China: China's national security review procedures commence - 10 March 2011

Last Updated: 15 March 2011
Article by Martyn Huckerby and Sharon Wong

On 5 March 2011, China's Ministry of Commerce (MOFCOM) introduced new trial procedures under China's national security review regime, which requires foreign investors to obtain prior approval before acquiring control of domestic Chinese companies in certain sensitive sectors. MOFCOM is currently seeking comments on such trial procedures before 10 April 2011.

Background

Just prior to the effective date of the State Council's Notice on the Establishment of the Security Review System in M&As of Domestic Enterprises by Foreign Investors (Guo Ban Fa [2011] No. 6) (Rules) (discussed in our alert 16 February 2011), MOFCOM issued corresponding implementing provisions entitled the Interim Provisions on Issues Relating to Implementing the Security Review System for Foreign Investors' Merger with and Acquisition of Domestic Enterprises (Interim Provisions.

The Interim Provisions, which took effect on 5 March 2011 and remain valid until 31 August 2011, detail the security review procedures from an applicant's perspective (i.e. foreign investors). In the mean time, the public has until 10 April 2011 to provide MOFCOM with comments on the Interim Provisions.

Key provisions

1. Initiation of an application

The Interim Provisions explicitly require that if the target of a M&A transaction is subject to national security review, the relevant foreign investor(s) must apply for a national security review with MOFCOM. Further, if a transaction is amended at a later stage so that it is within the scope of a national security review, the relevant parties must suspend the transaction and apply for a review.

State Council's departments, nation-wide industry associations and enterprises in the relevant market may report to MOFCOM any M&A transactions that in their view warrant a national security review. MOFCOM may, after consultation with the Inter-Ministerial Committee (a joint ministerial meeting in charge of national security reviews, led by MOFCOM and the National Development and Reform Commission and working with relevant government agencies in the target industry), require the relevant foreign investor to apply for a national security review.

If a foreign investor fails to apply for a national security review where required, MOFCOM or its local counterparts will refrain from providing transaction approval.

Fortunately, foreign investors may consult with MOFCOM on procedural aspects of their M&A transactions prior to a formal application for national security review.

2. Documentation

Applicants are required to provide a comprehensive set of documents when applying for a national security review. A list of required documentation is noted below:

i) An application letter and a description of the relevant transaction;

ii) Identification documents of the foreign investor, including notarised and legalised foreign investor identification or incorporation evidence, notarised and legalised bank reference letter, as well as identification documents of the authorised individuals;

iii) Background documents of the foreign investor, including a statement regarding the relationship between the foreign investor and its affiliates (such as its actual controlling party and parties acting in concert) and a statement regarding its relationship with the relevant governments;

iv) Background documents of the target, including a description of the target, Articles of Association, Business Licence, audited financial statements of the preceding year, company structure diagrams before and after completion, and a description of the investors of the target;

v) Documents in relation to the merged/acquired entity after completion, including the Articles of Association, Joint Venture Contract or Partnership Agreement, and a list of proposed senior executives (such as directors and general managers);

vi) Transaction documents in respect of, for example:

  • equity acquisitions, underlying documents including the share transfer agreement or subscription agreement, relevant shareholder resolution of the target, and relevant asset assessment report; or
  • asset acquisition, underlying documents including a resolution of the asset owner approving the asset sale, an asset purchase agreement, information of the relevant parties and the relevant asset assessment report;

vii) Documents reflecting the potential "control" of the foreign investor over the merged/acquired entity, including a description of the impact after completion of the foreign investor's voting power over the shareholder meeting and board resolutions, the foreign investor's actual control over management strategy, financial, employment and technological arrangements, as well as the supporting documents in relation to the above impact; and

viii) Other documents as required by MOFCOM.

3. Review and decision

While the Rules provide a timeline of how national security reviews will progress (see our alert 16 February 2011), the Interim Provisions supplement this timeline by specifying time periods within which a particular review must be commenced. This provides welcome guidance for applicants, as it gives applicants insight into the time likely to be required to complete an M&A transaction.

MOFCOM is required to provide written confirmation on whether a particular security review is triggered within 15 working days from the day it notifies an applicant in writing that its application is complete and accepted. Until the 15 day waiting period expires, an applicant is barred from proceeding with the relevant transaction and local counterparts of MOFCOM must cease regular M&A transaction reviews. If an applicant does not receive written word from MOFCOM that a security review has been commenced at the end of 15 working days, it is deemed that no security review is required and any relevant procedures required under other laws and regulations with respect to the proposed transaction may proceed.

Upon the completion of a national security review by the Inter-Ministerial Committee, MOFCOM will issue its decision to the applicant. Decisions will fall in one of the following categories:

  • No national security concern - The transaction does not raise any national security concerns and the applicant can proceed to obtaining regulatory approvals/procedures required under various foreign investment regulations with the competent authorities;
  • Potential national security concern – The transaction raises a potential risk to national security. The applicant is prohibited from proceeding with the relevant transaction and may elect to amend the transaction, revise the application documents and re-submit the security review application; and
  • National security concern – The transaction has had an impact or might have a significant impact on national security. MOFCOM may, according to the decision of the Inter-Ministerial Committee and with the assistance of the relevant department, unwind the relevant transaction or take other effective measures (i.e. ordering the transfer of shares/assets) to mitigate any negative impact on national security.

Conclusion

The Interim Provisions provide welcome clarity about the national security review process and an opportunity for foreign investors to comment. Foreign investors who are contemplating investing in sensitive sectors in China in the next couple of months may also obtain practical experience. By the end of August 2011, it is hoped that the Interim Provisions will generate some real examples that will illustrate how the State Council's Rules are to be applied in practice.

As previously noted, the Interim Provisions enable foreign investors to consult with MOFCOM prior to the submission of a formal security review application, which may, to some extent, assist foreign investors to ascertain whether their transaction is potentially subject to review.

Given that the Interim Provisions are only effective until 31 August 2011, it is expected that updated MOFCOM implementation provisions will be developed later this year.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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