China: National Security Review Mechanism Formally Established in China

Last Updated: 23 March 2011
Article by Susan Ning, Shan Lining, Angie Ng and Yin Ranran

On February 3, 2011, the State Council released the Notice on Establishing National Security Review Mechanism for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors ("Notice"). According to the Notice, China will implement a national security review process in relation to foreign funded mergers and acquisitions ("M&A") of domestic enterprises 30 days after the issuance of the Notice. A ministerial joint committee ("Joint Committee") led by the National Development and Reform Commission ("NDRC") and the Ministry of Commerce ("MOFCOM") will be set up to administer and enforce the national security review process.

The concept of national security review was first introduced in the Provisions on Guiding Foreign Investment of 2002, which prohibits foreign investment that may "jeopardize national security". In 2008, this national security review process was, for the first time, addressed in a law (as opposed to regulations or rules) – China's Anti-Monopoly Law ("AML"). Article 31 of the AML states that all foreign funded M&A of domestic enterprises involving national security will be reviewed for national security issues in accordance with relevant provisions of the State. The Notice echoes this AML provision.

Consequently, a foreign investor looking to invest in China by means of M&A will have to consider whether the proposed deal may trigger a national security review process on top of existing regulatory clearances (for instance, foreign investment approval from the perspective of industry policy; the antitrust merger clearance process).

1 What types of M&A deals may be subject to the national security review process?

Not all of the M&A deals will be subject to a national security review. The national security review process will apply only if the target domestic enterprise is involved in businesses that concern either national defense security issues ("national defense security businesses") or national economic security issues ("national economic security businesses"). National defense security businesses include military industry enterprises and supporting enterprises, enterprises adjacent to major and sensitive military facilities, and other entities relevant to national defense security of China. National economic security businesses include enterprises involving major agricultural products, major energy and resources, important infrastructure, transportation services, key technologies as well as major equipment that are related to national security.

In relation to M&A deals involving national economic security businesses, a national security review process may only be triggered if the foreign investor intends to acquire de facto control of the target domestic company. According to the Notice, a foreign investor will be deemed to have acquired de facto control if

  1. the foreign investor and its controlling parent or subsidiary hold an aggregate of 50% or more of the shares of the target company post-merger;
  2. several foreign investors jointly hold 50% or more of the shares of the target company post-merger;
  3. the foreign investor may have significant influence over the shareholders' meeting, the shareholders' neral meeting or the meeting of the board of directors by exercising the voting right attached to its shares post-merger, even if the foreign investor holds less than 50% of the shares of the target company post- merger; and
  4. other circumstances that may lead to shift of de facto control over the operations, finance, personnel and technologies of the domestic company to a foreign investor.

We note that the achievement of "de facto control" is a not a pre-requisite for triggering a national security review process in the context of an M&A deal involving a domestic national security defense business. In other words, all M&A deals involving domestic national security defense businesses may be subject to the national security review process.

2 What is the substance of the national security review process?

Pursuant to the Notice, the joint national security review committee will review the potential impact of the M&A deal on (i) national defense security, including impact on the capacity to produce products, provide services as well as relevant facilities equipment necessary for national defense, (ii) economic stability; (iii) basic social order; and (iv) research and development capacity of key technologies involving national security.

Though the provisions are very general, it is the first time that any statutory instrument in China has set out to define the scope of national security review mechanism. The 2002 Provisions on Guiding the Foreign Investment and the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (promulgated in 2003 and further revised in 2006 which provides that foreign investors about to acquire control over domestic enterprises shall notify MOFCOM if national economic security concerns exist) do not contain any explanation as to what the "national security review" process involves or how the term "national economic security" will be defined. The AML also does not go beyond stating that there will be a national security review process. Till today (and in spite of the Notice), it is still unclear how the Joint Committee will evaluate a merger deal from the abovementioned perspectives.

3 How a national security review process is initiated

Pursuant to the Notice, a national security review process may be triggered either upon voluntary request by the foreign investor involved or upon request by third parties. A foreign investor may voluntarily apply to MOFCOM for national security review. If MOFCOM decides that the potential deal does fall within the purview of the national security review process, MOFCOM will submit the matter to the Joint Committee to commence the process. The review process may also be triggered by third party filings to the Joint Committee through MOFCOM. In that case, the Joint Committee will decide whether to commence the review process.

A variety of parties may file such a request to commence the national security review process, including the relevant ministries of the State Council, nationwide industry associations, enterprises in the same industry and enterprises in the upstream or downstream industries. Therefore, for a deal that potentially involve national security review, even if a foreign investor does not make a filing voluntarily, it is still highly likely that a review will be triggered by request of third parties.

In addition, given that MOFCOM is also the authority in charge of foreign investment approval and antitrust merger filing clearances, we think it would be reasonable to expect that MOFCOM will submit a deal to the Joint Committee if it determines that the deal fall into the scope of national security review during the foreign investment approval process or antitrust merger filing clearance process.

4 What is the procedure of national security review

Pursuant to the Notice, the review process may take place in two stages. A deal will get into the "special review" process if it fails to go through the general review process. Please see the National Security Review Flowchart.

The general review process may last up to 30 working days from the date the Joint Committee receives MOFCOM's application. Within the 30 day period, the Joint Committee may either decide that the deal is free of national security concerns or decide that the deal should be taken to the next stage, namely, the special review process. During this general review process, the Joint Committee will solicit opinions from other relevant departments in writing. Decisions at this stage will be adopted on unanimous consent basis. In other words, if one department whose opinion is solicited thinks that the deal is likely to affect national security, the Joint Committee will kick off the special review process.

The special review process takes up to 60 working days. During this period, the Joint Committee will organize security evaluation of the deal and take into account the evaluation result in reviewing the deal. If basic consensus is reached, the Joint Committee will issue its decision. If huge disparity exists, the Joint Committee will, within the 60 day time frame, escalate this matter to the State Council for final decision.

During the whole review process, the merging parties are obligated to cooperate with the Joint Committee and are entitled to apply to MOFCOM for amendment of the deal proposal or to terminate the transaction.

5 What will be the consequence for failure of passing the review?

If the Joint Committee or the State Council decides that the proposed deal has or is likely to have major impact on national security, the merging parties will be required to terminate the deal or to undertake certain remedies such as the transfer of relevant shares, assets to eliminate any impact on national security.

Note that the Notice is silent on whether the parties at stake may file for administrative review or administrative litigation with respect to the review opinions of the Joint Committee. It remains to be seen whether the parties may have such rights in practice.

Concluding Remarks

The Notice has established the framework of the national security review process. While it gives some indication as to how the national security review process will be conducted (i.e. that there will be a ministerial joint committee system set up, the substantive tests used when conducting review), we anticipate that the State Council is likely to publish more implementing rules based on the Notice – to further specify and elaborate on how this national security process will be implemented and enforced.

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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