1. Generally

(a) Formal title: Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, promulgated jointly by the Ministry of Commerce, State-owned Assets Supervision and Administration Commission of the State Council, State Administration of Taxation, State Administration for Industry and Commerce, China Securities Regulatory Commission and State Administration of Foreign Exchange on 8 August 2006 and effective as of 8 September 2006

(b) Supersedes 2003 regulations—the 2006 Rules supersede the 2003 Interim Provisions for Foreign Investors to Merge and Acquire Domestic Enterprises

(c)MOFCOM to be lead agency—MOFCOM will be the lead agency for M&A, working with five other agencies: SAIC, SAFE, SASAC, CSRC and SAT. MOFCOM will also be the lead agency for anti-trust matters

(d) Scope—note the 2006 M&A Rules appear to apply only to acquisitions by a foreign investor of a the equity or assets of a "domestic company"—and therefore by definition not to additional investments in, or acquisitions of, existing FIEs

2. Summary

(a) Highlights

(i) MOFCOM is now the lead agency for all M&A activities, including formation of SPVs and restructurings in connection with offshore listings or "going-public transactions

(ii) The new Rules cover all acquisitions of domestic companies or assets by foreign investors, including overseas companies under the de facto control of PRC persons or entities (Art. 2)

(iii) MOFCOM approval from Beijing will be required if a "key industry" is involved, where the acquisition might have an impact on "national economic security" or result in a transfer of actual control of a domestic enterprise that owns a well-known trademark or historic Chinese brand name (Art. 12)

(iv) Appraisals are required for all acquisitions (Art. 14)

(v) The use of stock as consideration is now permitted, subject to new and detailed requirements, including:1

  • except for SPVs, only companies listed on recognized stock exchanges may use equity for acquisitions in China (Arts. 28-29)

  • approval from MOFCOM Beijing is required for all acquisitions in which equity is used as consideration (Art. 32)

  • higher leverage is permitted for companies acquired through stock swaps—the debt to registered capital ratio can be as high as 70% for companies with a total investment of only US$12 million (formerly $30 million) (Arts. 19-20)

  • a report from an "acquisition consultant" is required in all acquisitions in which stock is used as consideration (Arts. 30-31)

  • a complex system of provisional approvals is established, involving MOFCOM, SAIC and SAFE, and SASAC if State-owned companies or assets are involved (Arts. 32-35)

  • if the transaction does not complete (i.e., the equity is not transferred) within six months of the issuance of the business license, the transaction will be unwound (Art. 36)

(vi) There are new procedures requiring notice to creditors and publication in nationally-distributed newspapers in the case of any asset acquisitions (Art. 13)

(vii) There are new restrictions on "round-tripping investments" (flipping ownership of a PRC company offshore so that the domestic operations get the benefit of treatment as an FIE):

  • any such restructurings require at least 25% new money in order to continue to enjoy FIE treatment, and

  • MOFCOM approval at the national level will be required

(viii) There are new disclosure requirements in situations where parties to an acquisition are related—including where the control is only de facto—and prohibitions on evading these requirements through the use of trusts, nominees, or other means (Art. 15)

(ix) There are new rules governing the establishment and use of SPVs as a vehicle to achieve the public listing of PRC companies (Arts. 39-49):

  • MOFCOM approvals at the national level will be required for all SPV restructurings (Art. 42)2

  • a valuation, including a report by a PRC "acquisition consultant" will be required for the SPV restructuring (Art. 44)

  • there is a complex system of provisional approvals from MOFCOM, SAIC and SAFE (Arts. 44-47)

  • CSRC approval will be required for any direct or indirect offshore listing of an SPV (Art. 40)

  • if the listing does not occur within one year, or if the parties fail to complete the necessary reports to the authorities after a listing, the entire transaction will be unwound (Art. 48)

(x) Proceeds of the offshore listing do not have to be repatriated immediately, but a repatriation plan must be filed with SAFE and must be followed (Art. 48)

(xi) Transactions with or involving existing FIEs will continue to be governed in the first instance by existing laws and regulations (Art. 55)3

(xii) There are detailed new anti-monopoly (anti-competition) rules, which require antitrust clearance from MOFCOM and SAIC in Beijing in the following cases (Arts. 50-54):

  • "Large" transactions, where:
  • a party has more than RMB 1.5 billion in Chinese sales during the current year;

  • the foreign investor acquires more than 10 companies in a "related industry" in China within one year;

  • a party controls 20% of the relevant Chinese market; or

  • as a result of the transaction, a party controls 25% of the relevant Chinese market
  • Offshore transactions, where:
  • a foreign party owns more than RMB 3 billion (US$ 380 million) of assets in China;

  • a foreign party has RMB 1.5 billion (US$ 190 million) in Chinese sales during the current year;

  • a foreign party or its affiliates controls 25% of the Chinese market; or

  • as a result of the transaction, a foreign party owns shares directly or indirectly in 15 foreign-invested enterprises in a "related industry"

3. Examples Of Specific Types Of Transactions

See below, p. 18

4. Part One: General Provisions

(a) Definitions—an "acquisition of domestic enterprises by foreign investors" is defined as:

(i) equity acquisitions: foreign investor acquires equity in a domestic company thereby establishing an FIE, or subscribes for new equity via an increase of registered capital thereby establishing an FIE

(ii) asset acquisitions: foreign investor establishes an FIE which purchases and operates the assets of a domestic enterprise, or which purchases the assets of a domestic enterprise and injects those assets into a new or existing FIE

(iii) domestic company: a "domestic company" is defined as a non-foreign invested enterprise in China (Art. 2)

(b) Fairness, compliance with law and foreign investment guidelines—acquisitions of domestic companies by foreign investors must comply with the laws and principles of fairness, etc. (Art. 3) and foreign investment guidelines (Art. 4 ). Where SOEs or state-owned assets are involved, relevant laws must be followed (Art. 5)

5. Part Two: "Basic System"

Part Two of the M&A Rules sets out certain basic regulations applicable to all acquisitions by foreign investors.

(a) 25% "real" foreign investment required—if the foreign investment represents 25% or more of the registered capital of an enterprise, then the enterprise will be entitled to treatment as an FIE (Art. 9)

Art. 9 requires this 25% to be "real"—in other words:

(i) foreign investors (other than the PRC-controlled entity) must hold at least 25% of the post-acquisition company; or

(ii) the offshore company must invest fresh capital accounting for at least 25% of the post-acquisition company’s total capital4

(b) Approval authorities

(i) MOFCOM at the provincial or national level (presumably depending on the size of the investment)5

(ii) SAIC at the local or national level

(iii) SAFE at the national level or through its branches

The documents which must be submitted are detailed in Part Three of the new Rules, see p. 7.

(c) MOFCOM Beijing approval required for restructurings—acquisitions of related domestic entities by foreign entities established or controlled by PRC persons or enterprises requires MOFCOM approval from Beijing (Art. 11)

(d) Key industries—MOFCOM approval is required in special cases:

(i) where a "key industry" is involved.

(ii) where the acquisition might have an impact on "national economic security," or

results in a transfer of the actual control of a domestic enterprise that owns a well-known trademark or a historic Chinese brand name (Art. 12)

(iii) If a transaction proceeds without this approval, MOFCOM can order the transaction to be stopped, or actually order the transfer of relevant equities or assets, or adopt other measures, to eliminate the perceived adverse impact. (Art. 12)

(e) Treatment of claims and debts—the general rule follows the familiar approach: in an equity deal, the target retains its claims and debts but is owned in whole or in part by the foreign investor after the transaction, and in an asset deal the claims and debts are left behind. (Art. 13) There are two important caveats:

(i) Agreement as to claims and debts—if the parties to either an equity acquisition or asset acquisition enter into a separate agreement as to the target’s claims and debts, it must not "harm the interests of any third party and the public interest" and must be submitted to the examination and approval authority

(ii) Notice to creditors—in all asset deals, the domestic enterprise selling assets must issue notice to creditors and publish an announcement in a nationally-distributed provincial or higher-level newspaper; this must be done at least 15 days before investor submits the application documents to the examination and approval authority

(f) Appraisal required—in all cases, the transaction price must be based on an appraisal of the equities or assets to be sold, conducted by an "asset appraisal institution"

(i) the parties can agree on an "asset appraisal institution established according to the law in China"

(ii) the appraisal is to be conducted according to an "internationally-accepted appraisal method"

(iii) transferring assets overseas "in disguise" by setting a transaction price "obviously lower" than the appraisal result is prohibited (Art. 14)

(g) Related-party or affiliated transactions—the parties are required to disclose whether there is any affiliation or relationship between them

(i) if any two parties are de facto6 under common control, the controlling party must be disclosed

(ii) in the case of transactions involving parties under common control, the parties must "provide an explanation on the purpose of the acquisition and whether the appraisal result is consistent with fair market value" (Art.15)

(iii) avoiding this requirement by using trusts, nominees, or other means is prohibited (Art.15)

(h) Time for payment of purchase price—the full consideration of the purchase price must be paid as follows (Art.16):

(i) Equity acquisition (entire company)—where a foreign investor acquires a domestic company and transforms it into an FIE, the full consideration must be paid within 3 months; provided that, with the approval of the examination and approval authority, 60% may be paid within 6 months and the balance within 12 months7

(ii) Equity acquisitions into existing domestic companies by increase of registered capital—where the foreign investor subscribes for additional capital in an existing domestic company,8 then 20% of the increased capital must be paid in when the application for a business license is filed, and the remaining amount paid in according to the Company Law and any other applicable regulations

(iii) Asset acquisitions—the time for payment of consideration must be specified in the asset acquisition agreement. If a new FIE is being established to acquire and operate the assets, the portion of the registered capital representing the purchase price for the assets must be paid in within 3 months (subject to extension—see first bullet above). The rest of the capital must be contributed according to the rules applicable for establishment of FIEs generally.

(iv) Less than 25% foreign investment—where the acquisition of the domestic enterprise is to establish an FIE9 with less than 25% foreign investment, the entire consideration must be paid (1) within 3 months of issuance of the business license if cash; and (2) within 6 months of issuance of the business license if other than cash.

(i) Type of consideration (Art.17)

(i) If the investor uses RMB assets (including cash), payment must be verified and approved by SAFE

(ii) If the investor uses equity, the special requirements set out in Part Four must be satisfied
  • the effect of the special requirements is to limit the use of equity to companies listed on recognized exchanges (not OTCBB) and special purpose vehicles using equity to acquire a domestic company for the purpose of listing overseas10

(iii) Relevant laws and regulations must be followed

(j) Ratio of registered capital to total investment—the Rules set maximum ratios for registered capital to total investment, depending on whether an equity acquisition or an asset acquisition is involved (Arts. 19-20):

(i) Equity acquisitions—registered capital must be from 33% to 70% of total investment, depending on the size of the investment; this allows more leverage than under existing SAIC regulations11

Registered Capital

Maximum Total Investment

Up to US$2.1 million

10/7 x registered capital (min. RC = 70% of TI)

Up to US$5 million

2X registered capital (min. RC = 50% of TI)

Up to $12 million

2.5X registered capital (min. RC = 40% of TI)

More than $12 million

3X registered capital (min. RC = 33.3% of TI)

(ii) Asset acquisitions—the total investment must be determined by the transaction price and scale of production and operation; the ratio of registered capital must follow existing relevant provisions of law. These ratios also run from 33% to 70%, but the thresholds are higher; in other words, the higher percentages kick in sooner under existing regulations than the do under the new Rules

6. Part Three: Examination, Approval And Registration Process

(a) Application package—the application package differs somewhat depending on the type of transaction involved (Arts. 21-24)

(i) Equity acquisition—documents include the financial and audit report for the domestic company and a resettlement plan for employees (Art. 21) 12

(ii) Equity acquisition via an increase to registered capital (Art. 22) 13

(iii) Asset acquisition—includes proof of notice to creditors and a resettlement plan (Art. 23)14

(b) Transaction documents for asset acquisitions—asset purchase agreements must be governed by PRC law and include certain provisions, including a list of the assets (Art.24)

(c) MOFCOM and SAFE approvals —in an acquisition of a domestic enterprise "to establish a foreign-invested enterprise:"15

(i) the examination and approval authority (MOFCOM or its provincial counterpart)16 must act within 30 days of application (Art. 25)

(ii) If the application is approved, MOFCOM (or its provincial counterpart) will issue an "approval certificate"

(iii) MOFCOM (or its provincial counterpart) will send duplicates of the approval documents to the SAFE authorities located where the equity transferor and the domestic company are located

(iv) SAFE will issue a "certificate of foreign investment-related foreign exchange registration;" this certificate is the document which proves that the consideration has been fully paid. N.B. that if equity is used for the PRC acquisition, the examination and approval authority is MOFCOM in Beijing in all cases, see Part Four of the new Rules, p.10.

(d) SAIC approvals (Art. 26):

(i) Equity acquisitions—the foreign investor must apply to the registration administration authority (SAIC)17 to amend the enterprise’s registration and obtain a foreign-invested enterprise business license

(ii) Equity acquisitions—the domestic company must apply to the registration administration authority (SAIC)18 to amend the enterprise’s registration and obtain a foreign-invested enterprise business license and submit certain documents (Art. 26). After receipt of the business license, the foreign investor must handle taxation, customs, land administration and foreign exchange registrations.

7. Part Four: Acquisitions Using Equity As A Means Of Payment

(a) Section One: conditions for using equity

(i) Definition – for purposes of Part Four, "acquisition of domestic company by foreign investor using equity as means of payment" means (Art. 27):

"the act whereby a shareholder of an overseas company uses the equity it holds in the overseas company19 or an overseas company uses its newly issued shares as a means of payment to purchase the shareholder’s equity or the newly issued shares of a Domestic Company"

(ii) Prior law—before the 2006 Rules, there was no explicit statutory guidance on using equity for acquisitions in China, but applications to do so were generally rejected

(iii) Requirements applicable to overseas company—except in the case of an SPV, the following requirements must be met before a foreign company can be treated as an "overseas company" and therefore be entitled to use equity as consideration for a PRC acquisition (Arts. 28-29):20
  • the overseas company must be a listed company and its place of listing must have a sound securities trading system

  • the equity used for consideration must be legally owned by the buyer and transferable by it

  • there may be no ownership dispute over the equity

  • there may be no pledge or other restriction over the equity

  • except for SPVs, the equity of the overseas company21 must be "listed for trading in an open and legal overseas securities trading market (other than an over-the-counter market)

  • except for SPVs, the trading price of the equity of the overseas company must have been "stable" in the most recent year22

N.B. only companies listed on recognized exchanges may use equity for PRC acquisitions, except for SPVs making an acquisition for the purpose of listing the assets of a domestic enterprise (see Art. 39)

(iv) "Acquisition consultant"—any use of equity for a PRC acquisition requires the use of an "intermediary institution registered in China as a consultant (an "acquisition consultant")
  • the acquisition consultant conducts due diligence on the "truthfulness of the application documents, the financial status of the overseas company and whether the acquisition satisfies the requirements of Articles 14 (no sale obviously lower than appraised value), 28 and 29 (requirements applicable to overseas companies)"

  • the acquisition consultant will issue a report giving a "professional opinion" on each of these items (Art. 30)

  • the acquisition consultant must meet certain professional standards (Art. 31)

(b) Section Two: documents and procedures for submission

(i) MOFCOM (Beijing) approval— conditional approval good for six months

In all cases in which a foreign investor uses equity as consideration, the application must be submitted to MOFCOM in Beijing for examination and approval (Art. 32)

(ii) Additional documents required –in addition to those required in Part Three must be filed, the following documents must be filed (Art. 32):23
  • report of the acquisition consultant

  • list showing all 5%+ shareholders in the overseas company

  • most recent audited annual financial report

  • share trading report for most recent six months

MOFCOM must act within 30 days after the application package is complete.

Six-month approval certificate—if MOFCOM approves the application, it will issue an "approval certificate with an annotation of ‘acquisition of domestic company by foreign investor using equity, valid for six months from date of issuance’" (Art. 33)

(iii) SAIC and SAFE registration—conditional business license and foreign exchange certificate good for eight months

The domestic target must register with SAIC and SAFE within 30 days of the annotated approval certificate (Art. 35)

SAIC and SAFE will issue a "foreign-invested enterprise business license and a foreign exchange registration certificate respectively with the words ‘valid for eight months from the date of issue’ annotated thereon’" (Art. 34)

The domestic company must file at the same time an "advance submission of the documents designed to restore the equity structure, such as application for change in equity, amendment to the articles of association of the company and equity transfer agreement, which shall be signed by the legal representative of the Domestic Company" (Art. 34)

(iv) MOFCOM final approval

Within six months after issuance of the annotated business license by SAIC, the domestic company or its shareholders must apply to MOFCOM and SAFE to obtain non-annotated certificates (Art. 35)24

The earlier-issued certificates must be submitted in addition to those required by applicable regulations25

On approval, MOFCOM will issue an "approval certificate for overseas investment by Chinese enterprise"26 replacing the annotated foreign-invested enterprise approval certificate

(v) SAIC and SAFE final approval

Within 30 days after obtaining the non-annotated foreign-invested enterprise approval certificate from MOFCOM, the domestic company must apply to SAIC and SAFE for replacement of non-annotated foreign-invested enterprise business licence and foreign exchange registration certificate (Art. 35)

(vi) Transaction must complete within six months or be unwound—if the domestic company and the overseas company do not complete the "procedures for change of equity" within six months of the issuance of the annotated business license described in Art. 34, then:
  • MOFCOM’s previously issued annotated approval certificate and [non-annotated] approval certificate for overseas investment will automatically become void, and

  • SAIC will register the pre-filed "unwinding documents" and "have the equity structure of the domestic company restored to the status before the Equity Acquisition" (Art. 36)27

If the "issuance of new shares" by the overseas company "fails to materialize," the domestic company must reduce its registered capital and make an announcement to that effect in a newspaper, before SAIC completes the unwinding process

If the domestic company does not take the actions required in Art. 36, the SAIC will take action on its own.

(vii) Limitation on distribution of profits—the domestic company may not distribute any profits or make any capital account transactions until the non-annotated certificates are issued (Art. 37)

8. Section Three: Special Provisions Regarding Spvs

(a) SPV defined—an "SPV" is defined as "an overseas company28 directly or indirectly controlled by a Chinese domestic company or natural person for the purpose of realizing the overseas listing [going public transaction] of the interests it actually owns in a domestic company." (Art. 39). Therefore there are three elements of the definition; an SPV must be:

(i) an overseas company;29

(ii) directly or indirectly controlled by a Chinese person or entity;

(iii) for the purpose of realizing the offshore listing of interests it (the SPV) owns in the domestic company.

(b) Scope of Section Three—Section Three applies where the shareholders of an SPV use the equity they hold in that entity, or the SPV uses newly issued shares, to acquire the shareholder’s equity in a domestic company, or the newly issued shares of a domestic company, for the purpose of realizing an overseas listing (Art. 39). Thus, the following elements must be present for Section Three to apply:

(i) equity of an SPV must be used to acquire equity in a domestic company30

(ii) the acquirer must be either the SPV’s shareholders or the SPV itself

(iii) the equity being acquired must be held by the SPV’s shareholders or be newly issued by the domestic entity

(iv) the purpose of the restructuring acquisition must be to "realize an overseas listing" of the SPV itself or another entity which "holds an interest" in the SPV

See the summary of the Section Three procedures for Share Swaps involving SPVs, below.

On its face, the language of Art. 39 has some interesting implications and limitations, which may be clarified in subsequent regulations:

(i) if the shares used for the domestic acquisition (restructuring) are held by persons other than the domestic company’s shareholders, arguably it would remove the transaction from the scope of Section Three. N.B., however, that the general provisions of Art. 15 prohibit parties from circumventing the requirement to disclose relatedness "by trust, holding through a third party or other means"

(ii) on its face, Art. 39 appears to limit the scope of Section Three to instances in which equity is used for the restructuring—thus a cash transaction would fall outside the scope of Section Three

(iii) if the SPV uses equity to acquire assets and inject them into a new domestic company, it is possible this would fall outside the scope of Section Three; but see the caveat based on a reading of Art. 43, below at p. *

(iv) if the offshore company were not held by Chinese persons or entities at the time of the acquisition of the domestic company, then:

  • if it wanted to use cash for the acquisition, presumably the use of cash itself would remove it from the scope of Section Three; but
  • it would be prohibited from using equity because unless it were an SPV it could not use equity without meeting the requirements of Arts. 28-29

(v) if the offshore entity were already public at the time that it became an "SPV"—for example, if the Chinese persons acquired an already-public company and used that to acquire the domestic company or assets—it might fall outside the scope of Section Three, or least outside the scope of the requirement for CSRC approval, see below

(c) Summary of procedures for share swaps by private SPVs

(i) MOFCOM approval for establishment of SPV—MOFCOM approval is required before the PRC individuals or companies establish the SPV

Note: compliance with SAFE Circular 75 presumably is also required

(ii) Initial MOFCOM approval for restructuring—when an SPV engages in a Share Swap, either when a shareholder of the SPV uses its shares or the SPV uses its own shares, it must obtain an initial approval reply from MOFCOM

(iii) CSRC approval for overseas listing—the domestic company must then seek the approval of CSRC for the overseas listing of the SPV

(iv) Further MOFCOM approval for restructuring—the domestic company must then return to MOFCOM for an annotated foreign investment approval certificate valid for one year, permitting the restructuring to proceed

(v) Report to MOFCOM following listing: 30 days after the listing, the FIE must report to MOFCOM on its plan to return the proceeds of the offshore offering to China

(vi) One-year time limit—if the SPV does not complete a listing within one year from the issuance of the business license to the FIE, or if the listing is completed but the FIE does not report to MOFCOM on the repatriation of the proceeds, the Share Swap transaction will be unwound and the FIE will be converted back into a domestic company

(d) Caveat: 25% new foreign investment required—Art. 9 of the new Rules specifies that in any restructuring or other acquisition, the post-acquisition company will not be entitled to treatment as an FIE unless there is 25% new foreign money injected; see discussion above at p. 4

(e) CSRC approval—any going-public transaction ("overseas listing") of an SPV31 is subject to CSRC approval (Art. 40)

(i) The country where the listing takes place must have signed a memorandum of understanding on regulatory cooperation with CSRC

(ii) N.B. if the structure of the SPV’s transaction takes it outside the scope of Section Three, as defined in Art. 39, then an argument can be made that CSRC approval is not required

(f) Certain requirements applicable to the domestic company—the domestic company which is indirectly taken public must have clear title to its property rights; must have good corporate governance; and the company and its shareholders must have no record of major violations of laws or regulations in the previous three years (Art. 41)

(g) MOFCOM approval—MOFCOM (Beijing) approval is required for a domestic company to establish an SPV and submit certain documents (Art. 42). The documents to be submitted include:

(i) identity documents of the "ultimate controlling person of the SPV"

(ii) a business plan for the overseas listing of the SPV

(iii) an appraisal report prepared by the acquisition consultant "on the issue price of the shares of the SPV to be listed in the future"32

Oddly, this requirement does not seem to apply to an SPV established by a PRC natural person, even though Art. 39 contemplates that SPVs may be established by either persons or entities.33 See also the discussion of Art. 44, at p.15. In addition, the approval process set out in Art. 45 contemplates certain actions by "the domestic company or natural person that holds equity in the SPV."

(h) SAFE registration—after receiving MOFCOM’s approval to establish an SPV, the founder or controlling person then must apply to the local SAFE branch for a foreign exchange registration certificate for the overseas investment (Art. 42)

(i) Valuation –the "total value of the issue price for the shares of the SPV to be listed shall not be less than the value of the corresponding equity of the target Domestic Company as appraised by a relevant asset appraisal institution of China" (Art. 43)

(i) It is not entirely clear what this means:

(ii) it could mean that the initial market capitalization of the SPV must be at least as much as the appraised value of the domestic company; or

(iii) it could mean that the shares issued in the restructuring must have an "issue price" at least equal to the appraised value of the domestic entity

The latter interpretation seems circular and therefore nonsensical. The former interpretation at least makes internal sense.

(iv) N.B.- the phrase "asset appraisal institution of China" seems to refer back to Art. 14, which mandates an appraisal in both equity and asset acquisitions—this suggests the drafters may have intended to capture restructurings in which the SPV acquires assets, as well as where the SPV acquires equity

(j) Documents to be submitted—if an SPV uses equity to acquire a domestic company, certain documents must be submitted to MOFCOM (Beijing) in addition to those required by Art. 32,34 including:

(i) the "approval document and certificate for overseas investment in establishment of enterprises" issued at the time of establishment of the SPV—presumably this refers to the approval documents to be issued after the application required by Art. 4235

(ii) the "foreign exchange registration of overseas investment of the SPV"— this also appears to refer back to Art. 42

(iii) "the identity document or the document for commencement of operation and articles of association of the ultimate controlling person" of the SPV36

(iv) a business plan for the overseas listing of the SPV37

(v) an appraisal report prepared by the acquisition consultant on the issue price of the shares of the special purpose company to be listed overseas in the future38 (Art. 44)

If the company to be taken public is a parent of the SPV ("holds an interest in the SPV") then the following documents must also be submitted:

(i) charter documents for the parent

(ii) a "detailed explanation on the trading arrangement and discount method in respect of the equity of the target Domestic Company between the special purpose company and such overseas company" (Art. 44)

(k) MOFCOM approval in principle—if MOFCOM approves the documents submitted in accordance with Art. 44, it will issue an "approval-in-principle reply letter" (Art. 45)

(l) CSRC approval—on the strength of the MOFCOM reply letter, the domestic company must submit the "listing application documents"39 to the CSRC. The CSRC must decide whether to approve or reject the application within 20 working days.40 (Art. 45)

(m) MOFCOM conditional approval good for one year—after the CSRC approval is received, the domestic company then applies again to MOFCOM for an "approval certificate" bearing the annotation, "equity held by overseas special purpose company, valid for one year from the date of issue of the business license"41

(n) SAFE registration—if the acquisition leads to a change in the equity of the SPV, the "domestic company or natural person that holds equity in the SPV" must apply to MOFCOM for verification and approval of the "change of overseas investment in establishment of enterprise" and amend its (the company’s or the person’s) foreign exchange registration of foreign investment

(o) SAIC and SAFE registrations; issuance of annotated business license and foreign investment certificate valid for 14 months —within 30 days of receiving the annotated approval certificate from MOFCOM, "the domestic company"42 must process an amendment with SAIC and SAFE, who will issue a "foreign-invested enterprise business licence and a foreign exchange registration certificate respectively with the words ‘valid for 14 months from the date of issue’ annotated thereon’" (Art. 46)

The domestic company must also submit documents pre-signed by its legal representative that can be used to unwind the transaction, as required for all equity acquisitions, see discussion of Art. 34 at p. 11

(p) Final approval process—the approval process is finalized according to the following steps (Art. 47):

(i) within 30 days of completing the overseas listing of the SPV, the domestic company must:

(ii) report the status of the listing and financing proceeds repatriation plan43 to MOFCOM

(iii) apply for replacement of the annotated foreign invested enterprise certificate with a non-annotated certificate

(iv) report the status of the overseas listing and file relevant documents with the CSRC

(v) file the financing proceeds repatriation plan with SAFE, and implement the plan under the supervision of SAFE

(vi) within 30 days of obtaining the non-annotated foreign invested enterprise approval certificate from MOFCOM, the domestic company must apply to SAIC and SAFE for replacement of their annotated foreign-invested enterprise business licence and foreign exchange registration certificate

(q) Unwinding the transaction—the annotated MOFCOM certificate will automatically become void and the equity structure of the domestic company will be unwound and will "restore to the status before the Equity Acquisition" (see discussion of Art. 36, p.11):

(i) if the domestic company fails to report the transaction within the 30-day period (Art. 47); or

(ii) if the domestic company fails to obtain the non-annotated MOFCOM approval certificate within one year of issuance of the business license (Art. 48)

(r) Financing proceeds—the financing proceeds from the overseas listing44 must be repatriated back to China pursuant to the repatriation plan filed with SAFE. The repatriation may be accomplished in the following ways (Art. 48):

(i) loans to the domestic company

(ii) establishing a new FIE in China

(iii) acquiring a domestic enterprise

(s) Repatriation of dividends, etc.—the Chinese shareholders of the SPV must repatriate back to China within six months all "profits, dividends and foreign exchange income from capital change" (Art. 48)

(t) Follow-on acquisitions—acquisitions of PRC companies (or assets?) following the completion of the overseas listing using shares of the SPV will be subject to Sections One and Two of Part Four of the Rules.45

Footnotes

1. Previously, there was no explicit statutory guidance on using equity for acquisitions in China, but applications to do so were generally rejected.

2. As well as acquisitions of related entities by foreign entities established or controlled by PRC persons or enterprises, see above. Note, however, that Art. 40 appears only to apply to SPVs established by a domestic company and not by a domestic person.

3. See discussion below at p.17.

4. Art. 9: "If a Domestic Company, enterprise or natural person acquires, in the name of a foreign company established according to law or controlled by it, a Domestic Company connected with it, the foreign-invested enterprise established upon acquisition shall not be entitled to treatment for foreign-invested enterprises, unless the foreign company subscribes for the capital increase of the Domestic Company or increases its capital contribution to the enterprise established upon acquisition and the amount of capital increase reaches over 25% of the registered capital of the enterprise so established. The foreign-invested enterprise established in the aforementioned manner may be entitled to treatment for foreign-invested enterprises if the ratio of the capital contribution of the foreign investors other than its de facto controlling person in the registered capital of the enterprise is higher than 25%."

5. This is confirmed by a reading of Art. 21, for example, which refers to "the examination and approval authority with the corresponding examination and approval authority based on the total investment amount, enterprise type and industry of the foreign-invested enterprise to be established upon acquisition in accordance with the provisions of laws, administrative regulations and rules on the establishment of foreign-invested enterprises."

6. It seems significant that the Rules say "de facto" control rather than simply "control."

7. In this case any profits during the initial period must track the actual amounts paid in (Art 16).

8. Either a private company or a company limited by shares.

9. This would apply to existing domestic companies as well, since the foreign investment into an existing company "establishes" an FIE.

10. Note that Part Four appears to apply only to stock swaps and not to asset acquisitions using equity as consideration.

11. Under existing SAIC regulations, foreign investors could not drop below registered capital equal to 50% of total investment until the total investment exceeded US$3 million; the new Rules permit the ratio to drop down to 50% at the level of $2.1 million. Likewise, the existing regulations required total investment of more than US$30 million before registered capital could drop to 33%; the new Rules permit this at only US$12 million.

12. The documents required by Art. 21 are:

  1. the resolution by which the shareholders of the target domestic limited liability company unanimously consent to the Equity Acquisition by the foreign investor or the resolution of the shareholders' general meeting of the target domestic company limited by shares consenting to the Equity Acquisition by the foreign investor;

  2. the application of the target Domestic Company for conversion and re-establishment as a foreign-invested enterprise according to law;

  3. the contract and articles of association of the foreign-invested enterprise to be established upon acquisition;

  4. the agreement for purchase of the shareholder’s equity of the Domestic Company or for subscription for the capital increase of the Domestic Company by the foreign investor;

  5. the financial and audit report of the target Domestic Company for the most recent financial year;

  6. the identity document, registration certificate and creditworthiness document of the investor that have been notarized or certified according to law;

  7. the details of the enterprises in which the target Domestic Company invests;

  8. the (copies of) business licenses of the target Domestic Company and the enterprises it invests in;

  9. the resettlement plan for the staff and workers of the target Domestic Company; and

  10. the documents required to be submitted according to Articles 13, 14 and 15 hereof.

13. Art. 22 requires that the subscription agreement cover the following topics:

  1. the particulars of the parties to the agreement, including their names and domiciles, and the names, positions and nationalities of their legal representatives, etc.;

  2. the amount and price of the equity to be purchased or the capital increase to be subscribed for;

  3. the time limit and method of the performance of the agreement;

  4. the rights and obligations of all parties to the agreement;

  5. liabilities for breach of contract and resolution of disputes; and

  6. the date and place of execution of the agreement.

14. Art. 23 requires the following documents:

  1. the resolution of the owner of enterprise property rights or the authority body of the domestic enterprise consenting to the sale of the assets;

  2. the application for establishment of the foreign-invested enterprise;

  3. the contract and articles of association of the foreign-invested enterprise to be established;

  4. the asset purchase agreement concluded between the foreign-invested enterprise to be established and the domestic enterprise, or the asset purchase agreement concluded between the foreign investor and the domestic enterprise;

  5. the articles of association and (copies of) the business licence of the target domestic enterprise;

  6. proof of notification and announcement to the creditors by the target domestic enterprise and statement on whether the creditors have raised any objection;

  7. the identity document or certificate for commencement of operation and the creditworthiness document of the investor that have been notarized or certified in accordance with the law;

  8. the resettlement plan for the staff and workers of the target domestic enterprise; and

  9. the documents required to be submitted according to Articles 13, 14 and 15 hereof.

If the purchase and operation of the assets of the domestic enterprise pursuant to the preceding paragraph requires licenses from other relevant government departments, such relevant licensing documents shall be submitted together with the above documents.

15. An "acquisition of a domestic enterprise" is defined to include both equity and asset acquisitions; the resulting "establishment of a foreign invested enterprise" is the inevitable result—unless the acquisition is of an already-existing FIE, in which case the new 2006 Rules probably do not apply because of the definitions in Art. 2.

16. If equity is used for the PRC acquisition, the examination and approval authority is MOFCOM in Beijing in all cases, see Part Four of the new Rules, p.10.

17. Defined in Art. 10.

18. Defined in Art. 10.

19. An SPV is a special case of the general term "overseas company," see Art. 39.

20. Note this definition is only "for purposes of this Part [Four]." The full language is: "For the purposes of this Part, the term ‘overseas company’ shall be established according to law, its place of registration shall have a sound company law system, and the company and its management shall not have been subject to penalty by the regulatory authority in the most recent three years. Except for a special purpose company specified in Section Three of this Part, an overseas company shall be a listed company and its place of listing shall have a sound securities trading system." (Art. 29)

21. Presumably, this refers to the equity of the overseas company generally and is not a requirement that the consideration shares be free trading. This can be inferred from the use of the words "the equity" in the first two requirements, and "the equity of the overseas company" in the last two requirements.

22. There is no definition of "stable."

23. These requirements appear to apply to SPVs also.

24. The language of Art. 35 is ""for completion of the verification and approval, and registration procedures of overseas investment in establishment of enterprises in connection with their holding of equity in the overseas company".

25. Specifically, Verification and Approval Items Relevant to Investment in and Establishment of Enterprises Outside China.

26. Presumably if it is individuals who are the recipients of the overseas company’s equity, the approval certificate will refer to "persons" rather than "enterprise."

27. It is not clear how this provision would apply to an acquisition of assets using foreign equity.

28. See definition above.

29. Defined in Art. 29, see p.9.

30. Therefore, the use of cash to acquire equity, or the use of either cash or equity to acquire assets, appears not to be captured by Art. 39.

31. Again, the scope of Section Three is defined in Art. 39, and therefore may not apply to situations in which the SPV acquired domestic equity or assets for cash.

32. The reference to the acquisition consultant seems to reinforce the notion that only restructuring using equity is intended to be reached by Section Three, since acquisition consultants are only used in equity acquisitions, see p.10.

33. This does not seem to be inadvertent. Art. 42 uses the defined term "Domestic Company;" by contrast, Art. 39 refers to a "Chinese domestic company or natural person." But see the discussion of Art. 44, at p.15.

34. Art. 32 only refers to transactions in which equity is used for the acquisition. Again, this indicates that only equity-swap restructurings are intended to be captured by Section Three.

35. Again, Art. 42 only refers to SPVs established by PRC companies, not by PRC natural persons. But see the discussion of Art. 44, at p.15.

36. For the first time, this suggests that the SPV might be controlled by an individual, not only a PRC company.

37. The same business plan had to be filed with MOFCOM with the application to establish the SPV, see p.14.

38. The same report had to be filed with MOFCOM with the application to establish the SPV, see p.14.

39. It is not clear what the "listing application documents" are.

40. This is the CSRC approval referred to in Art. 40.

41. Art. 45 does not seem to allow MOFCOM any discretion at this stage; evidently, if CSRC approval is obtained, MOFCOM must issue the annotated approval certificate.

42. Again, no reference to natural persons here.

43. These "financing proceeds" appear to refer to the proceeds of the going-public transaction, which presumably includes a concurrent PIPE. The required "financing plan" might not cover a Black Box offering, however.

44. These "financing proceeds" appear to refer to the proceeds of the going-public transaction, which presumably includes a concurrent PIPE. The required "financing plan" might not cover a Black Box offering, however.

45. Art. 50 only refers to subsequent "acquisitions of Domestic Companies" using the shares of the SPV. Parts One and Two only cover acquisitions using equity.

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