Background
On 8 September 2006, the revised Rules on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors ("the New Rules") replaced earlier provisional rules issued in 2003 (the "Provisional Rules"). The New Rules represent China's most far-reaching legislation governing foreign takeovers of domestic enterprises and encompass investment in both listed and unlisted Chinese companies across all sectors. They also cite the integrity of national economic security and the protection of important local brand names as the basis for invoking anti-monopoly probes into foreign acquisitions of substantial Chinese companies. Compared to the Provisional Rules, the New Rules also bring in international standards with regard to mergers and acquisitions in China. Leaning heavily on the Provisional Rules, the New Rules introduce mechanisms regarding share swaps, the protection of strategic interests and a chapter on special purpose vehicles ("SPVs").
Foreign Companies And Domestic Companies
The New Rules define "foreign investors" as foreign companies as well as foreign-invested enterprises ("FIEs"). "Domestic enterprises" are defined as non-foreign invested companies registered in China and owned by Chinese companies or individuals.
Share Swaps
Under the New Rules, the acquisition of domestic companies can take one of 2 forms : share purchase or asset purchase. For the first time in Chinese law, foreign investors will be able to pay for a Chinese company using foreign-listed shares. This will help Beijing slow down foreign exchange inflows while paving the way for offshore initial public offerings by those Chinese companies being acquired. A condition of such cross-border share swaps is that the foreign company is listed in a territory with "complete corporate legal systems" and "complete securities transactions systems", and the acquiring company and its management must have a clean record. The only non-listed companies that may qualify for share swaps under the New Rules are SPVs for domestic companies listing overseas (see below).
Shareholders must lawfully hold and be able to transfer the consideration shares. Moreover, such shares may not be subject to any form of encumbrance (including disputes or liens). To conduct a due diligence of the subject shares and steer the transaction, a China-registered "M&A Adviser" must be retained as intermediary.
Anti-Trust
Among the key provisions of the Provisional Rules were certain anti-monopoly provisions that gave authorities standards for rejection of acquisition projects based on, for example, over-concentration in the domestic market. The New Rules further build on these by requiring that the following transactions be reported to and approved by MOFCOM. The mandatory anti-monopoly probe will apply to foreign acquisitions if either of the merger partners has assets of more than RMB3 billion, revenue inside China of more than RMB1.5 billion, a domestic market share exceeding 20 per cent, or it directly or indirectly controls more than 15 FIEs in related industries. The mandatory anti-monopoly probe reflects the Government’s concern about the escalating engagement in the market of both foreign multinationals and private equity investors.
SPVs
"SPVs" are defined as companies abroad which are controlled directly or indirectly by Chinese-registered companies or are owned by Chinese companies or individuals for the specific purpose of realizing the interests of such domestic companies. For example, SPVs are often established outside China to facilitate a listing. The New Rules introduce the concept and devote a new chapter to the conditions, approval procedures, status and repatriation arrangements for such SPVs. Of particular interest are provisions that exclude domestically-registered enterprises established by SPVs from FIE status and benefits, and the duty of disclosure if the SPV acquiring party and the domestic target company have the same ultimate controlling party.
Conclusion
The promulgation of the New Rules can be seen as a logical step towards establishing a more mature regulatory environment for cross-border M&A transactions in China. As a recent trend, the acquisition of domestic enterprises by foreign companies has already produced a striking effect on the economy of China but also at the same time has brought new opportunities for its economic growth. In the New Rules, the 6 promulgating ministries tried to strike a balance between encouraging foreign investment and improving the M&A regulatory environment on the one hand, and further protecting local industries and preventing the expatriation of strategic assets on the other. The importance of the New Rules lies in their introducing certain new concepts in M&A in China – which will likely be further clarified in the near future.
If you have any queries about the New Rules or any aspects of mergers and acquisitions of Chinese companies, please contact any of our lawyers in our China Business Department in Hong Kong or Shanghai.
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