Serial article regarding M&A on NNA (vol.102)

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 valuing assets, it is often a point of contention whether a value of real estate should be assessed at market value or book value. Particularly in Malaysia, property prices have historically continued to rise, and the older the date of purchase of a property, the greater the discrepancy between book value and market value tends to be, so valuing at book value may result in the value being too far removed from the reality.[1]

On the other hand, as a buyer, if a real estate is essential for the continuation of the target business, the buyer will not be able to resell the real estate after the acquisition and will have a large unrealised gain that cannot be realised immediately. To avoid this, a scheme may be adopted whereby the real estate is transferred from the target business to a separate legal entity owned by the owner, which then leases the real estate to the target company.

In a case in which we were previously involved, due diligence was carried out on the basis of this scheme. However, during the process of the due diligence, a number of problems were discovered, including: (i) a new business license would have to be obtained if the real estate was transferred to the new company; (ii) more taxes than expected would be incurred to transfer the real estate to the new company; (iii) the real estate was not registered for the preservation of the strata title; and (iv) there was a dispute over the boundary between the exclusive and common areas.

(i) As mentioned in the 100th article, business licenses are usually tied to a company, so a transfer of shares rather than a transfer of business is the norm, but in that case the buyer wanted to separate the real estate. The first obstacle was that the issuing of new licences was either frozen or, if it was possible, it would take a considerable amount of time.

(ii) With regard to taxation on the transfer of real estate, the tax rate varies depending on the number of years since the real estate was acquired and the attributes of the target company, and it was found that the highest tax rate is imposed on the target company, and it was discussed whether the seller or the buyer should bear this tax in what proportion.

(iii) As the target real estate had been built before the so-called the Strata Title Act came into force and the title of the target real estate had not been retained by the developer, who was the former owner, the issue arose as to whether or not the transfer could be registered without an intermediate step and whether the transfer could be promptly registered with the target company.

In general, there are many cases where there is a discrepancy between what the seller told us orally and what we were able to confirm through due diligence, but this case was an opportunity for us to be reminded that due diligence is essential for an accurate understanding of the issues involved.

[1] For example, the average price of a residential property in Kuala Lumpur increased from RM245,249 in 2000 to RM708,812 in the first quarter of 2021 at an average annual rate of 5.6%.

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