Due Diligence Guidelines –
2. Understanding of Business, History and Background
2.1.1 Based on reasonable due diligence, a sponsor should have a sound understanding of: … a listing applicant, including its history and background, business … operations and structure… [Paragraph 17.3(a)(i) of the Code of Conduct]
2.1.2 Regarding the preparation of a listing document, a sponsor should perform, without limitation, each of the following: … achieve a thorough understanding of the listing applicant, including its business, history, background, structure… [Paragraph 17.6(d)(ii) of the Code of Conduct]
2.2.1 This due diligence guideline focuses on certain circumstances where matters of foreign law may be relevant to the due diligence process. Sponsors should also refer to . For general guidance on conducting due diligence on the listing applicant, its history and background, business, operations and structure, the sponsor should refer to the other due diligence guidelines including, in particular, , and .
2.2.2 The sponsor will require lawyers in jurisdictions in which the listing applicant and its material subsidiaries are incorporated to assist in conducting searches in public registries and in the review of articles of incorporation or other constitutive documents, documents of title etc. in order to ascertain and verify certain information which is required to be included in the listing document.
2.3 Recommended Steps
2.3.1 The sponsor should ensure that local lawyers are instructed to conduct searches of public registries in relevant jurisdictions to verify relevant material information which is required to be included in the listing document. Such information may include, without limitation, the following information, and the searches that should be conducted are as set out below:
(a) the full name of the listing applicant9 and its directors;
(b) the date and country of incorporation or other establishment of the listing applicant and the authority under which it was incorporated or otherwise established.10 A search should be conducted of the company registry in the listing applicant’s place of incorporation or other establishment to confirm that it is duly established in that place, that it continues to exist and that the listing applicant is in compliance with its memorandum and articles of association or equivalent constitutive documents;11
(c) if the listing applicant is a subsidiary, the names of and the number of shares held (directly or indirectly) by each holding company of the listing applicant.12 A search should be conducted of the company registry in the place of incorporation of each holding company of the listing applicant to confirm that it is duly established in that place and continues to exist;
(d) the following information in respect of each company the whole of, or a substantial proportion of, whose capital is held or intended to be held (either directly or indirectly) by the listing applicant, or whose profits or assets make or will make a material contribution to the figures in the accountants’ report or the next published consolidated accounts of the listing applicant:
(i) the name, date and country of incorporation or other establishment; and
(ii) its issued share capital and the proportion thereof held by the listing applicant.13
A search should be conducted of the company registry in the place of incorporation of each such company to confirm that it is duly established in that place and continues to exist;
(e) the listing applicant’s authorised, issued and paid-up share capital;14
(f) winding-up and litigation searches should be conducted on:
(i) the listing applicant; and
(ii) each company whose profits or assets make or will make a material contribution to the figures in the accountants’ report or the next published consolidated accounts of the listing applicant or which is otherwise material to the Group, in:
(A) the jurisdiction of incorporation of each such company; and
(B) any jurisdiction where the Group carries on its major business(es) in which any such company operates.
Where appropriate, the sponsor may however take into account that in many jurisdictions, no centralised records are kept of insolvency, bankruptcy or litigation, thus often making such searches impractical and very expensive. In such circumstances, the sponsor should consider the relative level of additional comfort that might be gained from such searches against the feasibility and costs of doing so.
In appropriate circumstances, the sponsor may rely on reports produced by the listing applicant regarding litigation and insolvency; additional comfort may be derived from a confirmation, particularly one drafted specifically enough, which can show that the listing applicant and/or its directors have addressed their mind to the issue. It should be noted that litigation searches will not reveal any pre-proceedings claims or arbitration and that not all jurisdictions maintain publicly available records of litigation proceedings. It should also be noted that due to the logistics involved in carrying out searches and the time needed to be able to consider any matters raised in searches, particularly if these are in overseas jurisdictions, there will inevitably be gaps between the dates at which searches are carried out and the dates on which listing documents are filed or issued;
(g) searches should be conducted at public registries at which interests in the Group’s material properties are required to be registered or otherwise recorded; and
(h) searches should be conducted at public registries at which the Group’s material trade marks, patents, intellectual or industrial property rights, licensing arrangements and other intangible rights are required to be registered or otherwise recorded and documentation relating thereto should be reviewed to assess their existence and validity.15
In addition to the work referred to in (d) and (f) above in regard to companies referred to in (f)(ii) above, similar work as regards confirmation of ownership and good standing should be performed in regard to any intermediate holding companies in the “chain of ownership” between the listing applicant and each such company.
2.3.2 Where necessary, the local lawyers should also assist the sponsor in:
(a) summarising the provisions of the articles of association or equivalent document of the listing applicant with regard to the information required to be included in the listing document;16 and
(b) reviewing minutes of all meetings of the listing applicant’s board, committees and shareholders and material information or documents furnished to shareholders and directors during the track record period for significant issues such as a winding-up resolution or information which contradicts any statement in the listing document.
3. Reliance on Legal Opinions and Advice
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]
3.2.1 As set out under section 1 above, the sponsor’s ability to rely on any opinion, advice or other input provided by foreign lawyers will depend on:
(a) whether the tasks delegated to the foreign lawyers fall within their professional competency;17 and
(b) whether the sponsor has taken the steps set out in the Code of Conduct with respect to the foreign lawyers involved and their work product.
3.2.2 Any part 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. The lawyers which prepared such information will be regarded as “experts” for the purposes of Paragraph 17 of the Code of Conduct and the sponsor will be required to take the steps set out in Paragraph 17.7 Code of Conduct.18
3.2.3 Where non-expert sections of the listing document contain statements made within the general competence of foreign lawyers (for example where lawyers have advised on property titles), the sponsor should treat the lawyers as non-expert third parties for the purposes of the Code of Conduct and take the steps set out in Paragraph 17.6(g) of the Code of Conduct.
3.3 Recommended Steps
3.3.2 The sponsor should, in particular:
(a) review the terms of engagement and check that the scope of work set out is appropriate to the opinion required to be given. In particular, the sponsor should consider requesting advance approval for referring to the foreign lawyers’ opinions in the listing document or at the request of the Exchange or the SFC. Except in exceptional circumstances, it will not be acceptable if the scope of work of the foreign lawyers is so narrow that their opinion is largely based on the representations of or confirmations from the management of the listing applicant, without further independent enquiries or assessment by the foreign lawyers;19
(b) review the draft legal opinion to assess whether the results of the work performed are consistent with other information known to the sponsor including that derived from its other due diligence work; and
(c) with the assistance of its principal lawyers, check:
(i) details of the documents the opinion provider has examined in giving the opinion (sufficient detail should be included to enable easy identification);
(ii) enquiries that the opinion provider has made (for example, searches of local registries);
(iii) assumptions that the opinion provider has made (these should mainly relate to facts and, where relevant, issues of foreign law (that is foreign to the opinion provider’s jurisdiction);
(iv) qualifications on matters where it is established market practice that an unqualified opinion cannot reasonably be given; and
(v) any wording required to deal with emergency situations, for example, as a result of sanctions or wars; and
(d) check that nothing in the legal opinion, in particular the assumptions and qualifications, has the effect of rendering the opinion worthless.
3.3.3 With regard to the sponsor’s review of any foreign legal opinion, it should be noted that where the opinion provider is the author of an “expert report” (see paragraph 3.2.2 above), the steps which the sponsor is required to take under Paragraph 17.7 of the Code of Conduct with respect to the opinion provider and its work product, should be to the standard expected of a sponsor which is not itself expert in the matters dealt with in the legal opinion.20
3.3.4 If the advice or opinion of foreign lawyers contain statements that are inconsistent with the other information known to the sponsor about the listing applicant’s business or business plans, the sponsor is expected not to rely solely on the opinion but to make further due diligence enquiries so as to clarify the issues.21
4. US “10b-5” Letters
4.1.1 In the case of initial public offerings on the Stock Exchange which have a Rule 144A component, the sponsor will typically require a 10b-5 letter, also known as a negative assurance letter or a disclosure letter, from the sponsors’ or listing applicant’s lawyers that practise US law22 addressed to the sponsors, providing negative assurance regarding the contents of the offering document.
4.1.2 Although the exact form of assurance varies from firm to firm, the 10b-5 letter effectively states that nothing has come to the law firm’s attention to give it reason to believe that the offering document contains any untrue or inaccurate statements or omits any material facts required to be stated in the offering document or necessary to make the statements in the offering document, in light of the circumstances under which they were made, not misleading. The 10b-5 letter typically tracks the language of Rule 10b-5 of the US Securities Exchange Act of 1934, as amended. Unlike a legal opinion, the 10b-5 letter is a factual statement that expresses no legal conclusions or legal analysis. The 10b-5 letter helps the sponsors establish their due diligence defence to liability under sections 11 and 12(a)(2) of the US Securities Act of 1933, as amended, and Rule 10b-5 of the Securities Exchange Act of 1934, as amended. As such, it is applicable only to the international offering document of a Hong Kong listing with a Rule 144A component, and is not intended to provide a regulatory due diligence defence to sponsors in Hong Kong.
4.1.3 The SFC has made it clear that sponsors should not give undue weight to 10b-5 letters.23
4.1.4 The regulatory obligation in Hong Kong to conduct due diligence rests with the sponsor and the SFC will not regard the issue of a 10b-5 letter as lessening the scope or extent of that obligation in any way.
4.1.5 Notwithstanding the foregoing, the 10b-5 letter should be accorded some level of importance. In general, law firms which practise US law take the issuance of 10b-5 letters very seriously and will only issue them after completing significant due diligence and pursuant to rigorous internal policies and procedures.
When a reputable and experienced law firm which practises US law is willing to provide a 10b-5 letter, it indicates that these professionals are sufficiently comfortable with the disclosure contained in the offering document. In some circumstances, this can serve as an independent check on the sponsor’s due diligence. In many cases, the law firm which practises US law may have even participated in the drafting of the offering document. While the onus remains on sponsors to perform their due diligence, the 10b-5 letter serves to supplement this task.
The following paragraphs of Part A of Appendix I to the Listing Rules require the inclusion in the listing document of the information set out below.
1. The full name of the listing applicant.
5. The date and country of incorporation or other establishment of the listing applicant and the authority under which the listing applicant was incorporated or otherwise established.
7. The provisions or a sufficient summary of the provisions of the articles of association or equivalent document with regard to:
(1) any power enabling a director to vote on a proposal, arrangement or contract in which he is materially interested;
(2) any power enabling the directors, in the absence of an independent quorum, to vote remuneration (including pension or other benefits) to themselves or any members of their body and any other provision as to the remuneration of the directors;
(3) borrowing powers exercisable by the directors and how such borrowing powers can be varied;
(4) retirement or non-retirement of directors under an age limit;
(5) directors’ qualification shares;
(6) changes in capital;
(7) any time limit after which entitlement to dividend lapses and an indication of the party in whose favour the lapse operates;
(8) arrangements for transfer of the securities and (where permitted) any restrictions on their free transferability; and
(9) any restriction on ownership of securities of the listing applicant.
23. (1) The authorised share capital of the listing applicant, the amount issued or agreed to be issued, the amount paid up, the nominal value and a description of the shares.
(2) The amount of any outstanding convertible debt securities and particulars of the conditions governing and the procedures for conversion, exchange or subscription of such securities.
24. Particulars of and the number of founder or management or deferred shares, if any, and the nature and extent of the interest of the holders in the property and profits of the group.
25. (1) The voting rights of shareholders.
(2) If there is more than one class of share, the rights of each class of share as regards voting, dividend, capital, redemption, and the creation or issue of further shares ranking in priority to or pari passu with each class other than the lowest ranking equity.
(3) A summary of the consents necessary for the variation of such rights.
26. Particulars of any alterations in the capital of any member of the group within the two years immediately preceding the issue of the listing document, including:
(1) where any such capital has been issued or is proposed to be issued as fully or partly paid up otherwise than in cash, particulars of the consideration for which the same has been or is proposed to be issued and in the latter case the extent to which they are so paid up; and
(2) where any such capital has been issued or is proposed to be issued for cash, particulars of the price and terms upon which the same has been or is proposed to be issued, details of any discounts or other special terms granted and (if not already fully paid) the dates when any instalments are payable with the amount of all calls or instalments in arrear,
or an appropriate negative statement.
27. Particulars of any capital of any member of the group which is under option, or agreed conditionally or unconditionally to be put under option, including the consideration for which the option was or will be granted and the price and duration of the option and the name and address of the grantee, or an appropriate negative statement.
Provided that where options have been granted or agreed to be granted to all the members or debenture holders or to any class thereof, or to employees under a share scheme, it shall be sufficient, so far as the names and addresses are concerned, to record that fact without giving the names and addresses of the grantees.
28. (1) If the listing applicant is a member of a group, a brief description of that group covering the listing applicant’s position within that group and, if a subsidiary, the names of and the number of shares held (directly or indirectly) by each holding company of the listing applicant.
(2) If required by the Exchange, particulars of any contracts for the hire or hire purchase of plant to or by any member of the group for a period of over one year which are substantial in relation to the group’s business.
(3) Particulars of any trade marks, patents or other intellectual or industrial property rights which are material in relation to the group’s business and, where such factors are of fundamental importance to the group’s business or profitability, a statement regarding the extent to which the group is dependent on such factors.
29. (1) In regard to every company the whole of, or a substantial proportion of, whose capital is held or intended to be held (either directly or indirectly) by the listing applicant, or whose profits or assets make or will make a material contribution to the figures in the accountants’ report or the next published accounts, particulars of the name, date and country of incorporation or other establishment, whether public or private, general nature of business, issued capital and the proportion thereof held or intended to be held.
(2) In regard to the group, particulars of the location of the principal establishments.
Note: under paragraphs 26, 27, 28, 29 reference to the group is to be construed as including any company which will become a subsidiary of the listing applicant by reason of an acquisition which has been agreed or proposed since the date to which the latest audited accounts of the listing applicant have been made up. (Note 3)
The following Listing Rules require the inclusion of the information set out below:
Listing Rule 19.10(2) requires the listing document for an overseas listing applicant to contain a summary of all provisions of the constitutive documents of the overseas listing applicant in so far as they may affect shareholders’ rights and protections and directors’ powers (using the same subject headings as is required by section 2 of Appendix 13 in respect of certain named jurisdictions). 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).
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 issuer 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).
Listing Rule 19A.27(2) requires the listing document for a PRC listing applicant to contain a summary of all provisions of the constitutive documents of the PRC listing applicant in so far as they may affect shareholders’ rights and protection and directors’ powers (using, and covering at the least, the same subject headings as is required by Section 2 in Part D of Appendix 13 in respect of PRC listing applicants).
Listing Rule 19A.27(3) requires the listing document for a PRC listing applicant to contain a summary of the relevant PRC law in a form to be agreed upon by the Exchange on a case by case basis and in the Exchange’s absolute discretion. The note to 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.
Listing Rule 19A.27(4) requires that the documents to be offered for inspection for a PRC listing applicant include a copy of any statutes or regulations which are relevant to the summary of relevant PRC law.
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.