Editor’s Note: Dr. Elliot Feldman on October 5, 2011 presented the following speech at China-U.S. Investment Forum 2011.
Our firm has published a treatise, in English and Chinese, entitled Mergers & Acquisitions in the United States: A Practical Guide for Non-U.S. Buyers. I am one of the authors and the overall editor. My status as Senior Partner in the firm has made me a book peddler.
The treatise contains twenty chapters covering how to make a deal, how to paper it, how to arrange for the best tax situation, due diligence for labor, pensions, intellectual property and government contracts, dealing with national security issues and reviews, the Foreign Corrupt Practices Act, export controls, trade, customs, immigration, tax and bilateral investment treaties, Sarbanes-Oxley, antitrust, products liability – all focusing on issues arising from foreign ownership of corporations and subsidiaries in the United States. We have paid special attention to Chinese investors. One might say that this treatise has been written for you.
The overwhelming message of this conference is that your investments are welcome in the United States. People here, people you may engage to help you, want you to succeed. We all understand and recognize the importance of your mission for you and for us.
Good wishes and good will count a great deal in producing success, but business is business. It is competitive and it can be tough. As China has embraced capitalism it has come to understand competition. In every business dealing, your adversary is potentially your friend, and your friend is potentially an adversary. Because of this paradox, we memorialize just about everything in legal documents.
Perhaps more than in any other country, the American tradition has been to rely on legal systems to prevent, or alternatively, to resolve business disputes. An inability to appreciate this aspect of American culture can become a competitive disadvantage, even a liability.
For these reasons, I want to begin our discussion with three things the treatise does not say, at least not explicitly, and I want to present these points as questions:
First, welcome to the United States. Do you have a lawyer? In the United States, business is not conducted without lawyers. My partners, in writing the treatise, constantly wanted to say, “Don’t try this on your own,” or “You need a lawyer to understand the labor laws,” for example. I removed all of that language in editing because I thought it obvious that, in a book written about law by lawyers, once a corporate decision-maker understands generally the subject matter, he would know to get a lawyer. The decision-maker would know that there is a wide range of legal issues that may affect the success of an acquired investment – the point of the book—and he would ask informed questions of a lawyer so he could understand the impact of those issues on his particular investment. He then would make well-informed decisions and would know that it is most efficient for the lawyer, first, to provide counsel, and then to handle the details and documents necessary to execute decisions. My experience, however, at least with China, has been that these conclusions are not so obvious. So, I am telling you. You can’t enter complex transactions – you can’t make deals here – without a lawyer.
A recent issue of the China Business Law Journal makes this point. Entitled “Culture Clash,” the article notes, “Chinese businesspeople may still prefer to do deals on a handshake and a prayer, rather than to do their homework,“ and “our research suggests that foreign and even Hong Kong companies are more likely than their Chinese counterparts to engage advisers to tackle pre-merger due diligence. They are also more likely to seek external help with issues involving human resources, and other matters that can be the key to the success or failure of a merger or acquisition.” Your partners and your competitors for investment opportunities in the United States seek competitive advantages based in large part on the knowledge and advice they take from lawyers. You will miss opportunities for success if you are not equally well informed and advised.
Second question, in two parts: do you have a lawyer in China? Do you trust her? I ask these questions because there is an important cultural difference between China and the United States when it comes to lawyers. Here, lawyers owe a fiduciary duty to their clients. They take an oath to be loyal to their clients, and they take their oath seriously. It is not only a business matter. It is a matter of ethics. Lawyers here frequently tend to be trusted advisers and confidantes because information provided to the lawyers typically cannot be disclosed to the government, and because the more information the lawyer has, the more accurate, insightful and valuable is the advice that the lawyer can give. In China, in our experience, at least, lawyers are treated more like employees. They are used for technical purposes, not as trusted advisers. The relationship, and the expectations, are different here.
Third question: If you were to be dissatisfied with the legal services your lawyer might provide, would you expect to pay the lawyer’s bill? For lawyers, time is money, and when you use your lawyer’s time, even if you don’t like the result, you need to pay for it. Chinese companies unfortunately have acquired a reputation in the United States for not paying their legal bills, even when the agreed upon advice has been given. Perhaps because of the different relationships and expectations that I mentioned, Chinese companies do not seem to value legal advice as much, and agreements to pay for such advice are given less significance. There are exceptions of course, but it is the overall impression that may matter most. In the United States, engagement of counsel is a contract and bills must be paid. Over time, it will become more difficult for Chinese companies refusing to pay bills to find good counsel, which will become a critical problem for companies seeking valuable advice to keep pace with their competitors.
These are candid, perhaps even tough, opening remarks, especially on a panel of lawyers. But, as you can see, I have been around for awhile, and I am devoted to the proposition that China and the United States must understand each other, learn from each other, and work closely together for the prosperity of the whole world.
Too often, now, I have seen contracts major Chinese corporations have entered with Americans in which the Chinese either engaged inadequate counsel, or no counsel, or did not trust their counsel enough to achieve agreements favorable for their objectives. Such failures lead to resentments, misgivings, and missed opportunities for Chinese corporations to succeed. They are not necessary. So, as you consider investing in the United States, get a lawyer, preferably a legal team of many specialties, and trust them.
I urge you to think strategically about your investments, and for the long term. Even as the United States population is only about 25 percent the size of yours, we continue to be the world’s greatest consumers. Until recently, you have been making things we have been buying, but enormous pressure has built up that Americans need to be making more of the things that Americans are buying. In capitalism, profits still go to the owners of the means of production. There is no reason why Chinese cannot be the owners of some of the means of production in the United States, making things for Americans to consume, and to sell to other parts of the world.
The first wave of Chinese foreign investment has concentrated on the natural resources of other countries, buying and shipping them back to China. China must now embark more seriously on a second wave, not in a race to control the resources of others, but to invest in the long term for everyone’s prosperity. The opportunities for such investment and engagement are without limit.
You must start your quest by determining what it is you want to buy, and how it will fit with who you already are and what you or your company want to be. Americans – lawyers, investment bankers, consultants – can all help you identify specific targets of acquisition or merger, but only when you are able to articulate what you want, why you want it, the form you want it in, and what you can afford to pay for it.
Most of those first considerations are internal to your companies, but if you want a lawyer to understand fully what you are trying to do, you should include a lawyer in the discussions from the beginning. In negotiating the deal and packaging it with proper and legally complete documents, lawyers are not merely draftsmen decorating your thoughts with the right phrases. They are craftsmen making sure your interests are protected under the law. You cannot negotiate agreements and sign documents without lawyers who appreciate fully what you are trying to do.
There is a lot to do before getting to a handshake. We have encountered Chinese companies that understand taxes to be an important part of a deal, but few who have appreciated that the domicile of an enterprise and its structure (whether wholly foreign-owned or a subsidiary or sheltered through an offshore holding company, or a number of other possibilities) can determine whether the deal will be profitable or will lose money and fail. Taxes should not decide whether to make a deal, but certainly must be part of the consideration as to where and how to make it.
In deal-making a favorite phrase is “due diligence.” Conventionally, it refers to examining the financial books of a company – assets in buildings and equipment, liabilities in loans and accounts due, inventory on hand and in the pipeline. Traditional Mergers & Acquisitions lawyers concentrate on these considerations. In our treatise, we think of due diligence a little differently. A great attraction to investing in the United States is the presence of a highly educated and skilled work force. However, the work force can also be a serious liability. You need to know, before entering a deal, whether the labor force is unionized, whether there are health and pension plans that must be honored. There is a law in the United States – the WARN Act -- that prevents you from taking over a company and firing all the workers. Due diligence requires knowing all about the work force and its contractual and legal entitlements.
As the United States has become a service-based economy, the value and importance of intellectual property has become so important that it often exceeds, by far, the value of factories and inventory. In our view, potentially the greatest value in a deal will be found in intellectual property. However, intellectual property can also be contested. Before you invest, you need a complete inventory of the intellectual property. You need to know who owns it, whether and how it will convey in a merger or acquisition, and whether it is subject to pending or potential patent or trademark or trade secret lawsuits. Losing such lawsuits can destroy the value of a company.
Foreign ownership can mean the termination of contracts with the U.S. government. You need to know whether the company in which you are considering investment does business with the government, how dependent it is on that business, and whether the kind of business it is doing will be impacted by your financial intervention. A thorough examination of government contracts is also part of the due diligence process.
China is not unfamiliar with proposed projects implicating national security in the United States. There is a myth in China, however, that these projects always and must turn out badly. In fact, they can and usually do succeed, but there must be proper preparation, not only as to the legal process known as “CFIUS,” but the political process that lines up popular support. My partner Mike Oxley dealt with these issues intensively in Congress, and has written a chapter for our treatise all about them.
There is much more, of course, but I have no more time. I urge you to leap the first hurdle and get lawyers you trust and will engage from the very first steps in your journey. Then, start the journey with a detailed check list of what you need to know in order to make a deal. Finally, be prepared to make the deal. Become an investor here. Share in the profits of operating in the most technologically and economically advanced place in the world.