China: An Overview Of MOFOCOM's Recent Enforcement Actions Against Failures To Notify

Last Updated: 22 December 2017
Article by Fangda Partners

INTRODUCTION

This client briefing discusses the recent trend of enforcement actions taken by the Chinese merger control regulator, the Ministry of Commerce ("MOFCOM") against 'failures to notify' under Art. 21 of the Anti-Monopoly Law ("AML"). Since the first published failure to notify decision in December 2014 there have now been 15 published cases in total. Notably, in the past couple of months, MOFCOM has published 6 decisions1 in rapid succession on failures to notify. This "name-and-shame" mechanism is now becoming an increasingly important enforcement tool for MOFCOM.

Five cases are highlighted below which provide some insights into MOFCOM's enforcement rationale and point out some practical concerns for companies to consider when contemplating cross-border transactions potentially subject to MOFCOM's merger clearance review:

  • the Cummins case shows that notifiable joint ventures that are established without obtaining merger clearance are deemed by MOFCOM to be continuing violations vis-à-vis the statute of limitations for the Chinese administrative penalties (a fine of RMB150,000 for each party was imposed);
  • the Meinian , Canon, and OCI cases demonstrate MOFCOM's willingness to punish what it considers to be "gun jumping" in multi-stage deals constituting one single transaction (fines of RMB300,000, RMB300,000 and RMB150,000 were imposed, respectively); and
  • the Continental Automotive case shows the importance of making full disclosure in corrective reports to MOFCOM for a failure to notify (a fine of RMB200,000 was imposed);

Looking at each of the cases in more detail, we find the following worth noting:

Closed notifiable joint ventures which did not obtain merger clearance are deemed by MOFCOM to be continuing violations

Background

MOFCOM started an investigation on 20 January 2016 into the failure to file a notification for the joint venture between Cummins (China) Investment ("Cummins") and Xiangyang Kanghao Mechanical & Electrical Engineering ("Xiangyang"). Cummins and Xiangyang entered into the joint venture contract in December 2011 to set up a 50:50 joint venture which was formally established in 2012. MOFCOM's investigation was triggered in June 2015 by the parties' decision to voluntarily report to MOFCOM regarding their failure to notify the original agreement.

Analysis

It is interesting to observe this case in the context of the PRC Administrative Penalty Law, which in article 29 provides for a limitation period for administrative penalties of two years. The exception to this two year limitation is where the act in question is continuing, in which case the two year period runs from the date on which the violation ceases.

Here, the contract was entered into in 2011, and the joint venture entity was formally registered in 2012.

MOFCOM's investigation was formally launched in January 2016 and its decision against Cummins and Xiangyang was made in 2017. While not explicitly stated in MOFCOM's decision, this enforcement action implies that the MOFCOM deems an established joint venture to be a continuing violation, so that the two year limitation period does not run from the date of the establishment of the joint venture or the "closing" of such reportable transaction.

It is also worth noting that the parties proactively reported to MOFCOM their failure to notify this transaction, and that MOFCOM noted that the joint venture did not eliminate or restrict competition. It follows that MOFCOM considers the failure to notify to be an infringement of a "black-letter law" obligation under the AML and the continuation of such violations will be subject to the imposition of penalties by MOFCOM regardless of whether the joint venture has any adverse impact on the market structure.

This case is expected to draw attention from multinationals and their legal counsel especially given that there is no 'full-functional joint venture' concept under the AML – technically all joint ventures, including off-shore entities, are notifiable to MOFCOM if the relevant turnover thresholds are satisfied. While so far there has been no pertinent public precedent showing how closed M&A deals will be treated vis-à-vis the statute of limitations for Chinese administrative penalties, one could reasonably expect that the methodologies implied in the Cummins case should also apply to acquisitions. This would apply in the sense that the acquired businesses/entities would be operated on a continuing basis with ongoing impact (whether adverse or not) on market competition. Under this rationale, there appears to be the risk that a transaction that could have been cleared by MOFCOM before closing may be subject to more severe consequences (being unwound) if in several years post-closing, the (merged) entity is found by MOFCOM to have significant negative impacts on the competition.

Multi-stage transactions can be penalized by MOFCOM for gun-jumping

Background

In the past two months MOFCOM has issued three notable penalty decisions involving multi-stage transactions for failure to notify:

  • Meinian Onehealth Healthcare (Group)/Ciming Health Checkup ("Meinian");
  • Canon/Toshiba Medical Systems ("Canon"); and
  • OCI Corporation/Tokuyama Malaysia ("OCI").

In Meinian and OCI, the overall transactions were structured to involve a staged increase in shareholdings via different entities. In Canon, Canon initially acquired non-voting rights and share options in the target while the voting rights were disposed of to a special purpose vehicle; the transaction agreement stipulated that Canon's acquisition of voting rights was conditional upon obtaining merger clearances.

The parties in each case notified MOFCOM of their deals after completing a subsidiary part of the transaction, but before the final completion as a whole. MOFCOM found violations of the notification obligation under the AML when the relevant parties implemented the earlier steps, on the basis that the different steps constituted one single reportable transaction leading to an ultimate change of control. MOFCOM found, however, that none of these transactions had the effect of restricting or eliminating competition in their relevant markets.

Analysis

In Meinian, MOFCOM found Meinian Onehealth and its ultimate controller played a lead role in the overall transaction to acquire Ciming Health Checkup. Meinian Oneheatlh was the party to the share transfer agreement, the beneficiary of the deal as well as the acquirer obtaining actual control of Ciming Health Checkup - it had full knowledge of the whole deal. The other parties involved in the transaction merely temporarily held the target's shares under Meinian Onehealth's direction. Thus MOFCOM concluded that Meinian Onehealth failed to notify MOFCOM of this "one single transaction" before proceeding with the first two steps, which in MOFCOM's view were interdependent as they shared the goal of conferring Meinian control over Ciming Health Checkup.

In Canon, MOFCOM's decision draws a distinction between the "commencement of implementation" and the "completion of implementation". Specifically, it found that this transaction was structured in two steps: in the first step, a special purpose vehicle acquired the voting rights of Toshiba Medical while Canon obtained non-voting shares and share options; in the second step Canon was to exercise the share options to acquire control over Toshiba Medical after obtaining merger clearances in various countries including China. Similar to Meinian, MOFCOM considered that the two steps in Canon were closely related, forming "integral parts for Canon to acquire all shares of Toshiba Medical". Because the first step was complete when the target's voting shares and the share options were disposed of and Canon paid the full purchase price, MOFCOM concluded that Canon had intentionally delayed the notification so as to facilitate this initial step being completed within the desired timeframe. This therefore constituted a "failure to notify".

In OCI, MOFCOM noted that the deal in question involved three steps that were designed to enable OCI to obtain control of Tokuyama Malaysia. MOFCOM highlighted the fact that OCI failed to notify the transaction before OCI subscribed for its 16.5% increase in shareholding through an issuance by Tokuyama Malaysia in the first (subsidiary) step of the transaction. MOFCOM took into consideration the fact that OCI voluntarily notified MOFCOM before OCI subscribed for a further issuance of shares which would have increased its shareholding to 50.7% as part of the second step. MOFCOM nevertheless concluded that OCI violated the AML based on reasoning similar to that applied in Meinian and Canon, namely that the different steps had the same ultimate purpose and were interdependent, constituting one single transaction.

MOFCOM has previously issued penalty decisions involving multi-stage acquisitions in 2015, namely in the Fujian Electronics/Shenzhen Chine-E and Shanghai Fosun/Suzhou Erye cases. In these cases, the completion of a subsidiary part of an overall change of control transaction took place before notification to MOFCOM.

From the Meinian, Canon, and OCI cases, it can be seen that MOFCOM has become more sophisticated in challenging transactions with complex multi-stage structures for failure to notify. These cases highlight the importance of taking into consideration gun jumping risks in multi-stage transactions. In all three decisions, MOFCOM found similar links between the different stages of the transactions suggesting that the stages were all designed to result in a single concentration. Multinationals contemplating cross-border M&A transactions are often confronted with complex business considerations and significant time pressure for closing. Transactions that may trigger merger review in multiple jurisdictions are particularly challenging for the parties and their legal advisors attempting to balance compliance with the applicable merger control regulations with meeting commercial objectives. Some novel and creative structures such as "warehousing" or "hold-separate" arrangements adopted to remedy gun-jumping concerns have been tested before numerous foreign competition authorities. MOFCOM's recent gun-jumping decisions seem to have adopted a relatively stringent test for determining whether the transaction has a 'singular goal' in finding that multiple steps may constitute a single notifiable transaction. Transacting companies are thus recommended to engage with antitrust counsel at an early stage to review potential transaction structures and carefully examine the antitrust risks in China, which now has become one of the major merger control jurisdictions.

Failure to fully disclose in a corrective notification will aggravate penalties

Background

MOFCOM announced on 12 April 2017 that it had fined Continental Automotive and Huayu Automotive Systems RMB 200,000 each for their failure to notify a joint venture they set up in May 2015. The parties failed to file the transaction before the joint venture obtained its business license and when the parties subsequently submitted the corrective notification, they did not disclose that the transaction had already been completed.

Analysis

MOFCOM noted in the decision that while the parties voluntarily made a corrective notification post-closing, they did not disclose that the transaction had already been concluded. MOFCOM further found that the parties were in the process of preparing the notification to be filed with MOFCOM at the time that the joint venture was completed. This revealed that the parties were fully aware of the filing requirement, but still went on to complete the transaction prior to filing. Compared with the Cummins case, the parties in this case received a higher penalty. While the difference in quantum is not substantial, by describing the improper conduct in its decision and imposing a higher monetary fine, MOFCOM has strongly indicated that it will not tolerate non-cooperation by parties during an investigation and/or the submission of any intentionally misleading or incomplete submissions.

Concluding Comments

Length of the MOFCOM investigation and the timing implications:

In our experience, while it normally takes two to three months for MOFCOM to clear a "simple case", in contrast for a corrective post-merger notification or formally launched gun-jumping investigation, it may take significantly longer for the transaction to obtain Chinese merger approval (which often would come out as a penalty decision for failure to notify). In Cummins, it took 18 months for MOFCOM to issue the penalty decision after the parties submitted their voluntary notification in 2015.

The Meinian decision by MOFCOM also highlights risks specific to regulated entities. Meinian had to ask the China Securities Regulatory Commission ("CSRC") to suspend its review of Meinian's acquisition of its stake in Ciming due to the MOFCOM investigation into the failure to notify, as the CSRC was concerned that MOFCOM had the power to unwind an offending transaction. There was a lapse of nine months between the start of MOFCOM's formal investigation and its final decision, and the deal is still pending final approval from the CSRC.

This demonstrates how a failure to timely notify MOFCOM of a transaction can cause serious delays, especially in circumstances where the last steps of a transaction are conditional upon MOFCOM merger clearance and MOFCOM initiates an investigation into failure to notify before the completion of these final steps. The parties should expect that considerable resources will be required to go through this lengthy process with significant legal and time costs, before the parties can eventually "legally" close the contemplated transaction.

Practical considerations in addition to monetary fines

It is not clear how MOFCOM weighs different factors in deciding the final amount of its fines; there are however a number of considerations which may be relevant, including whether the:

  • investigation was triggered by a third party complaint (note that in both the Meinian and Canon cases, MOFCOM disclosed that it received third-party complaints, and the final penalties in these cases were twice as high as in the self-reported OCI case, which also involved a multi-step transaction);
  • parties planned to notify MOFCOM (or planned to delay this notification);
  • parties did in fact notify MOFCOM (and whether this took place before final completion);
  • parties cooperated with the investigation (and whether they made full and complete disclosure of all relevant information in the corrective notification);
  • parties have previously been found to have failed to notify (as seen in Bombardier Transportation Sweden, more below).

Currently, the maximum fines for failure to notify are capped at RMB 500,000 (under Art. 48, AML). There are, however, market rumors that MOFCOM is seeking to raise the level of fines it can impose. If this turns out to be true, MOFCOM's penalties against failure to notify are expected to have a greater deterrent effect – especially given MOFCOM's approach to continuing violations.

In addition to monetary fines, it is also important for companies to bear in mind some other practical risks in connection with the MOFCOM penalty decisions, for example:

  • reputational damage to the undertakings involved (note the penalty decision will be published on MOFCOM's website);
  • damaging the relationships between the undertakings involved and the regulators (which may be a factor in deciding the level of fines – the recidivism of Bombardier Sweden was a factor leading to the higher fines in the Bombardier Transportation Sweden/New United Group case Bombardier was fined RMB400,000 while its joint venture partner New United Group was fined RMB300,000);
  • MOFCOM may potentially order the parties to discontinue a concentration, and unwind a transaction that has not been notified.

So far, in all of the MOFCOM penalty decisions against failure to notify, MOFCOM has concluded that the deals did not have the effect of restricting or eliminating competition on the relevant market. It remains to be seen how transactions with substantive harm to competition will be penalized by MOFCOM if the parties fail to notify. In light of recent MOFCOM enforcement actions against failures to notify, transacting parties should be advised to carefully assess whether the contemplated deal is notifiable in China and arrange for proper engagement with MOFCOM at an early stage.

Originally published June 2017.

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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