Debt concerns prompt greater scrutiny of China’s entrepreneurs

Stephen Mulrenan

Despite a concerted eight-month lobbying campaign by the two main protagonists, few in the investment community were surprised when United States President Donald Trump blocked Canyon Bridge Capital Partners’ planned $1.3bn acquisition of Lattice Semiconductor Corp on 13 September 2017.

Launched last year, Canyon Bridge is partly funded by capital from Beijing and also has indirect links to China’s space programme. President Trump’s intervention came after the Committee on Foreign Investment in the United States (CFIUS) indicated that it would not approve the deal due to national security concerns.

The rejection of the deal comes at a sensitive time in US-China trade relations, with a number of other Chinese deals awaiting approval from CFIUS. These include Unic Capital Management’s $580m acquisition of US semiconductor testing company Xcerra Corp and HNA Group’s proposed purchase of SkyBridge Capital.

Bigger reverse breakup fees and signing deposits are being requested of Chinese bidders than in previous years. This is because foreign sellers are nervous about the ability of Chinese companies to close an outbound transaction in the current political climate, particularly from a funding perspective.

In response to the value of the RMB depreciating over six per cent against the US dollar in 2016 and the rapid decline in China’s foreign exchange reserves, Beijing has been restricting outbound foreign investment through a tightening of its approval and filing regimes.

The responsible government departments – the People’s Bank of China, the National Development and Reform Commission and the Ministry of Commerce – have reconfirmed Beijing’s support for strategic trade initiatives such as Belt and Road, but have also emphasised the importance of monitoring ‘irrational’ acquisitions.

However, the lack of any regulation around such investments has caused a great deal of uncertainty on what precise capital outflow restrictions were in place, leading to a sharp decline in Chinese outbound activity. For example, announced outbound mergers and acquisitions in the first six months of 2017 was down 42 per cent on the previous six-month period. This included a 79 per cent drop off in investment into the US.

Caroline Berube, a partner at HJM Asia Law & Co and Co-Chair of the IBA Asia Pacific Regional Forum, says it will be difficult for businesses to grow if they feel they cannot invest overseas due to uncertainty. ‘The fear of the officials is definitely legitimate, but if no one dares to invest overseas… the return on investment may be limited.’

Beijing’s real concern is around capital flight, particularly over deals that carry a suspicion of money laundering, as well as China’s rising debt levels. In July 2017, Suning became the latest Chinese company to come under attack for its ‘irrational’ acquisition of Italian football club Inter Milan. The Nanjing-based retailer initially paid €270m in June for a 70 per cent stake in the club, one of a number of deals that constituted a 44 per cent annual rise in outbound investment into non-financial sectors.

Although tighter scrutiny has been applied to investments in sectors as diverse as sports clubs, real estate, hotels, media companies and movie theatres, often the ownership of these Chinese acquirers, their level of indebtedness and the way in which some of their acquisitions are financed is far from clear. Seyfarth Shaw’s new Hong Kong Managing Partner, Raymond Wong, explains that these companies have often borrowed hugely from Chinese banks to do deals that simply do not add up. ‘The government quite properly wants to know if these companies are buying assets at a high premium and, if so, why?’ he says. ‘For example, is there any suggestion of the purchaser paying a high price to secure additional and undisclosed benefits?’

According to data from Dealogic, private companies Anbang Insurance, Dalian Wanda, Fosun International and HNA Group have accounted for $56bn of outbound activity from China over the last five years. Beijing’s concern with this aggressive dealmaking led to the China Banking Regulatory Commission launching a ‘fact-checking’ probe in June 2017 to establish whether high-interest financial products and overseas loans might have been utilised.

While most outbound activity has been funded with traditional loans from Chinese and foreign banks or from state reserves, meaning it can be tracked by Chinese regulators, some private entrepreneurs have sought financing through a number of potentially risky channels.

Standard & Poor’s recently followed its agency rivals in downgrading China’s credit rating over worries about the rapid build-up of debt in the country. While this is likely to increase the cost of borrowing for state-owned entities, increasing the debt risk, Beijing hopes that its recent publication of outbound investment guidelines will encourage China’s entrepreneurs to stop making ‘irrational’ acquisitions.

Issued by the State Council in August 2017, the Guidelines on Further Guiding and Normalizing the Directions of Outbound Investments effectively codify the previous restrictions on certain types of outbound investment, and classify types of investment and sectors as ‘encouraged’, ‘restricted’ or ‘prohibited’.

In that sense, argues Wong, categorising outbound investment in a similar way to inbound investment (the 2017 version of the Catalogue for the Guidance of Foreign Investment Industries came into effect on 28 July) is just a natural process for Beijing. ‘We will see, and to some extent are already seeing, a different kind of Chinese acquirer buying into local investment funds overseas to acquire local assets.’

As clarity emerges over China’s regulatory attitude towards outbound M&A, practitioners expect to see more China outbound activity in the final months of 2017. But Chinese buyers will no longer be as able to pay such high premiums for foreign assets that offer little in the way of returns.

‘China becoming more cautious is positive from a buyer’s perspective as it should create greater market certainty,’ says Wong. ‘But sellers might have to become more realistic in terms of pricing.’

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Global legal practitioners attend IBA Annual Conference in Sydney

left: Dr Robert Gates, Centre: The Hon John Winston Howard OM AC, Right: Julian Assange

With the IBA Annual Conference taking place in Sydney on 8–13 October, the next edition of Global Insight will be reporting on some of the highlights. The week-long event includes ‘Conversation with’ interviews with former Australian Prime Minister, The Hon John Winston Howard OM AC, former United States Secretary of Defense, Dr Robert Gates, and WikiLeak’s Founder and Editor-in-Chief, Julian Assange.

Showcase sessions focus on gender equality and womens’ rights; the wide-ranging risks of cybercrime; the impact of populism on legal services and lawyers; and the balance between migration, international security, rule of law and terrorism; plus, a keynote session on data, disruptive innovation and the new digital world.

Among the many notable speakers are Australia’s first female Chief Justice, The Hon Susan Kiefel AC; former US Trade Representative, Ambassador Michael Froman; the Minister of Justice of Ukraine, Pavlo Petrenko; and President of the Australian Human Rights Commission, Rosalind Croucher AM.

The Conference culminates with the Rule of Law Symposium, exploring the anti-corruption revolution in Latin America and the politics of judicial appointments. Be sure to check the next edition of Global Insight and the IBA website for interviews, films and reports from Sydney.

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Corporate accountability: US Supreme Court set to clarify alien tort statute

Michael Goldhaber, IBA US Correspondent

In October, America’s Supreme Court justices will finally address the question of corporate liability under international law, at the oral argument of Jesner v Arab Bank. It follows the doubly notorious case of Kiobel v Royal Dutch Petroleum and ongoing legal uncertainty over the scope of the Alien Tort Claims Act in the United States.

In Kiobel I, the Second Circuit Court of Appeals flatly declared that corporations cannot be held liable for violating customary international law. On review, the US Supreme Court avoided the minefield of corporate human rights impunity only by changing the subject late, and at the expense of clarity. In Kiobel II, the Supreme Court held that an alien tort claim must ‘touch and concern’ the US enough to displace the presumption against extraterritoriality. Alien tort had survived – yet the Supreme Court had left companies unaccountable in the Second Circuit, and virtually invited lower courts to create a convoluted mixture of territoriality tests.

The Supreme Court has an opportunity to clarify its Kiobel II ruling on extraterritoriality in its upcoming decision on whether to review Adhikari v KBR.

Human rights advocates are optimistic that, in taking Jesner, the Supreme Court signals an intent to overturn Kiobel I. ‘It’s become clearer, even since the decision was made, that the Second Circuit’s analysis of corporate liability is wrong,’ says Kiobel appellate counsel Paul Hoffman. ‘Every other circuit that’s looked at it has found corporate liability, and the US government continues to take the position that there should be corporate liability.’

According to Jesner plaintiffs’ counsel Michael Elsner, the Alien Tort Act ‘doesn’t restrict who can be sued, Congress had full discretion to create the statute the way that it did, and international law doesn’t make the distinction that the Second Circuit determined between a corporation and any other private actor’.

Although the US Solicitor General sides with the plaintiffs on Kiobel I, it urges the Court to remand Jesner under Kiobel II. This raises the distinct possibility that the alien tort claims in Jesner v Arab Bank will ultimately be dismissed on the grounds that they do not sufficiently ‘touch and concern’ the US.

The Fifth Circuit, in the KBR case, adopted the narrow business community approach. It limits its inquiry to the conduct on which the statute is focused, finding support in the Supreme Court’s rulings in Morrison v National Australia Bank and RJR v European Community. By contrast, the Fourth Circuit, in Al Shimari v CACI, adopted the broad plaintiffs’ approach and looked at all conduct relevant to the claim.

Even in the face of this uncertainty, a few rare alien tort plaintiffs have been able to strike settlements and use the US courts as a forum to recover for human rights abuses overseas. The latest example is Salim v Mitchell, which settled confidentially on the eve of a trial set for early September 2017. In Salim, victims of US torture sought to hold liable the two psychologists who designed the Central Intelligence Agency’s ‘enhanced interrogation’ programme. The plaintiffs won on summary judgment in August.

There are few alien tort cases left, yet each is extraordinary, involving issues such as torture and allegations of funding military groups. These may give the Supreme Court further opportunities to clarify alien tort law, including territoriality.

After all these years, the Supreme Court has ‘still not set the rules of the road’ for alien tort, says Kiobel counsel Hoffman – and, until it does, lawyers are reluctant to bring new cases. But, once the uncertainty clears, Hoffman predicts another wave of corporate accountability litigation. ‘Whether it’s under the Alien Tort Statute or foreign law or another theory of liability,’ he says, ‘these cases are not going away.’

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IBA and Arab International Women's Forum initiative

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New report on how blockchain can optimise legal processes

The IBA Legal Policy & Research Unit (LPRU) has added to its disruptive innovation series of reports with a new publication on blockchain technology and the legal profession. The Not-so-Distant Future explores the ways in which law firms could potentially optimise legal processes using blockchain – the decentralised, immutable public ledger that underpins Bitcoin and other cryptocurrencies. The report says legal professionals should keep abreast of the ways in which blockchain may potentially affect legal practice, from the rise of smart contracts to electronic discovery in litigation. It also considers the impact of the technology on internal firm management, identity management, cyber security, evidence, information sharing, estates and trusts, and land title and cross-border asset transfer.

The Not-so-Distant Future: Blockchain and the Legal Profession, as well as other LPRU reports on disruptive technology, can be downloaded at tinyurl.com/IBA-not-so-distant

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