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Focus: China – M&A – August 2006

New regulations affect M&A in China

In brief: On 8 August 2006, six ministries1 of the People's Republic of China jointly issued the Regulations Related to Foreign Investors Merger and Acquisition of Domestic Enterprises ([2006] No. 10). The Regulations, which take effect on 8 September 2006, establish new rules for foreign investors acquiring interests in PRC domestic companies. Partner Campbell Davidson(view CV) and Lawyers Toby Grainger and Wayne Wang report on the key aspects of the Regulations.

The Regulations

The Regulations Related to Foreign Investors Merger and Acquisition of Domestic Enterprises ([2006] No. 10) (the Regulations) replace the former Provisional Regulations on Foreign Investors Merger and Acquisition of Domestic Enterprise promulgated by the Ministry of Commerce (MOC) on 2 January 2003.

The Regulations apply to any mergers and acquisitions (M&A) by foreign investors including foreign companies, foreign invested investment companies registered in the People's Republic of China (PRC) and Foreign Invested Enterprises (FIEs)2 (collectively referred to as foreign investors) of domestically registered PRC companies including limited liability companies, joint-stock companies3, State-owned enterprises, private companies and FIEs4 (collectively referred to as domestic companies).

The Regulations further reform the PRC's inbound M&A legal environment and include new provisions in relation to:

  • the use of shares as consideration in acquisitions;
  • government review of certain sensitive acquisitions which influence, or may influence, the security of the State economy; and
  • rules governing acquisitions by overseas Special Purpose Companies5 (SPCs) established by domestic companies or natural persons.

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M&A by share swap

The Regulations are the first in the PRC to expressly address the issue of M&A by share swap.

The share swap concept

M&A by share swap occurs when shareholders of an overseas company use equity in that company, or the overseas company uses its own newly-issued shares as a method of payment to acquire existing equity in domestic companies or to acquire new shares in domestic companies.

Share swap pre-requisites

The overseas company should be lawfully established and its registered overseas location should have in place 'complete corporate legal systems'. The company and its management must not have been sanctioned by any supervisory authority during the past three years. The most important requirement is that, with the exception of unlisted SPCs, the overseas company must be listed and the location where it is listed should have in place 'complete securities transaction systems'. Unfortunately, no definition or standard is given to what constitutes 'complete' corporate legal systems and securities transaction systems.

In addition, the following conditions (in relation to the shares) of both the domestic company and the overseas company involved in the share swap must be satisfied:

  • shares must be lawfully held by shareholders, and able to be lawfully transferred; and
  • shares should not be the subject of any dispute, lien or any other form of encumbrance.

In relation to the shares of the overseas company (other than unlisted SPCs), they must be tradeable insofar as they are listed on a foreign, public and legal securities transaction market (excluding 'over the counter' trading markets). The price of the shares should also have been 'stable' for the past year. The Regulations do not define what is 'stable'.

Domestic M&A Advisors

The domestic company, or its shareholders, shall engage a PRC registered agency or intermediary organisation, such as a law firm, accounting firm or investment bank, to act as their advisor (the M&A Advisor) to conduct due diligence in respect of the proposed acquisition including, reviewing and verifying relevant documents and the financial state of the overseas company and ensuring that the acquisition complies with the requirements of the Regulations.

The M&A Advisor shall also issue an M&A advisory report. The M&A Advisor shall possess relevant professional experience, be of good repute with no record of any material contravention of laws or professional rules, and must be able to investigate and analyse the financial status of the overseas company and the legal system of the location where the overseas company is registered and / or listed.

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Government review of sensitive transactions

The Regulations supplement the existing rules on the review of potentially anti-competitive transactions by introducing a reporting requirement (to the MOC) where:

  • a transaction gives the foreign investor actual control of a domestic company which operates in a key industry, and where the acquisition will influence, or could influence, the security of the State economy; or
  • the foreign investor will control a domestic company that owns well-known trademarks or established traditional Chinese brands.

If the parties do not report the acquisition and such acquisition has a material influence or a potential material influence on the security of the State economy, then the MOC may, in conjunction with the other government bodies, order the parties involved to terminate the relevant transaction, transfer the relevant equity or assets, or take other measures in order to eliminate the effects of the acquisition on the security of the State economy.

There is lack of guidance on the meanings of terms such as 'security of the State economy' and 'key industry'. Further, the Regulations do not contain provisions providing for judicial review if the foreign investor is dissatisfied with the MOC decision. It remains to be seen how the sensitive transaction review provisions in the Regulations will inter-relate with the proposed anti-monopoly law currently being considered by PRC legislators, which will arguably provide more certainty in respect of specific anti-trust considerations.

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Overseas SPCs established by domestic companies

It has been common in recent years for many PRC domestic private companies to establish SPC companies in overseas jurisdictions. This is done to facilitate an overseas listing of PRC interests. The Regulations now contain a new chapter addressing the status, requirements, procedures, and approvals for such SPC companies and bring such practice under the supervision of the MOC.

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Comment

The Regulations have arisen at a time of considerable debate in the PRC concerning foreign M&A activity. Concerns have been raised about the creation of monopolies in key industries by multi-national companies which could undermine the security of the State economy.

Although there are differences of opinion on whether the Regulations actually encourage or restrict foreign investment, there are positive indications that the legal environment for inbound M&A in the PRC is becoming more flexible (eg use of shares as consideration) and settled (eg more detailed approval procedures have been introduced). There remains concern, however, that the introduction of the MOC's power to review sensitive economic transactions (with very little guidance on what these are) could lead to ongoing uncertainty and deter foreign investment. As with other legislation dealing with foreign investment, the MOC retains substantial discretion to block or approve any transaction on the basis that a number of the provisions in the Regulations are broadly drafted and open to wide interpretation.

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Further information

Allens Arthur Robinson offers one of the most experienced teams among international law firms in China. Our lawyers are based in Shanghai, Beijing and Hong Kong and have advised clients on projects in many different cities and provinces across the PRC. For further information, please contact the partners listed below.

Footnotes
  1. Ministries involved were the Ministry of Commerce, the State-Owned Asset Supervisory and Administration Commission, the State Administration of Taxation, the State Administration of Industry and Commerce, the China Securities Regulatory Commission and the State Administration of Foreign Exchange.
  2. Only if other regulations governing FIEs do not conflict.
  3. Only if other regulations governing foreign-invested joint-stock companies do not conflict.
  4. See note 2 above.
  5. An SPC is an overseas registered company which is directly or indirectly controlled by PRC domestic companies or natural persons and established for the purpose of listing overseas the domestic interests owned by its shareholders.  

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