The Acquisition and Leveraged Finance Review: Taiwan
Acquisitions are primarily financed through equity financing and debt financing in Taiwan. In practice, equity financing is mostly structured in the form of equity injection, whereas debt financing is structured to include, among others, a bridge loan or a mezzanine financing arrangement for the flexibility such arrangement could bring forth, and, typically, senior secured term loans to finance the acquisition. The participants typically include conventional financial institutions and private equity funds that have extensive experience in debt financing arrangements.
While the size of debt financing normally depends on the deal size and the financial condition of the target, in local market practice, the size of debt financing would generally not exceed 70 per cent of the aggregate acquisition amount, meaning that the acquirer is expected to supply 30 per cent of the funds in any given financing arrangement. One notable example is the recent take-private acquisition of Jintex Corporation Ltd, in which nearly 50 per cent of the acquisition funds were obtained from syndicated term loans extended by banks, while the rest were funded by equity.
As debt financing has become more prevalent in the local acquisition financing market, we herein focus on debt financing so as to provide a general landscape on such financing practices and the requirements to which they are subject.
Regulatory and tax matters
Under Taiwan law, there is no specific regulatory requirement on who can provide funds and a lender is not required to obtain a licence when financing an acquisition. However, the following caveats are worth noting when structuring a debt financing in Taiwan.
i Restriction on intercompany loans
The Taiwan Company Act (hereinafter, the Company Act) provides that the fund of a Taiwan-incorporated company shall not be lent to the shareholder of that company or any other person unless the borrower has a business relationship with the lending company or such lending is a necessary short-term financing. Because of this restriction, normally it would be banks, insurance companies or pawn shops in Taiwan that would engage in acquisition financing as part of their regular businesses, and companies that are non-financial institutions would primarily refrain themselves from entering into any similar arrangement.
ii Appointment of a security agent
It is commonly seen in most international syndicated loan transactions that a security agent or security trustee will be appointed to hold security on behalf of all finance parties. Yet, there is no 'security trustee' concept under Taiwan law and only a qualified security agent shall be appointed. Because the Civil Code of Taiwan requires a 'joint and several creditors' relationship among the finance parties (including the security agent) to entitle the security agent to enforce on the relevant security for itself and on behalf of the other finance parties, an appointment of the security agent and expressive acknowledgement of these joint and several creditors relationships are required when the relevant security agreement or facility agreement is governed by Taiwan law. In case the facility agreement is governed by foreign law but involves security in Taiwan, the provisions relating to the 'appointment of the security agent' and the 'joint and several creditor relationship' shall be included in the facility agreement.
In addition, when a registration of security interests with the relevant Taiwanese authorities is required (such as real estate mortgage and chattel mortgage), the security agent should be an entity registered in Taiwan (e.g., a Taiwan branch of a foreign bank) because of the practical requirement by the relevant authorities. The requirement comes as the result of different interpretations by the relevant local authorities on the recent amendment made to the Company Act in 2018. Generally, the amendment has removed the recognition requirement of a foreign company to enjoy the same rights with its local counterparts. Nonetheless, most of the local authorities still require the security holder to provide relevant documents to prove that it is a Taiwan registered company. In this regard, if an acquisition financing would involve certain onshore security (such as mortgagee over real estates or chattels), an onshore security agent must be appointed to allow for the local registration.
iii Anti-money laundering and sanctions
Similar to other jurisdictions as well as international practice, when structuring an acquisition financing in Taiwan, the anti-money laundering and sanctions laws should also be taken into account as the relevant regulatory regime and legal requirements in Taiwan have been brought in line with international standards. Such requirements would also form part of the 'know your customer' check of the banks in accordance with their respective internal policies.
iv Foreign investment approval requirement
Where the acquirer is a foreign entity, the acquisition of the Taiwanese entity would require a foreign investment approval from the Investment Commission (IC) of the Ministry of Economic Affairs of Taiwan. Hence, the obtaining of the IC's approval, among others, will normally be a condition precedent of the first utilisation of the debt financing.
v Foreign exchange regulatory issues
The debt financing would usually be denominated in the same currency as the acquisition consideration. When New Taiwan Dollars (NT$) is the denominated currency, two major issues would come into play. First, because NT$ is not an internationally traded currency, the facility agent is suggested to be a Taiwanese bank or the Taiwan branch of a foreign bank to engage in a banking licence required activity – handling the remittance of NT$ funds. If not viable, certain contractual arrangements should at least be in place to avoid the relevant disputes. Second, Taiwan has implemented certain measures in furtherance of its policy on foreign exchange control. If there are foreign funds to be converted into NT$ under an acquisition financing structure (e.g., lenders' funding to be conditional upon the borrower's foreign shareholder's certain amount of equity injection), the timeline of conversion and, if applicable, obtaining the approval from the Central Bank of the Republic of China (Taiwan) (CBC) should be taken into consideration. In general, the daily conversion amount is subject to the CBC's approval, which would depend on the size of the deal, the foreign exchange markets at that time and so forth. Further, if the aggregate converted amount exceed the 'annual quota' – which is (1) US$50 million (or its equivalent), in respect of an entity registered in Taiwan for non-trade or non-service related transactions in a calendar year, or (2) US$100,000 (or its equivalent), in respect of a foreign entity having no registration in Taiwan – such entities would need to obtain the CBC's approval for the proposed conversion. Because the approval is at the CBC's discretion on a case-by-case basis, a pre-communication with the CBC is usually recommended.
In sum, relevant parties to an acquisition financing should be wary of the foreign exchange issues mentioned above, especially when it comes to the time frame of fund arrangement, the conversion of investment fund denominated in foreign currencies into NT$, or the payment or repayment of the interests or principal of the loans denominated in foreign currencies while only NT$ is available to the borrower.
vi Foreign debt registration requirement
To deal with the annual quota mentioned above, Taiwan corporate borrowers can register their medium and long-term foreign debt with the CBC in accordance with the Directions for the Declaration of Medium- and Long-Term External Debts by Private Enterprises. For Taiwan corporate borrowers that have registered their foreign debts accordingly, the converted amount of their repayment of the interests and principals of those foreign debts that exceeds the annual quota would not be subject to the requirement of the CBC's approval.
vii Withholding tax
In general, stamp duty is not required for the execution of the finance documents in an acquisition financing. However, certain tax payables are required depending on the status of the lenders. Where a lender is a domestic financial institution (e.g., a Taiwanese bank or the Taiwan branch of a foreign bank), the interest payable on the loan extended by that lender is subject to profit-seeking enterprise income tax at a rate of 20 per cent and there is no withholding tax on the interest received by them.
On the other hand, if a lender is not a Taiwan resident or is a profit-seeking entity without an established place of business in Taiwan, the withholding tax rate applicable to a corporate borrower obtaining a loan from that lender is 20 per cent for the interest payable on the loan (if the loan is provided as short-term commercial papers, 15 per cent). This rate could be further reduced to 10 per cent or otherwise in accordance with tax treaties that Taiwan has entered into with the relevant country.
As to the portion of proceeds that is made by the lender to indemnify the principal of the loan, that portion will not be subject to the income tax withholding requirement. However, if the portion of the proceeds is to indemnify the default interest sustained by the lender, then that portion may be subject to income tax, and in the event that the proceeds include a penalty pursuant to an agreement between the lender and the borrower, that penalty will also be subject to income tax unless the lender can prove that the penalty is to indemnify the losses that the lender has sustained.
In practice, transacting parties would typically include the tax gross-up provision in the financing agreement so that the lenders' receipt of payment or repayment would not be reduced because of the tax withholding requirement.
Security and guarantees
The provision of guarantee or security is commonly seen in the condition subsequent to an acquisition financing. The lenders should be cautious in the restrictions on guarantee provided by a Taiwanese company and the relevant perfection requirement on various types of security.
Under the Company Act, a Taiwanese company is not allowed to act as a guarantor unless otherwise permitted by law (such as a bank as permitted under the Banking Act) or its Articles of Incorporation (AoI). If there is any restriction on the AoI of the purposed guarantor, the amendment of the AoI would be required prior to that company acceding as an additional guarantor. Moreover, if the proposed guarantor is a public company, its internal requirement such as the Rules for Endorsements and Guarantee should also be complied with. In this connection, courts in Taiwan have consistently ruled that in the event a company provides its assets as a security (e.g., chattel mortgage over equipment), that provision is by its nature not different from the prohibited scenario in which the company acts as a guarantor and provides suretyship for others. As such, the provision of company assets as a security for any person's obligations would also be subject to the same restrictions under the Company Act as mentioned above.
With respect to security provision, there is no 'all-asset lien', 'floating lien' or 'general security' concept under Taiwan law. Hence, the security provider and the security interest holder are required to enter into an agreement to identify the specific asset over which the parties contemplate to create the security. Depending on the main assets the relevant security provider (usually the borrower or its subsidiary after acquiring the target) has, the most common types of security can be generally categorised as follows:
- security over shares;
- security over bank accounts;
- security over real estate;
- security over movable assets (such as machines and equipment);
- security over intellectual properties;
- security over insurance interests or other material contracts; and
- pledge or assignment of receivables (e.g., loan receivables or account receivables).
By and large, regulatory approval is generally not required for the creation of security interests except for certain types of security interests that are subject to the registration requirements, including security over shares, real estate mortgage, chattel mortgage and pledge over intellectual properties. To give a broad picture of the commonly seen security package, we list below the formalities and relevant requirements of certain securities.
i Security over shares
In Taiwan, security interest can be created over shares in the certificated form and shares in the scripless form, both by entering into a share pledge agreement between the pledgor and the pledgee. As to the certificated form, a public company in Taiwan is obliged to issue such share certificates to its shareholders, whereas a Taiwan-incorporated private company may freely determine whether it will issue share certificates to its shareholders and, if so, whether the share certificates will be in certificated or scripless form.
To create a security over shares in the certificated form, a written agreement must be entered into and the certificates of the pledged shares should be duly endorsed by the pledgor and be delivered to the pledgee. Generally, the pledge of shares becomes valid and forms binding effect on the parties when the certificates of the shares are endorsed and delivered to the pledgee. Nevertheless, the company whose shares are pledged in this share pledging arrangement should also be notified of the creation of the pledge given that the company ought to register the said pledge on its shareholders roster. Neither the pledgor nor the pledgee can claim against the company in absence of the said notice.
On the contrary, the pledge of shares in scripless forms is executed in a different approach given that the shares in scripless forms are transferred through the book-entry system of Taiwan Depository and Clearing Corporation (TDCC). To create and perfect the pledge, the pledgor and the pledgee would be required to sign and execute a TDCC standard form and register the pledge with TDCC instead of endorsing and delivering an actual share.
In rare cases, the pledgor and pledgee may elect to have foreign laws as the governing law for the share pledge contemplated by the parties, such as New York or English law, as long as the creation and perfection of the pledge are executed in a manner compliant with the procedures and requirements described above so as to ensure its validity and enforceability under the laws of Taiwan.
ii Security over bank accounts
To control the fund flows, the accounts of the borrower or security providers (or more precisely described, the cash deposits maintained in the relevant bank account) are usually required to be pledged. In terms of formality, the pledgee and the pledgor must enter into an account pledge agreement that identifies the name of the account, the account number and the bank with which the account is maintained, and such pledge will not become enforceable against the account bank until the account bank is notified of the creation of the pledge. Because Taiwan law does not recognise 'floating charge', any fluctuation of the account balance would affect the validity of the pledge over the original cash deposit identified in such account. In other words, the pledge would not cover any cash that is deposited after the creation of the pledge of the account given that a floating charge is not a recognised security interest under Taiwan law. In this regard, pledgors in Taiwan would normally be required to periodically confirm with the pledgees the then updated balance in the bank account is under pledge so as to ensure that the security interest has included the cash that is deposited after the creation of the pledge.
iii Mortgage over real estates
If the borrower or any of its subsidiaries (after the acquisition) owns valuable real estate (such as land and buildings), a first priority ranking real estate mortgage is usually preferred by the lenders as the value of real estate is relatively steady compared to shares or intangible assets. To create a mortgage, the mortgagor and the mortgagee must enter into a written real estate agreement that identifies the object subject to the contemplated mortgage. The parties will then need to register the mortgage with the competent authority to perfect the mortgage and such registration would be the material factor when determining the priority of multiple mortgages over the same piece of real estate.
iv Security over movable assets
For securities over movable assets, such as machinery and equipment, the security may be created in the form of a chattel mortgage in accordance with the Personal Property Secured Transactions Act of Taiwan. The legal formality includes the execution of a written chattel mortgage agreement that identifies the name, the type, the brand, the manufacturer, the number of pieces, the value and the location of the pledged equipment or machine. Although the chattel mortgage can be effective upon the execution of the chattel mortgage agreement, the mortgagee must still register the mortgage with the competent authority so as to claim the chattel mortgage against a bona fide third party because the mortgagor is not required to deliver the possession of the mortgaged chattels to the mortgagee.
v Security over intellectual properties
Security interests can be created over intellectual properties by a pledge agreement, and intellectual properties that can be pledged include patents and copyrights. To create and perfect a pledge of intellectual properties, the pledgor and the pledgee are required to first enter into a written pledge agreement that specifies the intellectual property (e.g., a specific patent along with its patent number) that is to be pledged as a security. The parties should then register the pledged intellectual property with the competent authority to perfect the pledge, and the registration typically requires the certificate awarded to the pledged intellectual property, the pledge agreement and any other documents evidencing the validity of the pledged intellectual property. The pledge is not enforceable against a bona fide third party until the said registration is complete.
Priority of claims
While pledges and mortgages are consistently created in acquisition financing arrangements, tax-related claims (including claims in relation to land value incremental tax and house tax) would have the highest priority over all claims, pledges and mortgages, following by the claims that are protected from general creditors for being secured by the pledge or mortgage. However, because of public policy considerations, certain labours' claims in relation to unpaid compensations are designated to have shared the same priority with the claims secured by pledge or mortgage, making such claims to be immediately paid off after the tax-related claims are satisfied. For instance, when a company declares bankruptcy and has not paid the land value incremental tax, the workers' compensation and the debt owed to the creditors secured by the company's assets, the company's pledged assets, when in a liquidation process, will first be applied to satisfy the amount owed for the land value incremental tax before the remains of the assets are to be equally and concurrently distributed to the unpaid workers and the secured creditors.
In addition, given that multiple mortgages (including chattel mortgage) could co-exist over the same property and the security interests underlying those mortgage are identical in nature, the respective registration time of those mortgages would thus serve as the benchmark for determining the priority of the mortgages under the general rule that the earlier the registration is made, the higher the priority would be.
Under Taiwan law, the parties to the acquisition financing transaction can choose the law of any jurisdiction to govern their transaction documents. In this regard, the Judicial Yuan of Taiwan has held an internal conference and reached a conclusion that a submission to jurisdiction clause will be valid in the absence of any of the following circumstances:
- it would be unfair for the subject matter to be adjudicated by the chosen jurisdiction;
- the consent of a party to submit to the chosen jurisdiction was obtained by fraud, duress or other unlawful means;
- the parties were not equal-footed when they entered into the submission to jurisdiction agreement;
- it would be inappropriate or inconvenient for the chosen jurisdiction to adjudicate the subject matter; and
- the country of the chosen jurisdiction does not recognise and enforce judgments of Taiwan courts on a reciprocal basis.
In practice, most transactions choose the law of Taiwan, English, Hong Kong or Singapore as the governing law.
Usually, any final judgment obtained in a foreign court will be enforceable in the Taiwan courts without further review of its merits. However, several conditions are generally required to be met to have the court enforce the judgment, and the said conditions include, without limitation:
- in accordance with Taiwan laws, the foreign court that renders the judgment has jurisdiction over the subject matter;
- the judgment and the court procedure resulting in the judgment are not inconsistent with any public order or good morals stipulated by relevant Taiwan laws or ordinances; and
- a reciprocal agreement or similar arrangement has been entered into by Taiwan and the country where the court rendering the judgment sits, by which the judgments rendered by a Taiwan court are as well recognised by the said country.
As to the foreign arbitral award, while Taiwan courts would also recognise the arbitral award on the grounds as stated above, the court could dismiss a foreign arbitral award in the event that (1) the respective arbitration agreement is invalid because of the involved party's incapacity, (2) the respective arbitration agreement is invalid under the governing law of the arbitration agreement chosen by the parties, or (3) there exists no reciprocity in the recognition and enforcement of arbitral award between Taiwan and the country where the arbitral award is rendered.
Acquisitions of public companies
Financing arrangements for acquiring public companies are mostly identical with the arrangements for acquiring private companies, except for the following.
i Time frame
In general, acquisition of a public company is subject to additional laws and regulations that safeguard the integrity of the acquisition process and the rights of minority shareholders. Specifically, if the target public company is listed on the Taiwan Stock Exchange (TWSE) or Taipei Exchange (TPEx), the acquisition of that company would then be subject to rules governing the de-listing process, and all these additional laws, regulations, rules and requirements could lead to variations in terms of the financing time frame, the structure of fund utilisation or the conditions precedent, all of which should be taken into account when structuring the financing deal.
ii The requirement of shareholders' approval
Although the Company Act does not include specific provisions on minority squeeze-outs, the acquisition of a public company and the acquisition terms are still required to be approved by the shareholders of the target company with (1) a majority vote at the shareholders' meeting, which requires the attendance of shareholders representing two-thirds or more of the total number of the company's issued shares; or (2) where applicable, a super-majority vote at the shareholders' meeting, which is attended by shareholders representing a majority of the total number of the company's issued shares. Once the attending shareholders approve the acquisition and the terms, all shareholders of the target company are bound by the approval to the proposed acquisition. As such, a public company may conduct a cash merger or a cash-share exchange to squeeze out its minority shareholders by obtaining the approval from the shareholders with the said quorum and voting threshold, or, in the event that the target company is a subsidiary of the acquiring company by which 90 per cent of the target company's shares have been acquired, the acquisition can be carried out with the approval from both companies' boards of directors.
As to the correlation between the shareholder's approval and the financing arrangement for acquiring a public company, the shareholders' approval is often structured as the condition precedent for the utilisation of funds in the acquisition financing context. Transacting parties in Taiwan would typically agree that the substantial parts of the acquisition funds cannot be utilised unless the necessary shareholder approval is duly obtained. When the conditions are met, the funds would usually be handled by share transfer agent or the broker-dealer who assists in the acquisition and appropriated to shareholders of the target company.
iii Certainty of funds
If the acquisition involves tender offer, the competent authority would require the acquirer to provide documents evidencing the certainty of funds when the application of tender offer is submitted for approval. Information required by the competent authority typically includes, without limitation, the financing amount prepared or obtained by the acquirer for the proposed tender offer and the identity of the party that provides or structures the financing arrangement. As to acquisitions that involve no tender offer (e.g., done through merger or share swap), because no regulatory approval is required, no review of certainty of funds would be required given that such acquisition is purely private between the parties.
iv Information disclosed to competent authority
In general, public companies (including companies listed on TWSE or TPEx) are required to disclose certain material information, such as material resolution of the board of directors or shareholders' meeting, or other circumstances having a material effect on the shareholders' equity or the price of the shares. If the entry into a loan agreement, guarantee agreement or the provision of security for an acquisition financing is considered as material information, an instant disclosure of the major terms (such as the amount of the facility or limit of the guarantee) would be required pursuant to the relevant rules (note that the details, terms on fees or otherwise are not required). In addition, as a tender offer would require an approval from the competent authority, the offeror is usually required to disclose their financing arrangements to the competent authority so as to allow the authority to ensure the certainty of the funds in relation to the proposed tender offer. Such disclosure, however, is not required to be made to the general public or to include specific details.
The year in review
The covid-19 pandemic has significantly impacted the volume of acquisition financing activities in Taiwan as transacting parties are now ceasing their ongoing or contemplated merger and acquisitions arrangements in response to the uncertainty following the pandemic. We, hence, have not yet observed any significant developments in this practice area or material changes to our discussions laid out as above as at the time of writing.
We expect the numbers of acquisition financing arrangements to go up from the first quarter of 2021 because: (1) the cessation of deals because of the covid-19 pandemic is unlikely to last long once the pandemic (or the impact thereof) is under control; and (2) companies are readjusting their global presence in response to the US–China trade tension, and such adjustment would lead to an increasingly robust M&A market, thereby bringing up the needs for acquisition financing.
As such, we are optimistic about the volume of acquisition financing activities in 2021 and would expect major developments in this practice area in the coming year.
1 Sarah Wu is a partner, Odin Hsu is an associate partner and Andrea Chen is a senior attorney at Lee and Li, Attorneys-at-Law.