Due diligence in cross-border mergers: Navigating different cultures
By Muriel Joseph-Williams*
August 9, 2013
Another article on mergers and acquisitions? And cross-border deals at that! Why bother, given that so much literature has been published on cross-border M&A, especially with respect to why some transactions – particularly cross-border ones – often crash and burn and end in failure?
This article, however, looks at such deals from another angle.
In addition to the more typical corporate law and organizational structure discrepancies, geo-political and socio-cultural differences endemic to different countries (or even regions within the same country) should be added to the long list of challenges that routinely occur when two business organizations, located in separate countries, try to merge. This can result in unexpected pitfalls beginning during the due diligence process and continuing up through post-closing integration.
Due diligence in cross-border transactions can be particularly problematic. Mergers or other business transactions, to be successful, usually follow generally accepted rules that provide a standardized platform from which both parties can analyze the potential transaction. Providing ordinary course documents such as budgets, capex reports, financial statements, organization charts, business plans, R&D and technical process summaries, etc., is a key element of any methodology designed to help the parties know what is at stake and what each party is or will be dealing with when the merger closes. While this postulate is largely accepted in the US and elsewhere in the Western world, where different types of confidentiality agreements (primarily, non-disclosure agreements or “NDAs”) determine how confidentiality and disclosure will be governed, this approach is not universal.
In a recent transaction that involved the author, a company in China was looking for investors or partners to raise US$30 million to finance a new plant in the Philippines. In the due diligence phase for this transaction, the investors’ financial analysts requested detailed documentation containing sales and revenue projections and how the investment proceeds would be used. That did not happen and the reluctance to share such information by the Chinese company (because it considered it to be “strategic”) turned out to be a critical impediment to investors in assessing the Philippine opportunity. In many Asian societies, communication is both highly contextual and indirect and often not explicitly expressed. This carries over to diligence, where many Asian businesspersons expect the counter party to have a high level of acceptance for secrecy and an equal amount of tolerance for ambiguity. They also expect that the due diligence process will be based on trust, developed through social contacts and other interrelationships, and not so much on documentary and factual data. Thus, initially requesting or, if dissatisfied with the initial response, seeking additional internal, financial or other strategic documents or information from Asian counterparties can place the potential business partner or investor in the unenviable position of being viewed as bu gei mianzi – per the Chinese phrase, one not caring to give “face” or, in other words, not wanting to embarrass others.
The weight we give during due diligence to NDAs and other confidentiality agreements is based on the trust we have in our legal system and its application to most business transactions, rendering such documents generally enforceable by the courts. In certain countries in Asia, the Middle East or Latin America, however, laws, rules and regulations can be particularistic, which means their application and enforcement will likely depend on who the parties are and to whom the parties seek to have the agreements apply. For instance, when it comes to due diligence and the transfer of confidential, strategic or otherwise sensitive information to potential investors or business partners in the Middle East (Saudi Arabia or the UAE come to mind), business persons in those jurisdictions have real difficulty in understanding the necessity of entering into written confidentiality agreements, such as NDAs. The amount of value given to written agreements by courts in these countries depend on large parts on who is party to the agreement and their respect of position and influence on the society. And, more often than not, the commitment to hold disclosed materials confidential will take the form of an oath or a promise (“I give you my word”), rather than executing a written document defining the responsibilities and rights of the parties.
This might not be enough comfort for US or other Western companies used to entering into written documents that reflect the parties’ agreements, but such companies often must learn to adapt their usual expectations, customs and practices to work in the Middle East, Latin America and Asia, where the notions of honor and face are frequently critical and business relationships are based on personal interactions and social relationships. In these types of environments, business or investment opportunities are often community – or family-related and being accepted as an investor or a business partner is equivalent to becoming a member of a community or even part of an extended family, with the ensuing business relationship viewed as an exchange of mutual “favors,” that will bring benefits and wealth to those who are willing to accept the unwritten, but actually quite strict, rules of the group.
In addition to adapting to different social or cultural mores, it is also important to realize that different countries have different political and legal systems, many of which are based on the country’s geo-political, ethnic and, at times, religious heritage, resulting in transaction-related documents being treated as essentially nonexistent, superfluous or without legal merit. These systems may strike many Westerners as backward and parochial, but doing business in these countries requires an ability to understand and adapt to various local requirements. In the People’s Republic of China, for another example, business persons can be enormously reluctant to turn over internal business plans and analyses, citing the PRC government’s interest in the business as justifying “national secret” status for such materials. These societal, cultural and geo-political differences create additional constraints, that require agility on the part of U.S. and other Western companies doing business in these countries to adapt to an ultimately adopt the various local practices and customs to allow them to evaluate and analyze the terms and future benefits of a business deal.
Much has been written about the benefits of standardizing and making “transparent” on a world-wide basis all aspects of due diligence and deal-making, but the combination of disparate rules and systems, in our view, renders the likelihood of a globally accepted definition of “due diligence” and transparency in the conduct of such diligence in cross-border M&A transactions essentially inapplicable. The concept is a worthy one, but not easily achievable, as it would require an adaptive approach by all and, to be successful, would need to include consistent communication and understanding between the parties, some written and most verbal, all of which will vary, depending on which cultures and customs are in place.