Due Diligence Guidelines –
Code of Conduct Paragraphs
Key Stock Exchange Guidance Letters
1. Engagement of Foreign Lawyers
A sponsor cannot abrogate responsibility for due diligence. Where a sponsor engages a third party to assist it to undertake specific due diligence tasks (e.g. engaging lawyers to undertake verification of title to properties…), the sponsor remains responsible in respect of the matters to which the specific tasks relate. A third party’s work, in itself, would not be sufficient evidence that a sponsor has discharged its obligation to conduct reasonable due diligence. The degree to which a third party’s work can be relied on may depend on the professional qualifications of the third party to conduct the work. As a minimum the sponsor should:
(i) assess whether the third party is appropriately qualified and competent for the tasks assigned to it;
(ii) consider the scope and extent of the tasks to be performed by the third party;
(iii) assess the results of the work performed by the third party and arrive at its own opinion whether the work provides a sufficient basis to determine that reasonable due diligence has been conducted and whether further due diligence is required;
(iv) assess whether the results of the work are consistent with other information known to the sponsor including that derived from its other due diligence work; and
(v) assess whether the results of the work should be incorporated in the listing document and whether they should be brought to the attention of the regulators.
[Paragraph 17.6(g) of the Code of Conduct]
1.2 General Guidance
1.2.1 Due diligence is a collaborative process and sponsors do not have the expertise or professional qualifications necessary to express an opinion on matters of foreign law and regulation which are relevant to the listing of a new applicant and the information which is required to be disclosed in its listing document. Where the due diligence in respect of a listing applicant involves issues of foreign law or regulation, the sponsor will therefore need to rely on legal expertise as part of its due diligence,1 including legal advice and opinions on relevant issues.
1.2.2 In the course of a listing assignment, legal advice, opinions and input from lawyers in relevant jurisdictions will be required for a number of reasons, including:
(a) the requirement of the Listing Rules for listing documents of overseas listing applicants to include a summary of relevant regulatory provisions (statutory or otherwise) of such jurisdiction;2
(b) the requirement to disclose in the listing document the additional disclosure items in paragraphs 63 to 66 of the Joint Policy Statement Regarding the Listing of Overseas Companies in relation to an overseas listing applicant’s jurisdiction of incorporation;3
(c) the requirement that listing documents of overseas listing applicants include details of the obligations to which potential investors may be subjected under the laws and regulations of the relevant jurisdiction to facilitate investors’ understanding of their potential obligations and exposure, and how investors may be able to fulfill the obligations. Investors’ obligations could cover a range of areas, including obligations to disclose shareholders’ interests and tax payments on capital gains and dividends;4
(d) the requirement of the Exchange for the submission of the legal opinions referred to in paragraph 1.3.3 below in the case of listing applicants with operations in the PRC;
(e) to assist with the preparation of the “Applicable Laws and Regulations” section of the listing document in accordance with the requirements of Section G of Appendix 1 to Exchange Guidance Letter GL86-16. According to that Guidance Letter, listing applicants should disclose the laws and regulations that are material to their current and/or future businesses. Where a listing applicant has, or plans to have, material businesses, in terms of its operations and sales, in a number of jurisdictions, an appropriate description of the laws and regulations that have a material impact on the applicant’s business in each such jurisdiction should be included;5 and
(f) to assist the sponsor’s conduct of due diligence by providing opinions or advice on matters relevant to information to be disclosed in the listing document, such as property titles, validity of intellectual property rights, compliance with laws and regulations etc.
1.2.3 Providing legal advice and/or legal opinions is specialist work which is clearly only within the competence of the lawyers providing it. Accordingly, if the lawyers are negligent, the sponsor will not normally have any responsibility,6 provided that the sponsor assesses that the lawyers are appropriately qualified and competent for the tasks assigned to them and takes the other steps set out in Paragraph 17.6(g) of the Code of Conduct. Any section of the listing document which is a copy of or extract from a report, opinion or other statement issued or made by foreign lawyers and which is included in the listing document with their consent, will be an “expert report” for the purposes of Paragraph 17 of the Code of Conduct which will require the sponsor to take the steps set out in Paragraph 17.7 of the Code of Conduct. See further at section 3 below.
1.2.4 Certain information in relation to the listing applicant, its constitutive documents and the laws and regulations of its jurisdiction of incorporation which is required by the Listing Rules to be included in the listing document is reproduced in Appendix I to this chapter.
1.3 Recommended Steps
Opinions and Advice
1.3.1 Where the listing applicant is incorporated or otherwise established overseas, the sponsor should obtain a legal opinion from lawyers in the relevant jurisdiction to address issues including:
(a) the capacity and authority of the listing applicant to execute and perform the documents to be entered into in connection with the listing (the “Transaction Documents”);
(b) the legal effect of the Transaction Documents: for example, that they create valid, binding and (subject to necessary qualifications) enforceable obligations of the listing applicant; and
(c) governing law and jurisdiction: for example that the governing law of the Transaction Documents has been validly chosen, the listing applicant’s submission to the courts of the relevant jurisdiction is binding on it, and that a judgement obtained from such a court can be enforced or sued upon in the courts of the jurisdiction in which the listing applicant is incorporated.
1.3.2 The sponsor should ensure that lawyers in the jurisdiction of incorporation or establishment of an overseas listing applicant are instructed to provide the summary of relevant provisions (statutory or otherwise) of such jurisdiction and the information as to the obligations to which potential investors may be subjected under the laws and regulations of such jurisdiction which are required to be included in the listing document. (See paragraphs 1.2.2(a) to (c) above).
1.3.3 In the case of listing applicants with operations in the PRC, the sponsor should ensure that PRC lawyers are instructed to provide the following PRC legal opinions required by the Exchange:
(a) if the listing applicant has material business operations in the PRC, a legal opinion on:
(i) details of the relevant mainland interests where the Group has any PRC legal entity in its shareholding structure;
(ii) whether approval by any PRC government or regulatory authority is required for the listing of the listing applicant’s shares on the Exchange; and
(iii) details of all the requirements under applicable PRC laws and regulations relevant to the conduct of the Group’s business in the PRC, and whether it fully complies with the relevant requirements, including details of the licences, permits or certificates obtained by the Group;7
(b) for a PRC incorporated listing applicant, a copy of the PRC legal opinion sent to the CSRC for the company’s listing on the Exchange;8 and
(c) any legal opinion in respect of properties in the PRC as may be required under the Listing Rules. For further guidance, see Chapter 21 “Due Diligence Guidelines – Inspection of Assets and Property Valuers’ Reports”.
1.3.4 Where the listing applicant is – or has very significant assets or subsidiaries – incorporated or situated overseas, or has very significant operations in jurisdictions outside Hong Kong, the sponsor should consider obtaining legal opinions and/or advice from lawyers in relevant jurisdictions covering matters where specific areas of risk to the business are identified such as:
(a) title to material properties and assets which are critical to the listing applicant’s business;
(b) compliance with foreign laws and regulations in areas such as foreign investment, foreign ownership, tax, labour, environmental protection, health and safety, land/property use, competition and anti-trust, and laws specific to the listing applicant’s industry or major business(es);
(c) the validity and enforceability of contracts which are critical to the listing applicant’s business;
(d) any on-going litigation or government investigations to which the listing applicant is subject; and
(e) the validity and enforceability of proprietary interests, intellectual property rights, licensing arrangements and other intangible rights which are critical to the listing applicant’s business.
1.3.5 The sponsor should also consider instructing lawyers in relevant jurisdictions to assist with the preparation of the “Applicable Laws and Regulations” section of the listing document. See paragraph 1.2.2(e) above.
1.3.6 In the case of a very large listing applicant with subsidiaries or operations in numerous jurisdictions, obtaining a confirmation from the listing applicant’s in-house lawyer or a senior member of management after review by the listing applicant’s in-house lawyer may be an acceptable alternative to an opinion or advice of external lawyers under paragraphs 1.3.4 and 1.3.5 above.
1. The consultation conclusions on the regulation of IPO sponsors acknowledged that there are areas where a sponsor’s delegation of due diligence tasks is appropriate. They state, by way of example, that “a sponsor may need to rely on legal expertise as part of due diligence, including legal advice and opinions on proprietary rights. This specialist work is clearly only within the competence of the adviser and if it is negligent the sponsor would not normally have any responsibility”. See the Consultation Conclusions on the Regulation of Sponsors at paragraph 173.
2. Listing Rule 19.10(3) requires the listing document for an overseas listing applicant to contain a summary of the relevant regulatory provisions (statutory or otherwise) of the jurisdiction in which the overseas listing applicant is incorporated or otherwise established in a form to be agreed upon by the Exchange on a case by case basis and in the Exchange’s absolute discretion. This requirement is modified in the case of an overseas listing applicant which is incorporated or otherwise established in a jurisdiction in respect of which additional requirements are set out in Appendix 13 and which is applying for listing by way of an introduction in the circumstances set out in Listing Rule 7.14(3). In the case of a PRC incorporated listing applicant, Listing Rule 19A.27(3) requires the listing document to include a summary of the relevant PRC law in a form to be agreed upon by the Exchange on a case by case basis. The note to Listing Rule 19A.27(3) provides that in general, the relevant PRC law to be summarised normally would be expected to cover matters such as taxation on the PRC listing applicant’s income and capital, tax (if any) deducted on distributions to shareholders, foreign exchange controls or restrictions, company law, securities regulations or other relevant laws or regulations, and any PRC law which regulates or limits the PRC listing applicant’s major business(es) or the industry in which it mainly operates.
3. Paragraph 63 of the Joint Policy Statement Regarding the Listing of Overseas Companies requires an overseas company’s listing document to clearly disclose, among others, a summary of the provisions in the laws and regulations in its home jurisdiction and primary market that are different to those required by Hong Kong law regarding: (i) the rights of its holders of securities and how they can exercise their rights; (ii) directors’ powers and investor protection; (iii) the circumstances under which its minority shareholders may be bought out or may be required to be bought out after a successful takeover or share repurchase; and (iv) details of withholding tax on distributable entitlements or any other tax that is payable (e.g. capital gains tax, inheritance or gift taxes) and whether Hong Kong investors have any tax reporting obligations.
4. See SFC Dual Filing Update of July 2010 in which the SFC noted disclosure deficiencies in various cases where the listing applicant’s place of incorporation was recognised as an acceptable jurisdiction only recently. The listing applicants failed to provide full details of the obligations to which potential investors might be subjected, some of which could have been substantially different from or more stringent than those in Hong Kong. The SFC commented that without such information, investors could be unknowingly exposed to potential consequences of non-compliance as they might not be familiar with the legal or regulatory position in the relevant jurisdiction.
5. Exchange Guidance Letter GL86-16, Appendix 1, Section G provides guidance on the information which should be disclosed in the “Applicable Laws and Regulations” section of a new applicant’s listing document. The main requirements are that:
(a) the section should be written in a manner that conveys a regulatory overview that is easy to understand by investors who are not lawyers;
(b) the section should include up-to-date laws and regulations that are specific and have a material impact on the listing applicant’s business (e.g. rules and regulations governing the applicant’s key licences for operation). Disclosures should explain clearly how each law or regulation affects a listing applicant’s business. Boiler plate disclosures of laws and regulations that do not materially impact the listing applicant’s business (e.g. laws that apply to a business segment which represented, and is expected to represent, a relatively small percentage of an applicant’s revenue and profits) should be avoided;
(c) where an applicant has or plans to have material businesses, in terms of its operations or sales, in a number of jurisdictions, an appropriate description of the laws and regulations that have a material impact on the listing applicant’s businesses in each such jurisdiction should be made (e.g. protective tariffs or trade restrictions imposed on the applicant’s goods imported into the customer’s country; intellectual property protection in relation to the products sold by the applicant in the customer’s country and the applicant’s liability for breaches);
(d) where there is a risk that the listing applicant’s business may commit a material breach of a law or regulation, the steps that the listing applicant has taken and plans to take to ensure compliance should be disclosed in the “Applicable Laws and Regulations” section and cross references should be included to other sections of the listing document (e.g. the “Risk Factors” or the “Business” section). It may be appropriate to include the opinion of a legal adviser as to the materiality of the risk, the risk of enforcement, and the maximum liability of the listing applicant;
(e) future changes in laws and regulations that are expected to have a material impact on the listing applicant’s business should be disclosed under the “Applicable Laws and Regulations” section (e.g. the impact of an increase in stamp duty on a property development company; or a more stringent financial requirement for obtaining a licence). There should be cross references to the “Business” and the “Risk Factors” sections to describe the impact of the changes on the listing applicant, and its plans and procedures implemented or to be implemented to deal with such changes;
(f) changes in laws and regulations during or prior to the track record period do not need to be disclosed unless: (i) such changes continue to have a material impact on the listing applicant’s business, or (ii) such changes affect the interpretation of the listing applicant’s financial performance during the track record period, in which case cross references should be included to other sections of the listing document (e.g. the “Business” or “Financial Information” section);
(g) for listing applicants engaged in a highly regulated industry (e.g. banking, insurance or gambling), the “Applicable Laws and Regulations” section should include internationally implemented industry specific rules and regulations (e.g. anti-money laundering) as well as the local laws governing the industry (e.g. banking laws, laws governing insurance companies or gambling laws);
(h) the disclosure of regulatory provisions in relation to a listing applicant’s jurisdiction of incorporation (as required by Listing Rules 19.10(2) and (3) and the specific disclosure items in paragraphs 63 to 66 of the Joint Policy Statement Regarding the Listing of Overseas Companies) should be set out in a section of the listing document separate from the “Applicable Laws and Regulations” section; and
(i) where an applicant experiences legal process inefficacy in its jurisdiction of incorporation (e.g. considerable backlog in the local courts giving rise to significant delays in enforcing legal remedies; difficulty of enforcing of a foreign judgement against the applicant due to complexity over recognition of overseas judgements; procedural impediments in the judicial systems) which would affect the operation of its business and how shareholders (including depositary receipt holders) would exercise their rights against the applicant or among themselves in a timely manner, the applicant should highlight its observations on the difficulty of law enforcement in this section. There should be cross references to the “Business” and the “Risk Factor” sections to describe the impact, and its plans implemented or to be implemented (if any) to mitigate the impact on the applicant and its shareholders.
7. Form M104 Main Board: IPO – Additional information to be submitted together with the Form A1 at paragraph C.9.
HKCFEF Limited and the contributing law firms, accountants and sponsors are not offering these due diligence guidelines as legal, financial or professional advice or services and they should not be relied upon as such. These due diligence guidelines should not be used as a sole basis for any decision, action or inaction and are not meant to serve as a substitute for the advice of qualified professionals. See here for the full terms and conditions.