Serial article regarding M&A on NNA (vol.101)

Continuing from the previous article, this article looks at cases where actual events identified as a result of due diligence turned out to be a problem.

Assets and liabilities

In a case involving an acquisition of a manufacturer, it was found that part of a factory buildings was located on so-called Malay Reserve Land (MRL).

MRL is land that only Malays[1] are permitted to own, lease or grant security interests in, and its origins date back to 1913 during the British colonial period, even before Malaysian independence, and its purpose is to protect Malay rights. If a Japanese company were to become the owner of the company, it would no longer be allowed to own the land and buildings in the MRL, so it would be necessary to separate the land from the company or some other scheme would have to be considered.

In that case, it was not possible to demolish the part of the building built on the MRL, and the scheme was to separate only the land part of the MRL and transfer the ownership of that part to another Malay company using a nominee. However, the buyer decided that a nominee could not be used from a contingency risk perspective. As a result, the ownership of the MRL could not be transferred properly and the M&A itself eventually broke down, as the factory was essential for the continuation of the business.

Secondly, in a financing case in Japan, not M&A case, but the client attempted to provide a loan to a business partner on the security of its main manufacturing equipment, only to discover that the manufacturing equipment was already secured by another creditor.

If a valid security interest has been established against other creditors, a later creditor will in principle be subordinated and it will be difficult for the later creditor to secure its claim on the object in question, unless the amount of the object substantially exceeds the amount of the secured claim. Unlike mortgages on real estate, where a signboard immediately reveals whether a first priority mortgage has been established, it is not always possible to reveal the existence of a security interest on movable property externally, so due diligence, including on-site inspections, is essential.

In that case, the manufacturing equipment itself was not registered with the name of the creditor and the existence of the security interest could not be revealed during the on-site inspection. However, during the due diligence, the existence of the first priority security interest was revealed when an agreement was found which promised the establishment of the security interest. Although the lack of a signboard that the relationship of superiority and inferiority with other creditors was not always clear, the client did not want to risk a dispute with other creditors as its claims were not 100% protected by the manufacturing equipment, so it decided to acquire the target company’s shares and other assets as security instead of the manufacturing equipment. The client decided to provide the loan by acquiring shares and other assets of the target company as security, rather than the manufacturing equipment in question in the end.

* The relevant legislation defines Malays as people who are Muslim, speak Malay and belong to the Malay ethnic group.

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