Fake Brews: Chinese coffee company “Luckin Coffee” finds itself fresh out of luck over fake sales report

May 1, 2020

2 min read

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What's going on here?

Internal investigations in Luckin Coffee reveal fabricated sales amounting to US$310m, or 40% of its annual sales.

What does this mean?

Before the scandal, Luckin had announced its desire to displace Starbucks and become the largest coffee chain in China. This ambitious vision resulted in over two years of rapid growth. During this time, Luckin secured investment from powerful investors such as private equity firm BlackRock and Singaporean sovereign wealth fund GIC, and completed a US$560m initial public offering (IPO) in May 2019, declaring that it intended to disrupt “the status quo of the traditional coffee shop model”.

This growth was interrupted in January 2020 when Muddy Waters, a US-based investment firm specialising in conducting due diligence, made public an anonymous report pointing to possible fraudulent behaviour in Luckin’s business operations. Luckin subsequently announced the commencement of an internal investigation by a special committee which included US law firm Kirkland & Ellis (K&E) as outside counsel. On 2 April 2020, Luckin admitted that this was true – its Chief Operating Officer and other employees had fabricated financial reports for 2019, and have been suspended. Immediately after this, Luckin’s share price dropped by 74% to US$6.40.

What's the big picture effect?

The fabricated sales mean that Luckin has to deal with a potential fraud case. In such situations, companies often rely on advice from solicitors from the investigations and white-collar crime practice groups to help mitigate this threat to their business. In this regard, K&E’s role will be crucial when conducting investigations to help shareholders understand the facts and their legal implications. This will help Luckin prevent any further violations and make an informed decision on how to proceed. Importantly, K&E is bound by client confidentiality, which allows Luckin to receive market-leading legal advice without revealing information to the public. This means that Luckin’s public image is better protected.

Looking at it from a wider perspective, the Luckin scandal seems to be part of a trend that sees Chinese representation in all recent events that have had negative economic effects. A common factor in these events is a lack of transparency and poor economic practice. Examples of such behaviour range from stealing technology and intellectual property rights to failure to disclose a viral outbreak in Wuhan leading to the COVID-19 pandemic. After this scandal, China’s credibility as an investment opportunity is now questionable.

However, with massive ongoing projects such as the Belt and Road Initiative, investment in China-related opportunities is still invariably an attractive investment opportunity. Thus, foreign investors seeking to get involved will need to take additional precautions to protect themselves from any possible risks. This means that lawyers need to stay updated on existing and potential risk factors so that they can identify areas of concern and advise clients on a course of action to best mitigate these risks.

Report written by Matthew Poon

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