How to Prevent Legal Risks in the Low-Carbon M&A Wave? (III)
In the first two articles of this series, we discussed with readers the legal issues to be considered before and during low-carbon M&A transactions. But the completion of the M&A transaction is only the beginning of the whole project. The success of the transaction, to a large extent, depends on the business integration after the M&A. Post-merger integration strategy involves many aspects, including the company’s organizational structure, decision-making mechanism, human resources, business collaboration, technology and intellectual property, financial management, corporate culture, etc. This article will introduce how to effectively utilize carbon assets and control common legal risks after low-carbon M&A transaction is completed from the legal perspective.
1 Efficient Utilization of Carbon Assets
If the target company holds carbon assets or has the capacity to continuously develop carbon assets, the buyer should have had a preliminary strategic plan on how to utilize carbon assets when making the acquisition decision. After the M&A is completed, the buyer can take action and should consider how to fully utilize and liquidize these carbon assets to the economic benefit of the company.
Efficient utilization of carbon assets cannot be achieved without professional experience in carbon asset management and trading. The buyer may entrust the carbon assets to a professional institution, and if possible, the buyer may also consider setting up a professional carbon assets management team of its own. Several common ways of utilizing carbon assets are described below for reference.
1.1 Carbon Offset and Cabon Trading
Carbon offset is the most common way to utilize carbon assets. After the completion of the transaction, the buyer can use the carbon allowances and carbon credits held by the target company for the purpose of carbon emission compliance obligation and offsetting, thus reducing its compliance costs for carbon emission. In addition, the buyer can also use the surplus carbon assets for trading purposes.
For example, If the subject of the acquisition is a clean energy project, such as wind or solar power generation, etc., as such projects have the function of reducing carbon emissions, they can be used to apply for a large number of carbon credits, such as CCER, VCU, GS-VER, etc. The buyer may choose to cash out such carbon assets through trading.
1.2 Carbon Finance
Carbon assets themselves can be used as underlying assets for financing. For example, the buyer can obtain financial support from financial institutions by carbon pledge or repurchase. Meanwhile, low-carbon projects such as the development of energy-saving and emission-reduction technology, and clean energy power generation also have the potential as financing tools. The buyer can raise operating funds for low-carbon projects at a relatively low financing cost by applying for green loans from banks or issuing green bonds, to reduce the liquidity pressure.
Currently, the local governments of Shenzhen, Guangzhou, Jiangsu, and other cities or provinces also provide cash subsidies to the companies issuing green bonds. The subsidy for a single bond could reach RMB 2 million. Carbon credits obtained by the buyer through development of low-carbon projects supported by financing can be further used for financing and trading, so as to form a virtuous circle of low-carbon economy within the company.
1.3 Carbon Risks Management
Financial derivatives have the function role of hedging, increasing market liquidity, bridging information asymmetry, and discovering asset prices. Financial derivatives with carbon as underlying assets include carbon futures, options, forwards, swaps, etc. All these products can serve to lock carbon prices in advance, or for hedging and risk avoidance.
In China, carbon futures products are under research and development. Carbon options, carbon forwards, carbon swaps, and other products have already been adopted in some local carbon markets to a certain extent, nonetheless, the trading scale is limited, and the local markets are relatively separated and isolated from each other. In the future, after futures exchanges enrich the trading products, improved trading rules, launched standard contracts for carbon futures, and the national carbon finance market are further unified, the buyer can fully utilize carbon financial derivatives, mainly carbon futures, for risk management.
2 Common Legal Risks
There are some common legal risks in the process of integration after M&A transaction that require pre-planning by the buyer to avoid acquisition purposes being frustrated or violating the laws. In this section, we will introduce three prominent risks in the practices of low-carbon M&As, being the key employee retention risk, anti-monopoly risk, and policy risk.
2.1 Retention of Key Employees
Retention of talents after M&A is an issue worthy of attention. If the founding shareholders cash out or quit the target company along with the key talents team after the acquisition, having the buyer bear the operation pressure, or even setting up a new company competing with the business of the target company, the buyer could suffer heavy losses.
In the M&A of a carbon asset management organization, talents are the core competitiveness of such professional service organizations. To some extent, the acquisition of a carbon asset management company is approximately equivalent to the purchase of carbon asset management professionals. The methods used to retain talents generally include competitive remuneration package and equity incentives.
In terms of the remuneration package, in addition to increasing the basic salary, the buyer may also consider granting performance bonuses to employees. With respect to equity incentives, it usually includes granting employees stock option, phantom equity rights (phantom dividend rights), restricted equity, etc. The incentivized employees may hold equity interest in the target company through direct shareholding or through the shareholding platform, etc.
If the buyer chooses equity incentives, it shall consider how to design relevant plans at the early stage of the acquisition. For example, whether the equity interests to be used shall be the target company’s own equity or other affiliates equity. When it comes to use the target company’s own equity, whether to issue additional new shares or set aside a portion of the old shares. All these issues need to be considered and planned as early as possible with the assistance of professional teams.
In addition to traditional forms of incentive, buyers may also consider setting up a joint venture or partnership with key employees, step out of the original labor relationship and have the employees become shareholders or partners. In this way, the key employees will be motivated, and the loss of key employees will be reduced. This approach is relatively effective in a talent-driven business.
Moreover, the buyer, as the case may be, may request the founding shareholder who also holds important positions in the target company to undertake not to leave the target company within a certain period after the acquisition, otherwise they shall bear the corresponding compensation liabilities.
2.2 Anti-monopoly Risks
In the process of business integration after the acquisition, generally, the risk should be noted of constituting a horizontal monopoly agreement between the buyer and the target company. According to the Anti-monopoly Law of the People’s Republic of China (“Anti-monopoly Law”), the forms of horizontal monopoly agreements include business arrangements reached between competing business operators to eliminate or restrict competition by fixing or changing the price of commodities, limiting the output or sales of commodities, segmenting a sales market or a procurement market of raw materials, etc.
Business operators who illegally reach and implement a monopoly agreement will be ordered to cease the illegal conduct, be confiscated the illegal gains and imposed a fine of not less than 1% but not more than 10% of their sales revenue of the previous year. If the monopoly agreement reached by business operators has not been implemented, the business operator will be imposed a fine of no more than RMB 500,000. If such monopoly causes damages to others, the business operator shall also assume civil liabilities according to laws.
- Situations that may constitute horizontal monopoly agreements in low-carbon M&A projects
In the event that the buyer and the target companies business compete with each other, if there are price coordination, output control, market segmentation, or similar arrangements between the two parties after the acquisition, they may be deemed as reaching a horizontal monopolistic agreement and thus be punished by the anti-monopoly authorities.
In low-carbon M&A transactions, the parties usually hope to achieve business synergies through the transaction. The implementation of business synergies after the acquisition may involve the exchange of price, costs, and other commercially sensitive information, division of market regions, unification of pricing strategies, etc., which may increase the risk of violating Anti-monopoly Law and therefore, call for special attention from the transaction parties. It is important to note that the mere exchange of commercially sensitive information has a relatively low risk of violation of law in China. However, if the exchange of commercially sensitive information between competitors is accompanied by concerted practices to eliminate or restrict competition, the competitors may be deemed as reaching a substantial monopoly agreement.
In addition, if the buyer invests in a number of competing companies that engage in the same business, the buyer may have access to the information relating to the operations of those competitors or have the right to participate in their respective operational decisions. In this case, if the buyer takes advantage of the information or decision-making rights to coordinate these competitors to exchange commercially sensitive information, and even implement concerted business activities such as price control and output control, it may also constitute a horizontal monopoly agreement prohibited by the Anti-monopoly Law.
In low-carbon M&A transactions, if a buyer continuously acquires several clean energy projects to expand its asset portfolio, it should be careful to manage the independent operation of each project so as to reduce information exchange and concerted business activities that violate Anti-monopoly Law.
- Identification of Competition Relationship
The premise for constituting a horizontal monopoly agreement is that the parties are in a competitive relationship. In the anti-monopoly law enforcement practice in China, if the buyer has actual control over the target company, it is generally deemed that the buyer and the target company share the same commercial interests and are not in a competitive relationship. Therefore, their cooperation will not be subject to Anti-monopoly Law. On the other hand, if the buyer has no control over the target company and the target company’s operation is relatively independent of that of the buyer, the parties may have a competitive relationship if both parties engage in the same business, which may be subject to Anti-monopoly Law.
It is noteworthy that, under the Anti-monopoly Law, the criteria for determination of control adopts the principle of substance over form. Such criteria include not only active rights such as direct and indirect shareholding ratios, the proportion of actual voting rights, seats in the board of directors, and management appointment and dismissal rights, but also passive rights such as veto rights over specific matters. Therefore, even if the acquirer only purchases a minority equity interest in the target company, it may be deemed as having control over the target company because it has obtained actual control over the Target Company in other forms.
- Measures to Mitigate Horizontal Monopoly Risks
Based on the above analysis, in the process of business integration after a low-carbon M&A, attention should be paid to the antitrust risks arising from concerted business activities between both parties to the transaction or between the competing companies invested by the acquirer.
It should be first determined whether relevant parties may be deemed as in a competitive relationship, and then whether their cooperation models and exchange of sensitive information may expose them to the risk of a horizontal monopoly agreement so that more specific preventive measures can be taken. For instance, both parties to the transaction or different competitors invested by the buyer may operate independent business systems or build “firewalls” between them to prevent sharing of commercially sensitive information and reduce the risk of reaching an illegal monopoly agreement.
Meanwhile, the Anti-monopoly Law provides that an agreement for the purpose of realizing public interests, such as energy conservation, environmental protection, and disaster relief and assistance shall not be deemed as a monopoly agreement. Therefore, in a low-carbon merger or acquisition, if the buyer can prove that the business arrangement between the buyer and the target company is for the purpose of energy conservation and emission reduction, the risk of constituting a monopoly agreement may be reduced to some extent.
2.3 Policy Risks
In general, China is expected to continue to strengthen its policy support for the carbon emission industries, with various industrial support policies and financial and tax subsidies being promulgated, refined, and implemented. However, in the short term, since the carbon emission industries involve a wide range of fields and many aspects of the industrial supply chain, there are a lot of uncertainties on when the supporting policies will be released, their benefits, and their outcome. If the industrial policies in the carbon emission business have material adverse changes, the investment returns of low-carbon M&A projects may be adversely affected as well.
For example, currently, CCER filings are still suspended, with inventory trading in the market unable to support the sustainable development of the carbon emission industry. The National Carbon Emission Trading System does not support CCER trading either. Since there is no national unified market and CCER has no well-established price discovery mechanism, it is hard to determine the fair market value. Meanwhile, CCER is also faced the risk of price fluctuation. The CCER offset ratio, project type, the inclusion period of the project, the types of key emitters that may use CCER to offset carbon allowances, the issuance amount of carbon allowance, etc., may trigger significant price fluctuation and then affect the buyers decision-making in the transaction.
As for those carbon asset management organizations which mainly engage in CCER project development and consulting and CCER trading as their business, their business performance is closely linked to the CCER policy. Policy uncertainties will, therefore, affect the capacities of such entities of sustainable operation and the overall valuations of such entities.
Therefore, the buyer should consider whether to include the adverse change of the policy as a trigger of the price adjustment in the transaction documents, or whether to adopt a price adjustment mechanism based on the revenue indicators of the target company. In addition, attention shall be paid to the definition of “force majeure” in the transaction documents. If the scope of force majeure includes the adverse change of the policy, the target company or the seller may rely on the force majeure clause to exempt from the liabilities for losses suffered by the buyer caused by such adverse change.