2013 Asia Pacific Guide to Mergers & Acquisitions – Vietnam Chapter

 

October, 2013

 

M&A in Vietnam: An Overview of the Legal Framework

 

With the passing of the Law on Investment[1] and Enterprise Law[2] by the National Assembly of Vietnam, a foundation was laid for establishing a new Vietnamese investment regime in general and creating an equal playing field for foreign and local investors in particular. The legal framework for the M&A sector in Vietnam has since been developing at a promising pace. Portfolio (foreign indirect) investment was for the first time recognized as one of official investment channels and has achieved spectacular growth for the last several years. Currently, with some limitations, foreign investors can freely acquire stakes in Vietnamese enterprises. The limitations on foreign investment are defined by both Vietnam’s WTO commitments as well as domestic legislation.

 

Why M&A in Vietnam?

 

The following are some factors influence the choice for multinationals to channel their investment towards Vietnamese acquisition targets:

 

  • The legal framework around M&A is becoming more business friendly with the Vietnamese Government planning to open up “sensitive” sectors like education, health care and telecommunications to foreign investment.
  • The Vietnamese Government shows strong commitments on “equitization” (privatization) of State-owned enterprises. Equity of key players in telecommunications, airlines, etc. will be offered to outside investors including foreign ones.
  • Due to the global financial crisis, many local companies have encountered severe difficulties and need capital to improve their economic situation.
  • M&A reduces costs/time for starting businesses which to some extent is still problematic for foreign investors, especially those who come to Vietnam for the first time. In some cases, portfolio investment would eliminate the risk of entry barrier for a number of sensitive sectors such as distribution.
  • From a commercial point of view, M&A would take advantage of the availability of customers, manpower, “golden” location, distribution channels, etc…

 

State of M&A in Vietnam

 

Despite some difficulty, M&A activity in Vietnam has been growing on average 30% in recent years, with deals being primarily in consumer products, banking and finance services, technology, utilities, personal and household goods, energy and power. During 2010-2012, enterprises were in trouble due to the difficult economic situation. However, that has resulted in the growth of M&A activity as the assets are at cheap valuation and the owners are trying to sell.

 

How a Typical M&A Vietnamese Deal Occurs

 

  • Preparing an M&A Deal
 

Foreign investors should initially work with legal counsel to ensure the legal feasibility of the preferred deal structure and based on that commence pre-deal negotiations with the potential seller. This step involves the investors preparing a letter of intent showing its intent to acquire shares in the target company. A non-disclosure agreement is typically signed between parties before the investor is granted access to information/database of the seller and the target company in question.

 

At the end of this stage, the investor will conduct due diligence on the operations and business of the seller as well as the target company to investigate them both in legal and financial respects.

 

  • Executing an M&A Deal
 

Upon the completion of the due diligence report, the seller and the buyer negotiate terms and conditions of the definitive share transfer agreement.

 

As a matter of Vietnamese M&A practice, for “complicated” projects (i.e. – the ones that involve the use of land, touch on “sensitive” business sectors or involve structures that may not be familiar with to the licensing authority) it is highly advisable for both parties to seek unofficial approval from the relevant state bodies beforehand.

 

  • Completing an M&A Deal
 

The final step of a typical Vietnamese M&A deal process is that the contracting parties submit the application dossier to the licensing authority for issuance of an investment certificate or certificate of enterprise registration as the case may be (collectively the “Investment Certificate”) registering the change of ownership in the target company. This stage may involve the opening of an escrow account for the benefit of the seller. Upon the issuance of the Investment Certificate, post-licensing procedures need to be completed, including preparation of completion accounts and adjustment of valuation of the target company, if any.

 

Key Considerations in a Typical M&A Deal

 

The following issues are taken into consideration when looking at an M&A deal in Vietnam:

 

1. Market Access


Foreign M&A of local companies may face market access barriers in some business sectors addressed by either domestic legislation or commitments on opening up service sectors that Vietnam made to the World Trade Organization during its 2007 accession. For example, foreign investors are not allowed to hold more than 49% or 65% equity in a joint venture fixed line/mobile network operator depending on whether such operator provides facilities-based services or non facilities-based services respectively. Similarly, current law provides that foreign ownership in public companies (including listed companies or companies with 100 shareholders or more, excluding professional securities investors) cannot be more than 49%.

 

Duane Morris Comments: In the context of Vietnamese market, reviewing the legal feasibility of the deal should be top priority before the parties discuss other deal aspects. This is to ensure that the application for issuance of an Investment Certificate registering the equity transfer will not be rejected by the licensing authority. In some cases, year-long efforts by sellers and buyers have been frustrated at the last moment. On a similar note, for target companies that engage in “sensitive” sectors (e.g. – distribution of goods), consultations should be also sought with the licensing authority prior to a formal application. Thus, an in-depth investigation on market access plays a crucial role in determining the success of an M&A transaction.

2. Due Diligence of Local Target Companies


The foreign investors often face the following difficulties when targeting a Vietnamese company:

 

– Financial information is not transparent and is incomplete.[3] In practice, a company may keep different versions of its accounting book for a specific fiscal year, each of them is designed for a separate purpose (i.e. – for the shareholders’ review only, for tax purposes, etc.).

– The distinction between different levels of management of a company is unclear given the fact that its key shareholder(s) may act concurrently as the members of the board of management and CEO of the company.

– The fact that related party transactions (i.e. – transactions between shareholders, their companies and subsidiaries) are carried out without complying with strict regulations on conflicts of interest.

– Compliance with tax rules and other regulations relating to their operations (environment, employment, etc.) may be patchy.

 

The above common problems of local companies obviously stress on the importance of an extensive and in-depth due diligence process. However, due diligence and disclosure are often unfamiliar concepts to many Vietnamese sellers which further hampers the due diligence process. Limited access to documents and poorly organized data rooms can make it difficult to meet due diligence requests. Perseverance is the key!

 

Legal due diligence for M&A transactions is frequently a difficult and drawn-out process in Vietnam. As there is no nationwide system of public searchable registries in Vietnam, there is greater reliance on the documents provided by the target company and so certain related risks must be managed. Despite being compulsorily required by the law, the progress in developing such a national business registration database has been hampered for many reasons in different parts of the country.

 

Duane Morris Comments: In absence of a workable national business registration database system, the bottom line for investors conducting due diligence is that risk allocation requires resolving issues prior to completion or accepting the risk. Due diligence is even more crucial and so it is vital that foreign investors persevere with the process when legal recourse is limited. The investor, with the strong support of its legal counsel, needs to identify problems of the target company via various sources of information, not merely relying on what the sellers provide. Based on an investor’s findings, they should request extensive representatives and warranties of the sellers in the main transactional documentation.

 

EXAMPLES OF DUE DILIGENCE ISSUES

Issue

Issue Description

Risk

Solution

Capital Contribution Seller fails to make full capital contribution Fines/Future contribution obligation Seller to make full paymentIndemnity
Capital Structure Unlawful increase of charter capital by revaluation of fixed assets Fines / future compliance Seller to make up the difference or decrease the charter capitalIndemnity
Related Party Transactions Failure to comply with special regulations on approval process of these transactions Invalidity The in-charge body of the target company to ratifyIndemnity
Construction Permits Buildings completed without construction permits Demolition Seller to obtain the certificate of ownership of construction work prior to completion
Land Rental Fees Investor’s potential liability to pay land rental fees on the conversion of allotted land to leasehold status Risk that land rental fee become payable Quantify US$ riskIndemnityRetain sum to cover
Internal Labor Rules Target has no [registered] internal labor rules Fines/No solid legal basis to impose labor disciplines on employees Seller to register prior to completion
Intellectual Property Target fails to register its trademarks, trade names and industrial design of local target companies Cybersquatting Seller to file the registration with the National Intellectual Property Office of Vietnam
Environment Failure to comply with strict regulations on environmental protection with respect to the discharge of waste Heavy fines/Potential revocation of Investment Certificate Seller to have the target company comply with such regulationsIndemnity

 

 

3. The Dual Licensing System and the Licensing Process


One of the primary challenges facing investors in Vietnam is the different requirements for foreign investors versus domestic investors. Specifically, foreign investors setting up enterprises in Vietnam for the first time (regardless of foreign equity ownership) are required to secure an investment certificate via a licensing process for evaluation/registration of an investment project which is much more time consuming and complicated than the simple business registration which is applied to local enterprises.

 

In the M&A context, it is not clear whether a foreign investor purchasing a stake in a pre-existing domestic-invested enterprise will need to meet the investment certificate requirements for foreign investment. In fact the law provides a threshold of 49% ownership ratio to indentify whether foreign acquisition in Vietnamese target companies would be subject to the foreign licensing procedures (i.e. – more than 49%) or entitled to the simple business registration (49% or less). Despite such distinction, investment in conditional investment sectors, such as trading and distribution, and those falling under the WTO Schedule, will usually in practice require the issuance of an investment certificate regardless of the foreign equity percentage.

 

Another concern is that discretionary opinions of relevant “in-charge” ministries can vary widely and have considerable impact on whether or not a license to set up an enterprise in Vietnam will be obtained.

 

Duane Morris Comments: Aligning the Investment Law, Enterprise Law and their guiding regulations (as well as clarifying the licensing requirements) will better level the playing field between foreign and domestic companies operating in Vietnam. Different interpretations of the requirements should not exist between the various local and ministry-level authorities should play their part in addressing such inconsistencies.On the investors, extensive consultations between the investors and their legal counsel/licensing authority, where necessary, on how to structure the M&A deal prior to the official application for issuance of the investment certificate is essential. 

4. Valuation and Payment of the Transfer Price


In the case of a share acquisition in a local company, the seller and the buyer may agree on the transfer price. However, this price cannot be less than the “market price” at the time of sale or the book value of the capital contribution portion or shares at the time the management body approves the transfer. For tax management purposes, if the relevant tax authority deems that the transfer price agreed between parties is inconsistent with the “market price”, it can fix the consideration based on documents obtained from an investigation or based on comparable prices in similar transfer contracts (even without referring to the “book value”).

 

Another obstacle is that Vietnamese law currently requests an application for approval of transfer of shares to include “documents evidencing the completion of the assignment.” This application is submitted in order to amend the investment certificate of a foreign invested enterprise and is regarded as an approval process rather than a registration or notification process. The lack of clarity as to what “documents evidencing the completion of the assignment” are required has led to varying interpretations. There have been instances where proof that the seller has received full payment of the consideration from the purchaser was required for the application file to be submitted and the investment certificate amended.

 

Duane Morris Comments: Pending guiding regulations addressing current ambiguities in the law surrounding closing, all buyers should seek to ensure that payment of the transfer price is conditional on an amended/ new investment certificate first being issued. Investor should work closely with their legal counsel, the seller, and most importantly the licensing authority on a workable payment option that protects both the seller and the buyer (e.g. – opening an escrow account, etc.) when the investment certificate is issued. Other solutions for security of payment such as (i) a deposit; (ii) retention sum; (iii) earn-out; or (iv) the buyer granting seller security over shares, etc.) can be considered.

5. 
Anti-trust Restrictions

Pursuant to the Competition Law,[4] a merger/acquisition is prohibited if the “economic concentration” would result in the companies involved in the transaction having a combined market share of more than 50% of the “relevant market.”

 

If the parties to an M&A deal have a combined market share of between 30% and 50% of the relevant market, they are required to notify the Vietnam Competition Administration Department (“VCAD”) 30 days before the proposed economic concentration. The proposed economic concentration can only be carried out once written confirmation has been received from VCAD confirming that it is not prohibited.

 

Concepts such as “relevant market” and “market share” are loosely defined in the Competition Law. As such, the basis for calculating the market share of a potential target company in relation to an economic concentration is not clear under the Competition Law. This lack of clarity can cause difficulty and inconsistencies in the administration of the economic concentration rules. In fact, it may take several months for VACD to issue its written confirmation on the possibility of the deal in question in light of the Competition Law.

 

Duane Morris Comments: Given potential delay that the above anti-trust process can cause, the seller and the buyer should arrive at a workable solution that would better protect investors against the risk of inappropriate economic concentration limitations. An example would be an agreement on indemnities of the seller for a specific period of time after the closing.

6. 
Tax for M&A Transactions in Vietnam


There are currently two tax regimes that apply in the case of M&A transactions depending on whether the transfer of “securities” or “capital” is involved. Generally, any assignment of capital is subject to the standard capital gain tax rate (i.e. – 25% of the profit derived from such assignment). It is important to note that the border between “capital assignment” and “securities transfer” is not crystal clear under either the Enterprise Law or the Law on Securities[5]. In fact, the distinction is based on the contents of official letters of the Ministry of Finance,[6]which is per se not an official legal instrument, that “securities” are shares of public [shareholding] companies while “capital” generally means capital contribution in other companies including non public shareholding and limited liability companies. This lack of clarity regarding the applicable tax rates creates uncertain financial obligations for investors.

 

Duane Morris Comments: Tax laws are subject to rapid policy change and investors should also be aware of tax breaks and incentives that may apply to some M&A activity. Tax is often a major deal structuring driver so it is critical to address tax issues from the outset with your advisors.

Moving Forward: Outlook for M&A in Vietnam

 

While the current realities for foreign investors include legislative and bureaucratic obstacles, there are still great numbers of investment opportunities for foreign investors who persevere in Vietnam’s business sector.

 

There are certainly issues of concern for investors, including an unstable rate of inflation as well as the national trade and budget deficits.

 

However, as aforementioned, despite the issues discussed above, the outlook for M&A in Vietnam seems positive, with the number of M&A deals expected to increase significantly again in the next few years. Indeed, compared to other WTO members, the limitations on market access in Vietnam have been ranked as “low”, which is on a par with Singapore and ranked better than Cambodia, Indonesia and the Philippines who were all ranked as having “medium” level limitations on market access.

 

Moving forward, infrastructure projects are likely to expand as the huge demand for power, roads, and ports, encourages private investment in this sector. The retail sector also continues to attract a great deal of attention while pressures from competition and capital requirements in the financial services sector may push smaller banks to look to new foreign investors to achieve expansion.

 


[1]Law No. 59/2005/QH-11 on Investment dated 29 November 2005 (“Investment Law”).

[2] Law No. 60/2005/QH-11 on Enterprises on 29 November 2005 (“Enterprise Law”).

[3] Due to some common problems under the Vietnamese Accounting Standards, especially the lack of an official system of valuation and the lack of compliance with accounting requirements in respect of the depreciation rate. These common problems create difficulty in assessing the real financial standing of target companies. As a result, inadequate record-keeping and accounting practices continue to pose obstacles to M&A deals in Vietnam.

[4] Law No. 27/2004/QH11 dated 3 December 2004 on Competition (“Competition Law”).

[5] Law No. 70/2006/QH10 on Securities dated 29 June 2006.

[6] Official Letter No. 12501/BTC-CST (“Official Letter 12501”) issued by the Ministry of Finance on 20 September 2010 providing tax policy on transfer of shares in joint stock companies.

 

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For further information, please contact:

 

Giles T. Cooper, Partner, Duane Morris
gtcooper@duanemorris.com

 

Oliver Massmann, Partner, Duane Morris
omassmann@duanemorris.com

 

Le Hoang Ho, Duane Morris
lhho@duanemorris.com

 

2013 Asia Pacific Guide to Mergers & Acquisitions. 

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