortgage agreements. 

• Agreements where the Target Company guarantees the obligations of a third party. 

• The Target Company’s financial statements. 

• Documents related to foreign loans and financial obligation guarantees.

• Information from the land registration office and the National Registry on secured transactions 

Key considerations during due diligence: 

• The Target Company has not registered medium- and long-term foreign loans with the State Bank of Vietnam. 

• Loans taken when the charter capital has not been fully contributed, which may impact the validity of loan interest as a deductible expense for corporate income tax.

• Violations of regulations regarding lending or guaranteeing financial obligations to foreign entities without proper approval from the authorities. 

The due diligence process related to the business activities of the Target Company is critical in M&A transactions. By conducting due diligence important contracts, assets, and financial obligations, investors can identify potential risks and make well-informed decisions regarding the valuation and execution of the M&A transaction. 

See more:

1. M&A: 02 Notes For Sellers In Legal Due Diligence

2. What Is Legal Due Diligence And Why Is It Important In M&A Transactions?

3. IP Due Diligence in a M&A deal

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