This article is intended to provide a general guide to the subject matter. Specific advice should be sought about individual circumstances. Further information or advice may be obtained from Linklaters & Paines, Hong Kong office, 14th Floor, Alexandra House, Chater Road, Hong Kong; telephone: (852) 2842 4888; fax: (852) 2810 8133; contact David Mullarkey or Jeremy Parr.
The following article examines takeover and merger activity in the PRC in the recent years and the regulatory framework applying to such activities.
I. Takeover and merger activity in the PRC
Takeovers and mergers in the PRC have received some publicity of late.
In 1993 several state enterprises were purchased by foreign investors, an example being the purchase by China Strategic Investment, the Hong Kong vehicle of Indonesia's third largest conglomerate, Sinar Mas, of over 200 joint ventures in the PRC, many of which subsequently became subsidiaries of a holding company, China Tire Company Limited, which was in turn listed on the New York Stock Exchange. In February 1993, the Sichuan Provincial Government announced that it would auction off 16 state enterprises to foreigners at a sale in Hong Kong.
In 1993, there was also controversy generated over the takeover attempt by Shenzhen Baoan Group ("Baoan"), a company listed on the Shenzhen Stock Exchange, of Shanghai Yanzhong Industrial ("Yanzhong"), a company listed on the Shanghai Stock Exchange. In that case, Baoan had purchased shares in Yanzhong which stake, combined with the stakes held by two affiliated companies of Baoan, resulted in Baoan's direct and indirect interests in Yanzhong's share capital amounting to 19.8 per cent. at one point. Yanzhong reacted angrily to this hostile act and threatened legal action to defend itself. In October 1993, the Chinese Securities Regulatory Commission ruled that Baoan had violated the disclosure requirements of the National Provisional Regulations for the Administration, Issue and Trading of Securities, which require the disclosure of shareholdings held by legal entities exceeding five per cent. of the total share capital of a listed company. Baoan was subsequently penalised Rmb 1 million, and ordered to account to Yanzhong for any profits made from the trading in the latter's shares. That penalty is itself interesting to a Western lawyer in that, whatever the penalties imposed in the West for breaches of applicable law, one would not expect to find a bidder forced to account to a target for profits made by the bidder on trading in the target's shares.
Subsequently, Shenzhen Vanke Co., Ltd. ("Vanke"), a company listed on the Shenzhen Stock Exchange, disclosed that it had purchased five per cent. of the share capital of Shanghai Shenhua Industrial ("Shenhua"), a company listed on the Shanghai Stock Exchange. Shenhua has indicated that it would welcome a merger with Vanke, so this case has been viewed as perhaps China's first friendly corporate takeover since the return of stock markets in 1990, in contrast with the hostile attempt in the Baoan case.
In April 1994, Vanke itself was the subject of an abortive takeover attempt when a minority shareholder, J&A Securities Company, announced its intention to rally support for acquisition of a controlling stake in the company so as to change the management of the company. Vanke successfully fended off this attempt.
II. Meaning of "Takeover" and "Merger" in the PRC
The term "takeover" is not a technically defined term in the existing legislation in the PRC. This may be contrasted with the term "merger", which has been defined in the national, Shanghai and Shenzhen company legislation, and of which there are two forms, "merger by absorption" and "merger by new establishment".
From the language used in the press releases on the Baoan and Vanke cases, the Shenzhen Provisional Regulations for the Supervision and Control of Listed Companies and the National Provisional Regulations on the Administration, Issue and Trading of Shares, the term "takeover" in the PRC refers to the acquisition of a substantial stake of shares in a listed company. The legislation does not appear to make a distinction between friendly and hostile takeovers, which respectively describe the situation where the bidder's attempt to acquire a stake in the target company is either welcome, or not welcome, by the target company. In both cases, under PRC law and under the regulatory framework in various jurisdictions internationally, the acquisition by the bidder of a certain stake in the target company triggers off the mandatory bid process, where the bidder is required to make an offer to the other shareholders of the target company to acquire their shares.
Mergers on the other hand, as used in the national, Shanghai and Shenzhen company law legislation, applies to all joint stock limited companies, whether or not listed. The legislation here appears to contemplate the situation where the two companies concerned are in agreement over the merger, and merely sets out the procedural steps to effecting the merger by agreement, and the approvals to be sought. Such legislation does not attempt to regulate a takeover or merger through the acquisition of shares on the stock exchange, nor does it deal with situations of hostile takeovers. The term "merger" is in turn divided into an "absorption merger", where the target company is dissolved as a legal entity and is merged with the bidder, which survives as a legal entity; and a "new establishment merger", which refers to the case where the bidder and the target company are dissolved as legal entities during the merger and a new company is established. The distinction between these forms of merger appears to be largely technical and procedural; whether one form of merger is advantageous over the other will largely depend on the circumstances of each case.
III. Legal framework in the PRC: National, Shenzhen and Shanghai Legislation
The Legal Framework
The law on takeovers and mergers in the PRC is still being developed. The following is the relevant legislation applicable nationally and in Shenzhen and in Shanghai:-
(i) PRC Companies Law ("Companies Law").
(ii) PRC Provisional Regulations for the Administration, Issue and Trading of Securities ("National Securities Trading Regulations").
(iii) PRC Provisional Implementing Measures on the Disclosure of Information ("Disclosure Measures").
(iv) PRC Provisional Measures on the Prohibition of Fraudulent Conduct relating to Securities ("Fraudulent Conduct Measures").
(i) Shenzhen Regulations on Joint Stock Limited Companies ("Shenzhen Company Regulations").
(ii) Shenzhen Provisional Measures for the Supervision and Control of Listed Companies ("Shenzhen Listed Company Measures").
(i) Shanghai Adminstrative Measures for the Trading in Securities ("Shanghai Securities Measures").
(ii) Provisional Rules for Market Trading Operations ("Shanghai Market Trading Rules").
Since the national legislation does not expressly repeal the municipal legislation, it is presumed that the municipal legislation will still apply in areas not specifically dealt with by the national legislation. In the event of conflict, the national legislation should prevail.
In addition, the Hong Kong Takeovers Code would apply to PRC companies which are listed on the Hong Kong Stock Exchange. It is yet to be seen how its requirements will operate at the same time as the PRC national and local requirements.
The following points may be noted.
(a) Mergers: The provisions in the Companies Law, the Shenzhen Company Regulations and the Shanghai Company Regulations are mainly procedural in nature, and as indicated above, only appear to deal with the circumstances of a merger by agreement.
(b) Disclosure requirements: Article 60 of the National Securities Trading Regulations provide that an increase or decrease in the holdings of a shareholder holding more than 5 per cent. of the shares in the company, which involves the movement of 2 per cent. or more of the company's shares, will be a significant event requiring disclosure of the same by the company to the securities authorities and the public.
(c) The categorisation of shares into A shares (which may only be held by PRC legal entities and persons), B shares and H shares (which may only be held by foreign investors), and the further categorisation of A shares into state shares, legal entity shares and individual shares: This categorisation, strictly speaking, no longer exists in law since the Companies Law does not provide for such distinction in a company's shares (unlike the previous companies laws). In practice, however, the distinction still subsists.
(d) Article 147 of the Companies Law contains restrictions against the transfer of shares held by the promoter, certain employees and the directors of a company within certain time periods.
(e) Mandatory bid requirements. The National Securities Trading Regulations and the Shenzhen Listed Company Measures provide more detailed regulation of takeovers, and both introduce the concept of the mandatory bid.
Briefly, the National Securities Trading Regulations provide that a person acquiring a stake of five per cent. or more of the shares of a listed company must disclose such acquisition, and each additional acquisition of two per cent. over this five per cent. threshold. Under the National Securities Trading Regulations, the target company is also required to publicly disclose such acquisitions. Upon a shareholder owning, directly or indirectly, a certain stake in the issued shares of the company (30 per cent. under the National Securities Trading Regulations and 25 per cent. under the Shenzhen Listed Company Measures), the mandatory bid provisions are triggered. A takeover announcement must be issued by the bidder, detailed provisions as to the contents of which are contained in the Disclosure Measures and (in respect of Shenzhen companies) in Article 56 of the Shenzhen Listed Company Measures. Prior to such announcement, the National Securities Trading Regulations also provide that the bidder must make a written report to the China Securities Regulatory Commission of his takeover intentions.
The Shenzhen Listed Company Measures and the National Securities Trading Regulations differ from each other in certain important respects. Under the National Securities Trading Regulations, the bidder's offer is subject to acceptance by the shareholders of the target company during a bid period which must be not less than 30 working days from the date of the offer; the offer may not be withdrawn within 30 working days of the offer being made. Under the Shenzhen Listed Company Measures, however, the offer appears to take the form of an agreement signed between the bidder and the directors of the target company. The agreement must then be published in the print media, prior to which publication, trading in the shares of both the bidder and the target company will be temporarily suspended (such suspension in trading does not occur under the National Securities Trading Regulations). The agreement must be approved by more than 50 per cent. of the shareholders (other than the bidder and its affiliates) at a shareholders' general meeting which must take place within 45 days of the signing of the agreement.
(f) Offer period restrictions on dealings. During the sensitive offer period, Article 72 of the National Securities Trading Regulations and the Fraudulent Conduct Measures prohibit dealings in the shares of the bidder and the target company by persons in possession of price sensitive information, which information is not otherwise available to the public. The same provisions prohibit the manipulation of the stock market or the creation of a false or disorderly market. The Shanghai Securities Measures and the Shanghai Market Trading Rules also contain analogous provisions.
IV. Some problems associated with takeover and mergers in the PRC
It largely remains to be seen how these provisions will work in practice; so far, the Baoan and the Vanke cases have been the only concrete instances of enforcement and compliance publicly disclosed. The following are the main problems that may occur:-
1. There are some minor inconsistencies between the legislation at the Shanghai, Shenzhen and national level. Moreover, in respect of the securities legislation, this may be incomplete as the National Securities Trading Regulations apparently do not apply to the trading of B shares or H shares.
2. The major problem however in the mandatory bid concept under PRC legislation is that such a bid will have to be made to all the shareholders of the target company. The shareholders may comprise holders of A shares, B shares and H shares, and amongst the holders of A shares, these in turn divide into holders of state shares, legal entity shares and individual shares. With these different categorisations of shares, it is unclear how the mandatory bid can work in practice because of the following obstacles:-
(a) if a bidder is a holder of A shares, how can it make an offer to buy B shares or H shares when he is legally not allowed, as a PRC legal entity, to hold such shares? Even if it is attempted to resolve the dilemma by excluding the B shares or H shares from the mandatory bid, the problem is not entirely solved. Under the National Securities Trading Regulations, the mandatory bid will be deemed to have failed if the bidder cannot purchase at least 50 per cent. of the total issued shares of the company. If the target company has issued B shares and/or H shares in excess of 50 per cent. of its total share capital, then the mandatory bid may be doomed to fail from the start;
(b) a similar problem, vice versa, exists where the bidder is a holder of B shares or H shares, although there may be an additional policy problem of whether such bidder, who will be a foreigner, should be allowed to make a mandatory bid and therefore acquire a PRC listed company;
(c) a lesser problem, but which may give rise to some difficulties in practice, is the categorisation of A shares into state shares, legal entity shares and individual shares. State shares in general are not listed for trading, nor are, for some companies, the legal entity shares. Under Article 29 of the Tentative Procedures for the Administrative of State Owned Shareholdings in Companies Limited by Shares, a state owned shareholding may be assigned only after a number of requirements are satisfied, and if the assignee is a non PRC person, the approval by the State Administration of State-Owned Assets is required. Notwithstanding this requirement, suppose that a legal entity manages to purchase all of the state shares in a takeover bid which is successful (i.e. having passed the
50 per cent. threshold) but which does not necessitate the de-listing of the company (at the 75 per cent. threshold). Will these former state shares, now legal entity shares, be allowed a listing if the bidder so wishes? One of the concerns of the authorities in respect of the emerging PRC stock markets is the potential for destablisation of these markets by the listing of shares held, or formerly held, by the state, which comprise a large number.
3. There is a further restriction on the transfer of shares set out in the legislation which may have to be considered, although this problem may disappear with the course of time. Under Article 147 of the Companies Law, for instance, shares purchased by a promoter are not permitted to be assigned within three years of the establishment of the company, and shares held by the general manager, supervisors and the directors of a company are not permitted to be assigned during their term of office. This is another factor that the bidder may wish to bear in mind when calculating the probability of the success of his bid.
4. A further problem is that under Article 12 of the Companies Law, a company may not invest more than 50 per cent. of its net asset value into another company. The bidder will have to be careful therefore as to the size of the target company which it may be attempting to acquire. Unfortunately, the bidder may not overcome this obstacle by offering for instance, to finance the takeover with cash and assets up to the 50 per cent. limit, and to finance the remainder through debt, since the debt itself would cut into the net asset value of the bidder. A possible solution may be to finance the takeover through a share exchange, whereby shares in the bidder are exchanged for shares in the target company held by the target company's shareholders. However, such a share exchange may not be always acceptable to the shareholders of the bidder itself, since their shareholding in the bidder will be diluted. Further, the share exchange may run into the problems discussed in the next point.
5. Article 48 of the National Securities Trading Regulations stipulates that the bidder's offer must be made to the holders of all classes of shares of the target company at the higher of:-
(i) the highest price that the bidder has paid for the class of shares in the 12 months preceding the offer;
(ii) the average market price for the class of shares during the 30 working days immediately preceding the offer.
A number of problems arise from the formula:-
(a) firstly, the reference above to the price for "the class of shares" during the relevant period raises again the problem where the mandatory bid may have a cross market application to A shares, B shares and H shares. The regulations state that the offer must be made to the holders of all the different classes of shares, but at a price referenced to only one class of shares (ie., the class of shares being acquired by the bidder). This formula is clearly unfair and unworkable; for instance, the holders of B shares cannot be offered an A share price (or vice versa), as the two types of shares are traded in different markets and quoted in different currencies. On the other hand, if the regulations are liberally interpreted to mean that the holders of each class of shares should be offered a price calculated with reference to the price of that particular class of shares in the relevant preceding period, this would result in each class of shareholders being offered a different price. This is itself not necessarily unfair, since the trading of the different classes of shares on different markets would bring about such discrepancy. But it might make it difficult for a bidder to correctly time his bid; although the price of one class of shares may be low (thus making it an attractive time for the bidder to strike), the price of the other class of shares may be high (thus discouraging the bidder). A friendly takeover could thus be foiled;
(b) the strict definition of the offer price may preclude more creative means of financing a takeover, e.g. by means of a share or asset exchange, whereby the shareholders of the target company are offered shares in or the assets of the bidder in exchange for their shares, which practice is quite common in the international markets;
(c) the legislative fixing of price may also pre-empt the occurrence of a competitive bid, where more than one bidder is attempting to acquire the target company. If no offer price is fixed, usually the higher, and therefore more attractive, price will secure the takeover for the relevant bidder. Under the existing PRC legislation, such auctioning may not occur, which may not be to the benefit of the shareholders of a target company. A simple solution may be to interpret Article 48 of the National Securities Trading Regulations as fixing a minimum offer price, although this is not what the letter of law says.
6. There is no legislation dealing with the possibility of conflicts of interest occurring in the board of directors of the target company or the bidder, or for the appointment of an independent financial adviser to the shareholders of the target company to advise on whether the offer is a good or bad offer. Such appointment of an independent financial adviser is a requirement under the Hong Kong Takeover Code, and may be required in the PRC where the directors of a target company may have conflicts of interests in advising their shareholders, for instance, where they also hold shares in the bidder or where they are also directors of the bidder.
Further information or advice may be obtained from Linklaters & Paines, Hong Kong office, 14th Floor, Alexandra House, Chater Road, Hong Kong; telephone: (852) 2842 4888; fax: (852) 2810 8133; contact David Mullarkey or Jeremy Parr.