A Practical Guide to Corporate Due Diligence in China

Legal due diligence is the process of examining a company before a transaction to understand what is being acquired and where the risks lie. This guide explains, in practical terms, what such a review typically covers in China and how its findings feed into a transaction. It is general information rather than legal advice, and the appropriate scope in any case depends on the deal, the sector and the risks involved.

Executive summary

Due diligence exists to answer two questions: what is actually being acquired, and what could go wrong. In a PRC acquisition, the answers commonly turn on corporate standing and ownership, material contracts and assets, licences and compliance, employment, litigation, and encumbrances. Findings rarely stop a good transaction, but they routinely reshape its price, its conditions and the protections a buyer seeks.

Why due diligence matters

A transaction proceeds on a set of assumptions about the target. Due diligence tests those assumptions against the documents and the record. Where reality differs from the assumption, the buyer can respond — by adjusting price, requiring a condition to be satisfied before closing, seeking a specific protection, or, occasionally, deciding not to proceed. Without diligence, those responses are unavailable, because the problem is unknown until after closing.

What a review typically covers

The scope varies, but a legal review of a PRC company commonly examines the following areas.

Corporate standing and ownership

Whether the company is validly established and in good standing, who owns it, how its capital is structured, and whether its constitutional documents are consistent with the intended transaction.

Material contracts and assets

The company's significant contracts — including any change-of-control or termination provisions — and its principal assets, together with the rights and any limitations attaching to them.

Licences, permits and compliance

Whether the company holds the licences and permits its business requires, and whether its activities are within its registered scope.

Employment

Key employment arrangements and any obligations that a transaction might trigger.

Litigation and encumbrances

Existing or threatened disputes, and any security interests or other encumbrances affecting the company or its assets.

From findings to protections

Diligence findings feed directly into the transaction documents. Depending on what is found, a buyer may seek:

• an adjustment to price, where an issue affects value;
• a condition to closing, where something must be put right first;
• a specific indemnity or warranty, where a known risk should sit with the seller; or
• further investigation, where a finding is material but not yet fully understood.

In this sense, diligence and negotiation are not separate stages but parts of a single process.

Scoping the review proportionately

Not every company warrants the same depth of review. A proportionate scope reflects the size and nature of the transaction, the sector, and the risks identified as the review progresses. Focusing effort where the risk is greatest — rather than reviewing everything to the same depth — generally produces a more useful result within a sensible timeframe.

Practical considerations

• Define the scope early, and revisit it as findings emerge.
• Prioritize the areas most likely to affect value or feasibility.
• Treat diligence findings as inputs to negotiation, not merely as a report.
• Coordinate legal diligence with financial, tax and commercial workstreams so that issues are seen in the round.

Any actual review should be scoped to the specific transaction and conducted in light of the applicable law and the facts of the particular company.