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Business Matters

More suggestions from Goltsblat BLP

/ 10:46 PM November 23, 2012

(Second of two parts)

IN ADDITION to those discussed last week, Legal Update has four other practical suggestions for local enterprises.

Admittedly, no amount of due diligence, no matter how thorough, can unearth all significant data about an enterprise. All investors, local or foreign, know that only too well.


The investor’s usual method of self-defense is to impose price adjustment mechanisms that may be invoked upon discovery or surprise occurrences of unseen problems after closing a deal. Another is to ask for indemnities for certain specified risks.

Local enterprises ought to resist the temptation of agreeing totally to foreign investors’ demands. What they ought to do, in their own counter-defense, is to try to require limitations on their vulnerability.

A standard limitation is the time within which a covered risk may occur. Just as the law sets down prescriptive periods for certain actions and claims, because the lapse of time erodes both record and remembrance, the right of action of foreign investors against the local enterprise has to be time-bound.

Another is the amount of compensation for the defects uncovered. The purpose of inviting foreign investors is to leverage on their participation in the business, not to totally abdicate one’s interest therein. Hence, the locals must not risk all.

There should be provisions on the manner that claims can be pursued, on the prior exhausting of recourse from insurers and other third parties. Other protective provisions are condition precedents before actions detrimental to the business can be taken.

Significant is the identification of who will make the indemnification. The foreign investment is in the enterprise, and not on the personalities owning the enterprise. Hence, there should be no need for the owners to personally be liable to indemnify newcomers. Where foreign investors insist on doing so, a modification to their proposal may be for the target owner’s vulnerability to arise only after the failure of mediation or other nonjudicial modes of settlement.

A complete rejection of the demand indemnification may be made where the target company is listed. Also, if the owners of the target enterprise have other businesses and/or are notable members of the country’s business community, the local company may hint on either taking umbrage or feeling disappointed, and the request for indemnification can be framed as an indication, in the foreign investor’s view, that the major stakeholders of the target company are not to be trusted. Foreign investors are briefed on the sensitivity of Filipinos, and a play on the likelihood of wounded feelings just might ward off requests for indemnity.

Foreign investors have many methods of slowing down the inflow of risk capital until they are comfortable with the target local enterprises. Deferred payments according to a defined schedule, subsequent inflows dependent on the attainment of certain pre-agreed levels of business performance, non-cash infusions like loan notes or shares in affiliates, and claw-backs, retentions and escrows are examples of what are in the foreign investor’s bag of tricks.


Local companies ought to be wary of those methods. Foreign investors are desired for their capital and know-how, introduction of new markets and opening of new product lines and processes. The sooner the local company gets them, the better for all, including the foreign investor.

Foreign investors like using offshore institutions, branches or subsidiaries to limit the head office’s exposures and calibrate their vulnerability and overall expenditures. Locals need to be familiar with them as well as the related stratagem of demanding the issuance of new classes of shares designed for foreign investors, or of options and convertibles. All these are devices to expand their influence without enlarging their exposure.

A significant issue is determining who will be on the driver’s seat. It is easy to be collegial when the road ahead is clear, but when a traffic jam is encountered, or the stress of travelling together gets on the nerves of the partners, when alternative solutions seem to be equally attractive, and when crucial crossroads are reached, then there should be a built-in mechanism, set up way before any of these eventualities, to identify who is the final decision-maker.

Foreign investors often require veto powers against certain changes, or consent requirements in cases of shifts of policy and direction, board representation and audit functions, and head office consultations for decisions that need to be secured for selected decisions. All these dilute the rule of the majority and should be resisted by locals. After all, taking the macro picture, although foreign investors are welcome, the economic patrimony is a heritage of Filipinos.

Finally, an exit mechanism is needed for both foreign and local investors. The most common method is listing in the formal markets; it opens the enterprise to outsiders and provides a walk-away for insiders. Locals should be familiar with tag rights (ability to tag along when the foreigners sell) or drag rights (ability to force a purchase by the foreign partner), and put and call options, as well as buy-outs, share purchase agreements, and other mechanisms, in order to be ready if and when the parties decide to fold their tents and move on separately.

* * *

“Ricardo J. Romulo is senior partner of Romulo Mabanta Buenaventura Sayoc & De Los Angeles.

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TAGS: column, due diligence, exit mechanism, glotsblat blp, indemnification, investors, Ricardo J. Romulo
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