Malaysia: Investment In The Bird's Nest Industry In Malaysia

Ting Shi Jing provides an overview of the legal requirements in relation to the bird's nest industry in Malaysia.

1. INTRODUCTION TO THE BIRD'S NEST INDUSTRY IN MALAYSIA

Malaysia is amongst the top five countries in the world which has an industry producing swiftlet bird's nest. Other than Malaysia, the other countries are Indonesia, Thailand, Vietnam and The Philippines.

Edible bird's nest has been traded in Malaysia for the past 500 years. It was traded between the Malay Archipelagos and China since the 16th century. Traditionally, the nest is collected in limestone caves in Borneo Island, such as Niah Cave in Sarawak, and Mandai and Guamantong Cave in Sabah.

Swiftlet bird's nest farming is a profitable venture in Malaysia. The demand for bird's nest, once reserved for emperors, has created a global market that caters to Asia's growing wealthy consumers. Known as the "Caviar of the East", raw or unprocessed bird's nest is valued at RM2,000 to RM6,000/kg, whereas cleaned nest is retailed at the price range of RM8,000 to RM20,000/kg.

Due to its high potential of generating high incomes for the operators, the bird's nest industry is accorded due attention by the Ministry of Agriculture and Agro-Based Industry. It was reported that the export value of Malaysia's bird's nests was worth RM1.3 billion in 2018 and RM 1.1 billion in 2019, and is expected to increase to RM1.5 billion in 2020. Besides China, which is Malaysia's main export market for bird's nest, Malaysia also exports to Hong Kong, Taiwan, Laos, Korea and the United States, and has plans to expand to other countries.

In traditional Chinese medicine, bird's nest is considered as having a neutral energetic property with special influence on the lungs, kidneys and stomach. It is believed to offer good effect for treating consumptive diseases, curing tuberculosis, suppressing cough, alleviating asthma, relieving gastric troubles, and general weakness of bronchial ailments. In addition, bird's nests are also said to have the ability to rejuvenate and restore youthfulness and make the skin glow.

Bird's nests can be prepared in many ways – in savoury soups, desserts with rock sugar, or added with medicinal herbs such as ginseng. With the advancement in technology, a large variety of bird's nest related products have also emerged in the market – these include pre-cooked bottled bird's nest beverages and bird's nest skincare products.

Bird's nests have been widely used by the public as rare herbal medicines and delicacies. The bird's nest industry in Malaysia is therefore believed to be a highly lucrative industry.

Regulatory Requirements Pertaining to the Processing or Trading of Bird's Nest in Malaysia

The processing or trading of bird's nest is a regulated business in Malaysia. A company which intends to carry on the business of processing or trading of bird's nest in Malaysia is required to obtain certain licences, permits, registrations and/or certifications from the relevant governmental agency or competent issuing authority in Malaysia.

These licences, permits, registrations and/or certifications include the following:

(a) Processing of Bird's Nest

A company carrying on the business of bird's nest processing must, amongst others:

1. register its bird's nest processing plant as a food premise with the Ministry of Health ("MOH");
2. register its bird's nest processing plant with the Department of Veterinary Services ("DVS");
3. obtain a business premises licence from the relevant local government in respect of its bird's nest processing plant;
4. either obtain a Veterinary Health Mark ("VHM") certificate or a Good Veterinary Hygienic Practice (GVHP) certificate;
5. obtain a Hazard Analysis and Critical Control Point ("HACCP") certificate;
6. obtain a Good Manufacturing Practice ("GMP") certificate;
7. obtain a manufacturing licence from the Ministry of International Trade and Industry of Malaysia ("MITI") for its bird's nest processing plant (where applicable); and
8. obtain a Makanan Selamat Tanggungjawab Industri ("MeSTI") certificate (where applicable).

Registration as "food premise" with the MOH

A company carrying on the business of bird's nest processing must register its bird's nest processing plant as a food premise with the MOH pursuant to the Food Hygiene Regulations 2009 ("Food Hygiene Regulations") (which is made pursuant to the Food Act 1983 ("Food Act")).

The MOH is responsible for the administration of the Food Act which is an Act to protect the public against health hazards and fraud in the preparation, sale and use of food, and for matters incidental thereto or connected therewith.

Pursuant to Regulation 3 of the Food Hygiene Regulations, no person shall use any food premises specified in the First Schedule for the purposes of, or in connection with the preparation, preservation, packaging, storage, conveyance, distribution or sale of any food or the relabelling, reprocessing or reconditioning of any food except the premises is registered under the Food Hygiene Regulations.

The First Schedule to the Food Hygiene Regulations defines "food premises" to include all food premises involved in manufacturing of food, and all premises where food is prepared, processed, stored or served for sale. Section 2 of the Food Act further provides that "food premises" means premises used for or in connection with the preparation, preservation, packaging, storage, conveyance, distribution or sale of any food, or the relabelling, reprocessing or reconditioning of any food, whereas "food" includes every article manufactured, sold or represented for use as food or drink for human consumption or which enters into or is used in the composition, preparation, preservation, of any food or drink and includes confectionery, chewing substances and any ingredient of such food, drink, confectionery or chewing substances.

Bird's nest, being an article manufactured or sold for use as food for human consumption, would fall within the meaning of "food" under the Food Act, and a bird's nest processing plant, being a premise used to prepare or manufacture food, would fall within the meaning of "food premise" under the Food Hygiene Regulations.

Therefore, a bird's nest processing plant is required to be registered with the MOH as a "food premise".

Registration with the DVS and other certification requirements

A bird's nest processing plant is also required to be registered with the DVS.

Based on the Schedule of the Ministers of the Federal Government Order 2009, the functions of the DVS include, amongst others, control, prevention and eradication of animal and zoonotic diseases, inspection of animal product processing plants, and control of import/export of animals and animal produce.

Pursuant to the Guidelines on the Development of Swiftlet Industry issued by the Ministry of Agriculture and Agro-Based Industry ("MOA"), a bird's nest processing plant shall, amongst others:-

1. be registered with the DVS and obtain from the DVS a VHM certification and traceability;
2. be registered with the MOH and obtain a HACCP certification and a GMP; and
3. be issued a business premise licence from the relevant local municipal council within which the processing plant is located. Note that most local municipal councils have a Licensing of Trades, Businesses and Industries By-Laws which stipulate that no person shall carry on any trade, business or industry in any place or premises within the respective municipal council unless he is licensed.

Please find below a more detailed explanation of the relevant certifications:

VHM Certification	The bird's nest processing plant is required to be registered with the DVS and obtain a VHM certification. Based on the Veterinary Health Mark Procedure Manual issued by the DVS ("VHM Manual"), a VHM certification is a symbol of quality awarded to animal-based processing establishment under the Veterinary Inspection and Accreditation Program under the DVS. A VHM logo shows that the processing establishment complies with the minimum standards of hygiene and sanitation, GMP, HACCP and environmental control. Paragraph 1 of the VHM Manual provides that participation in the VHM certification is voluntary for animal-based processing establishments but compulsory for animal-based processing establishments that exports animal products out of Malaysia. Paragraph 4.1 of the VHM Manual further provides that a processing establishment must have developed and implemented: (i) GMP, (ii) Good Hygiene Practice (GHP), and (iii) HACCP for at least 3 months prior to its application for a VHM Certification.
HACCP Certification	In order to obtain a VHM certification, the bird's nest processing plant is required to be registered with the MOH for a HACCP certification. HACCP is a management system wherein food safety is addressed through the analysis and control of biological, chemical, and physical hazards from raw material production, procurement and handling, to manufacturing, distribution and consumption of the finished product. Premises applying for HACCP certification must fulfil, amongst others, the following requirements: the premises must be registered with the MOH; the premises must be licensed by the relevant local authorities; the HACCP system and the GMP / pre-requisite program (PRP) system should have been implemented for a minimum of 3 months prior to the application; and the premises must comply with the applicable laws and regulations in Malaysia.
GMP Certification	In order to obtain a VHM certification, the bird's nest processing plant is required to be registered with the MOH for a GMP certification. GMP is a set of guidelines that controls the operational conditions within a food processing establishment allowing for the production of safe food. Premises applying for GMP certification must fulfil, amongst others, the following requirements: the premises must be registered with the MOH; the premises must be licensed by the relevant local authorities or other government agency (as applicable), except for premises maintained by the Government; the GMP system should have been implemented for a minimum of 3 months prior to the application; and the premises must comply with the applicable laws and regulations in Malaysia.

Manufacturing Licence

A company which intends to manufacture bird's nest products (such as bottled instant bird's nest) is required to obtain a manufacturing licence from the MITI pursuant to the Industrial Co-ordination Act 1975 ("Industrial Co-Ordination Act"), unless it is exempted under the Industrial Co-ordination (Exemption) Order 1976 ("Exemption Order"). Both the Industrial Co-ordination Act and the Exemption Order are regulated by the MITI, which is responsible for the co-ordination and orderly development of manufacturing activities in Malaysia.

Under the Industrial Co-ordination Act read together with the Exemption Order, manufacturing companies (except those with shareholders' funds of less than RM2.5 million and less than 75 full-time paid employees) are required to be licensed under the Industrial Co-ordination Act.

Based on publicly available information on the Malaysian Investment Development Authority's (MIDA) website, since June 2003, foreign investors are allowed to hold 100% of the equity in all investments in new projects, as well as investments in expansion / diversification projects by existing companies, irrespective of the level of exports and without excluding any product or activity.

MeSTI certificate

Pursuant to Regulation 9(1) of the Food Hygiene Regulations, a proprietor, owner or occupier of food premises involved in the manufacturing of food is required to provide and make available a food safety assurance programme in the food premises.

There are several food safety assurance programmes which have been introduced to premises involved in the manufacturing of food – these include GMP, HACCP and ISO 22000. However, these are difficult to be obtained, especially by small and medium enterprises (SMEs).

As such, the MOH has introduced a simple scheme which fulfils the minimum requirements set out in Regulation 9(1) of the Food Hygiene Regulations, which is the MeSTI certification scheme. Through MeSTI certification, a food manufacturing premise will be guided in developing and implementing a food safety assurance programme before recognition is granted.

(b) Exportation of Bird's Nest to China

A company carrying on the business of exporting bird's nest products to China must, amongst others:

1. be registered by the Certification and Accreditation Administration of the People's Republic of China ("CNCA");
2. have a bird's nest product certification issued by the Beijing Ecocert Certification Centre Co., Ltd. ("BECCC");
3. obtain an export permit from the Department of Malaysian Quarantine and Inspection Services ("MAQIS Department") in respect of the consignment of bird's nest products; and
4. obtain a health certificate from the MOH in respect of the consignment of bird's nest products.

Registration and certification by the CNCA and the BECCC

China allows the importation of bird's nest from entities which are registered by the CNCA. The CNCA is established by the State Council of the People's Republic of China and is authorized by the State Council to exercise administrative responsibilities of undertaking unified management, supervision and overall coordination of certification and accreditation activities across the country. On the other hand, the BECCC is established under the support of the related ministries and authorities of the People's Republic of China and is authorised to provide international organic product standards certification, including planting, breeding and organic products.

Export permit

A company which intends to export bird's nest to China is required to obtain an export permit from the MAQIS Department pursuant to the Malaysian Quarantine And Inspection Services Act 2011 ("MAQIS Act").

The MAQIS Department is established under the MOA as a department to provide intergrated services relating to quarantine, inspection and enforcement at entry points, quarantine station, premises quarantine and certification for the import and export of plants, animals, carcasses, fish, agricultural produce, soils and microorganism and include inspection of and enforcement relating to food and for matters related to it.

Section 11(2) of the MAQIS Act provides, amongst others, that no person shall export any agricultural produce without a permit or licence issued under the MAQIS Act. "Agricultural produce" is defined under the MAQIS Act to include any product from a bird, whether processed or otherwise.

Bird's nest would fall within the meaning of "agricultural produce". As such, the exportation of bird's nest would require an export permit to have been obtained.

MOH health certificate

A company which intends to export bird's nest to China is also required to obtain a health certificate from the MOH pursuant to the "Standard Operating Procedure for Issuance of Health Certificate for the Export of Raw Clean Edible Bird's Nest to China" issued by the MOH ("MOH Health Certificate Guidelines").

Pursuant to the MOH Health Certificate Guidelines, an exporter of edible bird's nest is required to obtain a health certificate from the MOH for the exportation of edible bird's nest based on the requirements of the importing country. A separate application for health certificate is required to be made for each consignment of edible bird's nest to be exported.

Under the MOH Health Certificate Guidelines, the requirements for the issuance of a health certificate include the following:

1. sources of raw materials must be obtained from bird's houses and/or middlemen which have been registered with the DVS;
2. the raw clean edible bird's nest must be processed by processing establishments which have been listed in the Compliance List for Export of Raw Clean Edible Bird's Nest to China by the MOH and approved by the CNCA;
3. the processing establishment must comply with the "Standard Operating Procedures on The Control of The Safety of Raw Edible Bird's Nest Along The Food Supply Chain" and the "Standard Operating Procedure on The Control of Nitrite Level in Edible Bird's Nest" issued by the MOH; and
4. an exporter which is not a processing establishment must be registered with the DVS.

Other relevant certificates

As a matter of practice, note that a company carrying on the business of exporting bird's nest products to China may also be required to, amongst others, obtain the following certificates:

1. a certificate of freedom of state from disease issued by the DVS;
2. a veterinary health certificate issued by the DVS in respect of the consignment of bird's nest products; and
3. a certificate of origin issued by the DVS in respect of the consignment of bird's nest products.

2. TRANSACTION STRUCTURE

2.1. Introduction of the Investment Project

In 2019, one of our Chinese clients, which is engaged in the healthcare and medical sector, invested in a Malaysian private company limited by shares which is involved in the business of trading and exportation of bird's nest. The investment was carried out through a subscription of shares in the target company by our client via capital injection whereby our client acquired approximately 70% equity in the target company whereas the existing shareholders of the target company ("Target's Existing Shareholders") held approximately 30% equity in the target company.

2.2. Transaction Documents

In connection with the transaction, our client and the Target's Existing Shareholders entered into a shares subscription agreement to govern the rights and obligations of our client and the Target's Existing Shareholders with respect to the subscription of shares in the target company. In addition, our client and the Target's Existing Shareholders had also entered into a shareholders agreement to govern their rights and obligations with respect to, amongst others, the management of the target company.

2.3. Due Diligence Investigations

It is not a legal requirement for an acquirer / buyer to carry out a due diligence investigation prior to entering into any transaction. As such, it is possible for an acquirer / buyer to enter into a transaction without carrying out any due diligence investigations on the target company, especially if the investment value of the transaction is small and/or the acquirer / buyer is familiar with the business and affairs of the target company.

In our client's case, as our client did not have a clear understanding of the business and affairs of the target company, our client and its professional advisors have undertaken a legal and financial/tax due diligence review on the target company to obtain up-to-date and detailed information about the target company and its business, contracts, assets and liabilities. Such information would enable our client to:

1. evaluate the information obtained, such as the state and condition of the business, affairs, records, assets and liabilities of the target company;
2. value the target company; and
3. structure the transaction so as to deal with potential problems.

The scope of our legal due diligence for the transaction includes reviewing, assessing and/or verifying, amongst others:

1. the agreements and arrangements entered into by the target company for its business;
2. the licences, permits, registrations and/or certifications obtained by the target company for its business;
3. the ownership of the real properties, assets and intellectual properties owned or used by the target company for its business; and
4. the risks, liabilities or commitments relating to the business of the target company.

The purpose of such an investigation is to identify key issues relating to the verification of the legal affairs and good standing of the target company, which could, in turn, impact on the consideration of the transaction or on the ultimate success of the transaction. In our client's case, following the identification of certain issues, we have sought protection against those issues in the relevant transaction documents. In general, potential risks can be limited/covered by means of:

1. lowering the purchase price;
2. including specific conditions precedent or conditions subsequent; and/or
3. including applicable warranties and indemnities.

3. PROJECT FINANCING METHOD

As there are no prohibitions against a part of the subscription price being paid to the target company by way of part-payment and forfeitable deposit upon the execution of the shares subscription agreement, it is therefore in the interest of our client to persuade the target company to accede to an arrangement that the full amount of the subscription price is to be payable at completion. In this specific case, the purchase price was paid by our client as a lump sum at completion. The subscription price is funded by our client directly via its internally generated funds.

As an alternative, it is common that transactions of similar nature can be financed via bank's credit facilities or through intra-group financing arrangements.

The financing method of using the target company's loan to finance the subscription price of the subscription shares is not envisaged in our client's case as the target company is in need of capital injection from our client for its business. In addition, note that under Section 123(1) of the Companies Act 2016, a company is generally not permitted to give any financial assistance, whether directly or indirectly and whether by means of a loan, guarantee or the provision of security or otherwise, for the purpose of or in connection with a purchase or subscription made or to be made by any person of or for any shares in the company, unless, amongst others, the company is a company whose shares are quoted on a stock exchange or the lending of money by the company in the ordinary course of its business if the lending of money is part of the ordinary business of a company.

4. KEY TERMS IN TRANSACTION DOCUMENTS

Shares Subscription Agreement ("SSA")

4.1. The provisions which are commonly found in a SSA are as follows:-

1. the agreement of an investor(s) ("Subscriber") to subscribe for new shares ("Subscription Shares") in the company and the existing shareholders ("Existing Shareholders") of the company to procure the allotment and issue of the Subscription Shares to the Subscriber (note that the obligations to be undertaken by the Existing Shareholders in an SSA may also be assumed by the directors of the company in addition to or in lieu of the Existing Shareholders);
2. the amount and terms of payment of the subscription price ("Subscription Price");
3. the conditions precedents to be fulfilled, such as:-
   
   1. approvals of the relevant regulatory authorities;
   2. approval of the shareholders of the parties; and
   3. satisfactory outcome of due diligence;
4. the obligations of the parties at the completion of the transaction, such as the payment of the Subscription Price against delivery of the share certificates in respect of the Subscription Shares and other deliverables;
5. the warranties to be furnished by the Existing Shareholders.
   (Note: the primary purpose of warranties is to provide the Subscriber with assurance on the state of affairs of the company and to enable the Subscriber to seek legal redress against the Existing Shareholders if the warranties are untrue or inaccurate.
   Where it is necessary to qualify a warranty, the qualifying event or circumstances may be disclosed in the SSA or a disclosure letter. The purpose of making such disclosure is to preclude the Subscriber from making a claim against the Existing Shareholders to the extent that the subject matter of such claim has been disclosed.)

4.2. The parties to be included in an SSA are:-

1. the Subscriber;
2. the Existing Shareholders; and
3. the company.

The Existing Shareholders are included as parties to the SSA primarily for the purpose of providing warranties on the company and its business and affairs. They are included as they have, or ought to have, knowledge of the state of affairs of the company. (However, note that as mentioned above, the obligations of the Existing Shareholders under the SSA may be assumed by the directors in addition to or in lieu of the Existing Shareholders.)

Shareholders' Agreement ("SHA")

4.3. Matters which are commonly dealt with in a SHA include:-

1. issue of new shares;
2. transfer of shares;
3. appointment and removal of directors (including executive directors) and key management personnel;
4. decision making process at board and shareholders meetings;
5. specific obligations of the parties in relation to the company's business;
6. funding;
7. dividend policy;
8. deadlock and dispute resolution;
9. termination of the agreement.

4.4. Specific Issues in a SHA

(a) Pre-Emption Rights

A SHA usually confers on each shareholder –

1. a pre-emptive right over the unissued shares of a company, based on the proportion of shares held by that shareholder; and
2. a right to be offered, on a pro-rated basis with the other remaining shareholders (if any), any issued shares which a shareholder wishes to dispose.

In the case of pre-emption over issued shares, it is important to include a mechanism in the SHA to determine the price of the shares. The common mechanism is for (i) the seller to set a price, and (ii) for an independent party (usually an auditor) to determine the price if the seller's price is unacceptable to the other shareholder(s).

Where shares are to be transferred to any person who is not a party to the SHA, it is imperative to ensure that the transferee undertakes to be bound by the provisions of the SHA.

(b) Directors and Key Management Personnel

A SHA will usually contain provisions that set out the number of directors which each shareholder is entitled to appoint to the board of directors and, where applicable, to any committee of directors.

Where appropriate, it will identify the key management personnel of the company (including executive directors and senior management) and the manner in which such persons are to be appointed.

The SHA will also set out the procedures for the replacement of directors as well as key management personnel.

(c) Decision-Making Process

The SHA will set out the procedures for –

1. convening meetings of shareholders, directors and where appropriate, committees of directors;
2. the quorum requirements (and the consequences of inability to achieve quorum); and
3. the decision-making process (including the right to a casting vote or otherwise).

(d) Reserved Matters

A "reserved matter" is a matter which requires the unanimous decision of all shareholders or a specified majority of the votes of shareholders.

A minority shareholder can protect itself against the "majority rule" principle by including reserved matters in a SHA which can only be carried into effect if the minority shareholder or their nominee directors vote in favour of such matters.

As company law recognises the division of powers between the shareholders and the board of directors of a company, it is preferable that a SHA includes separate lists of reserved matters that are to be decided by the shareholders i.e. "shareholders' reserved matters" and by the board of directors i.e. "board reserved matters".

(e) Tag Along Rights v Drag Along Rights

A minority shareholder may require "tag along" rights to be included in a SHA which require the majority shareholder to include the minority's shareholding in the company in a sale by the majority shareholder of its shares to a third party.

Conversely, a majority shareholder may insist on the inclusion of "drag along" rights which require a minority shareholder to sell its shares together with a sale of the majority shareholder's shares.

"Tag along" rights benefit a minority shareholder whereas "drag along" rights are advantageous for a majority shareholder.

(f) Use of Name

If a party to a SHA permits its name to be used as part of the company's name, provisions should be included in the SHA to set out the circumstances in which the company's right to use that party's name ceases. The most common situations are where the party ceases to be a shareholder or reduces its shareholding in the company below a specified percentage.

It would also be prudent for the party to enter into an agreement on similar terms with the company to ensure that the party concerned has a direct cause of action against the company to prevent the use of its name.

(g) Deadlock

A "deadlock" arises in the following situations –

1. in the case where 2 shareholders hold an equal percentage of voting shares in a company, where the shareholders or directors of a company, as the case may be, are unable to obtain unanimous approval on a matter; or
2. in the case of a company that has a minority shareholder, where the minority exercises its veto rights or does not consent to a matter.

As a deadlock may affect the operations of the company, it is important to include a mechanism in a SHA to deal with the consequences of such a situation arising.

The common methods for dealing with a deadlock are as follows:-

1. refer the deadlock to the shareholders (or their respective representatives) for an amicable resolution within a prescribed period;
2. refer the deadlock to a designated third party expert (whose decision is binding) for resolution ("third party resolution");
3. initiate optional or mandatory buy-outs ("buy-outs");
4. wind-up the company ("winding-up").

The deadlock resolution methods can be used individually or in combination or be available as alternative remedies in a SHA.

Third Party Resolution

The risk of adopting a third party resolution to resolve a deadlock is that the decision is placed into the hands of a third party who may or may not have the expertise to decide on the subject matter of the deadlock. Third party resolution may be inappropriate in circumstances where a deadlock arises from differences of views on a business or commercial decision.

Buy-Outs

In addition to the pre-emption rights, provisions can be included in a SHA for optional or mandatory buy-outs. Buy-out offers can consist of an offer by a party to purchase the shares of the other or an offer by a party to sell its shares to the other or both.

Optional buy-outs do not give rise to any particular risk as each party retains the right to decide whether or not to make an offer, and the offeree is not obliged to accept an offer received by it. Due to this lack of compelling force, the use of optional buy-outs on a stand-alone basis may not be an effective deadlock resolution mechanism as the deadlock will remain unresolved if no offer is made or an offer made is not accepted.

Optional buy-outs may be more effective if it is coupled with a right to wind-up the company if no offer is made or accepted after a prescribed period.

A mandatory buy-out can take any of the following forms –

1. each party can have a put option that requires the other party to purchase its shares and a call option that requires the other party to sell its shares to the first-mentioned party;
2. a Russian Roulette whereby –
   
   1. a party may offer to purchase all the shares of the other and alternatively, at the election of the offeree, to sell all the offeror's shares to the offeree, in each case at the same price per share as determined by the offeror;
   2. the offeree must within a stipulated time frame, elect to buy the offeror's shares or sell its shares to the offeror; and
   3. if the offeree does not reply within the stipulated time frame, it is deemed to have agreed to sell its shares to the offeror.
3. a Texas Shoot-Out whereby –
   
   1. a party offers to purchase another party's shares at a price set by the offeror;
   2. the offeree must, within a specified period, indicate whether it (i) will sell its shares to the offeror at the price set by the latter; or (ii) purchase the offeror's shares at a higher price; and
   3. if the offeree notifies the offeror that it wishes to acquire the offeror's shares at a higher price, a sealed bidding process will ensue and the shares will be sold to the party who sets the highest price.

Mandatory buy-outs give rise to legally enforceable obligations to purchase or sell, as the case may be, shares in the company, as soon as an offer is made.

Winding-Up

Winding-up is a drastic measure. It does not resolve a deadlock but puts an end to the business carried on by the company and the relationship of the parties as shareholders thereof. The inclusion of winding-up as the final option in a deadlock resolution mechanism may be an impetus for parties to a profitable venture to seek a negotiated settlement of the deadlock.

5. MAIN LEGAL ISSUES

(a) Regulatory Approvals and Requirements

Typically, regulatory authorities and licensing bodies in Malaysia will impose a requirement on a licensee to notify them or obtain their approval when there is a change of shareholders or directors of the company.

For instance, a company which has obtained VHM certification is required to notify the DVS of any changes in the management of the company within 30 days of the change pursuant to Paragraph 4.1.4 of the VHM Manual. Failure to do so may result in the VHM certificate being withdrawn.

In addition to the abovementioned notification requirement, we have also sought clarification from the DVS on its requirement (if any) on the director(s) and shareholder(s) of a company engaged in the business of processing and trading of bird's nest. Based on our enquiry with the DVS, we were informed that a company which is engaged in the business of processing and trading of bird's nest must have at least one Malaysian director and one Malaysian shareholder. However, note that this is not publicly available information, and a Chinese investor is advised to consult its professional legal advisors on structuring its investment in Malaysia.

(b) Warranties

In our client's case, the Target's Existing Shareholders refused to provide any warranties to our client on the ground that our client had carried out a legal due diligence investigation on the target company. The primary purpose of warranties is to provide our client with assurance on the state of affairs of the target company and to enable our client to seek legal redress against the Target's Existing Shareholders if the warranties are untrue or inaccurate.

As there is no guarantee that a due diligence review, no matter how extensive, will disclose all matters, such as undisclosed liabilities, that may materially affect the business, assets or liabilities of the target company, it is therefore inadvisable for our client to accept due diligence as a substitute for warranties. In addition, as the subscription shares comprise a substantial part of the enlarged share capital of the target company, our client is advised to include extensive warranties.

Upon several negotiations amongst our client and the Target's Existing Shareholders, the Target's Existing Shareholders have agreed to provide reasonably extensive warranties to our client with certain carve outs as disclosed in the SSA and a disclosure letter (which was delivered to our client prior to the execution of the SSA). On a related note, as the warranties are provided by the existing shareholders of the target company, the liability of the existing shareholders has been agreed to be joint and several.

(c) Profit Guarantee

One of the main legal issues during the negotiations with respect to the transaction documents was the profit guarantee clause in the SSA. It is not uncommon for an acquirer / subscriber to include a profit guarantee clause in the SSA, requiring the target company and its existing shareholders to warrant that the target company and its existing shareholders will achieve a specified amount of profit for an agreed period after the completion. Our client wanted to have a profit guarantee to be secured by a deposit of cash (or retention of part of the purchase price) or placement of securities, such as shares, so that the same can be used to make good any shortfall in the profit. The parties had extensive discussions regarding the manner in which a breach of the profit guarantee should be dealt with, i.e. whether the shortfall payable is limited to the amount of profit guaranteed, given that the Target's Existing Shareholders will continue to be the key management of the target company's business upon completion of the shares subscription. After due consideration, the parties have agreed to fix a lower amount of the profit guarantee and that the shortfall payable is limited to the amount of profit guaranteed and does not include the obligation on the target company or the Target's Existing Shareholders to make good any loss in addition to paying the amount of the profit guaranteed.

6. OTHER ISSUES AND RELEVANT SOLUTIONS

Other issues which we come across when assisting our Chinese clients include:

(a) Failing to consider obtaining the necessary regulatory approvals for the transaction

Malaysia imposes local / Bumiputera equity participation requirements in foreign investments in various economic sectors. Certain regulatory authorities require approvals to be obtained even before the commencement of negotiations and before an agreement is executed.

Regulatory approvals may be required pursuant to:-

1. legislation that regulates specific industries, such as the Financial Services Act 2013; or
2. conditions under licences issued pursuant to specific legislation, such as the Petroleum Development Act 1974 or the Industrial Co-ordination Act 1975; or
3. guidelines of general application, such as the Economic Planning Unit's Guidelines on Acquisition of Properties; or
   (The Economic Planning Unit of the Prime Minister's Department ("EPU"), which is the principal government agency responsible for the preparation of development plans for Malaysia, introduced the Guidelines on the Acquisition of Properties. The said guidelines regulate the direct and indirect acquisition of immovable property having a value of RM20 million or more which results in a dilution of ownership by Bumiputera interest and/or governmental agency. In addition, foreign interest is not allowed in the following:
   
   1. properties valued less than RM1 million per unit;
   2. residential units under the category of low and low-medium cost as determined by the relevant state authority;
   3. properties built on Malay reserved land; and
   4. properties allocated to Bumiputera interest in any property development project as determined by the state authority.)
4. guidelines of specific application, such as the Guidelines on Foreign Participation in the Distributive Trade Services issued by the Ministry of Domestic Trade and Consumer Affairs ("MDTCA") ("Distributive Trade Guidelines").
   (The Distributive Trade Guidelines seek to, amongst others, increase Bumiputera participation in the economic sector, and ensure orderly and fair development of the industry, while ensuring the growth of local businesses.
   Pursuant to the Distributive Trade Guidelines, all proposals for foreign involvement which will result in more than 50% of foreign participation in distributive trade are required to obtain the approval of the MDTCA. Under the Distributive Trade Guidelines, distributive trade comprises all linkage activities that channel goods and services down the supply chain to intermediaries for resale or to final buyers. The linkages may be direct or indirect between 2 parties (or levels) or more than 2 parties (or levels) within the chain. The Distributive Trade Guidelines provides that manufacturing companies are excluded from the definition of distributive trade.
   Note that the Distributive Trade Guidelines is a guideline and not statute or law, and hence does not have the force of law as such. The Distributive Trade Guidelines do not confer the MDTCA the power to enforce or instigate any enforcement action against a company for failing to observe and comply with the Distributive Trade Guidelines. In other words, should a company fails to comply with the Distributive Trade Guidelines, the company would not have committed any offence under any applicable laws of Malaysia.
   However, not obtaining a MDTCA approval can have other practical implications. Based on the current immigration practice, all applications for employment passes to the Immigration Department of Malaysia have been streamlined through an electronic platform: the ESD Portal. The ESD Portal requires a majority foreign owned distributive trade company to submit a copy of the MDTCA approval as a supporting document in its application for employment pass for its expatriate or foreign workers. In the absence of the MDTCA approval, the company will not be able to proceed with the application.)

In view of the above, it is important from the onset to determine the regulatory approvals that are required for a proposed transaction.

(b) Failing to consider the foreign exchange administration rules in a transaction

The foreign exchange administration rules in Malaysia are aimed at providing an appropriate framework that will influence capital flows and facilitate currency risk management to promote financial and economic stability in the country. In line with the objective, the foreign exchange administration rules have been liberalised by the Central Bank of Malaysia ("BNM") with effect from 1 April 2007. Non-residents are free to invest in any form of ringgit assets either as direct or portfolio investments. They are also free to remit out divestment proceeds, profits, dividends or any income arising from investments in Malaysia. The repatriation or payment, however, must be made in foreign currency.

Notwithstanding the aforesaid, there remains a risk that the BNM may re-impose or introduce any rigid exchange control measures in light of the current economic climate. In such event, foreign investors may be limited from carrying out certain trades or transactions in Malaysia, for instance, not being able to carry out any repatriation or payment between residents and non-residents of Malaysia for a specified period of time, or may only do so after paying tax or levy, or obtaining prior approval from the BNM.

In view of the above, it is therefore advisable for a foreign investor to consult with its professional advisors on the legal implications of the foreign exchange control measures on its proposed transaction prior to carrying out any trade or transaction in Malaysia.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.