I. Introduction
On August 8, 2006, the Ministry of Commerce (“MOFCOM”) of the People’s Republic of China
(“PRC”)
and five other Chinese government authorities issued the Regulations on Mergers
and Acquisitions of Domestic Enterprises by Foreign Investors (the “2006 Regulations”), which expand on and replace the
Provisional Regulations on Mergers and Acquisitions of Domestic Enterprises by
Foreign Investors
(the “2003 Provisional Regulations”) previously promulgated in
2003. The Regulations, effective
from September 8, 2006, are considered as a significant development in China’s
regulatory regime relating to mergers and acquisitions.
Compared to the 2003 Provisional
Regulations, some new features are included and clarifications are made in the
2006 Regulations for the first time, such as share swaps, offshore special
purpose vehicles (“SPVs”), and issues concerning national economy security.
This article aims to provide you
with highlights of the 2006 Regulations, and also some comparisons between the
2006 Regulations and the 2003 Provisional Regulations.
II. Key Changes
Introduced by the 2006 Regulations
1. Share Swaps
For the first time in the PRC, the
2006 Regulations expressly allow share swaps as one of the payment methods
against share transfer in M & A transactions.
The term “share swaps” is defined
under Article 27 of the 2006 Regulations as the activities of the shareholder
of an overseas company to use the shares it holds in the overseas company, or
of the overseas company to use its newly issued shares as payment method to
purchase the shares held by the shareholder of a domestic enterprise or the
newly issued shares of the domestic enterprise.
It is worth noting that share swaps
are allowed only when the following conditions are satisfied:
(1)
The
overseas company must be legally incorporated and there is sound company legal
system in the place of its incorporation;
(2)
The
overseas company and its management must not have been punished by any
regulatory authority in the past three years;
(3)
Except
in the case of SPVs, the overseas company must be publicly listed, and
there is sound system for securities transaction in the place of its public
listing.
(4)
The
shares to be swapped must be legally held and assignable, and not be the
subject of any dispute, lien or any other form of encumbrances;
(5)
Except
in the case of the SPVs, the shares to be swapped must be tradable insofar as
they are publicly listed in a foreign securities exchange (excluding “over the
counter” trading markets);
(6)
Except
in the case of the SPVs, the trading price of the shares of the overseas
company must be stable in the past three years.
The domestic company, or its
shareholders, shall engage a PRC registered agency or intermediary organization
(for instance, a law firm, accounting firm or investment bank) to act as their
“M&A Counsel” to conduct due diligence in respect of the proposed
M&A. Upon the completion of
the due diligence investigation, the M&A Counsel shall also issue a
detailed M&A report.
2. SPV
SPV,
which was not mentioned under the 2003 Regulations, is defined under the 2006
Regulations as an overseas company directly or indirectly controlled by the PRC
companies or PRC individuals for the purpose of consummating the listing in an
overseas securities exchange of the shares in a PRC domestic company actually
owned by the PRC companies or individuals. As an exception to the general rule under Article 29 of the
2006 Regulations, shareholders of the SPV may use unlisted shares in the SPV or
newly issued shares in the SPV as the consideration for the acquisition of
shares in a domestic affiliate.
If a PRC domestic company wants to set up a SPV, it must submit
application documents to MOFCOM for approval, and, once MOFCOM grants approval
for the SPV, the shareholders shall go through the relevant foreign exchange
registration formalities with the local branch of the State Administration of
Foreign Exchange.
The
listing of a SPV in an overseas securities exchange is subject to the approval
of the China Securities Regulatory Commission (“CSRC”). Prior to the submission of the
listing application to CSRC, the related M&A transaction with share swaps
must be approved by MOFCOM. The
total value of the shares issued should not be lower than the value of the
shares in the domestic enterprise under the share swap based on the appraisal
report issued by a qualified PRC asset appraisal firm.
Within 30
days of the completion of the overseas listing, the domestic company must report
to MOFCOM regarding the overseas listing and the plan for the repatriation of
the proceeds from the listing back into China.
3. National
Economic Security
If an M&A
transaction would cause any change of control of any domestic company in a “key
industry”, or change of control over any “famous Chinese trademark or brand”,
or have potential or actual adverse impact on “national economic security”, the
parties to the transaction must report to the MOFCOM. Failing which, MOFCOM and other relevant government
authorities may mandate the parties to terminate the M&A transaction, or to
adopt measures to eliminate the adverse impact on “national economic security”
caused by the concerned transaction.
Please note
that the 2006 Regulations do not define important terms such as “key industry”,
“famous Chinese trademark and brand” and “national economic security”, or set
forth clear procedures and timelines for the Chinese government to decide
whether to give green light to a specific M&A transaction. Therefore, foreign investors have
raised their concerns that the future M&A transactions in the PRC would be
subject to greater scrutiny by the Chinese government, and could result in
uncertainty and delay in deal execution.
It is expected that MOFCOM or other relevant Chinese government
authorities would issue implementing rules to address such concerns.
4. Antitrust Review
The 2006
Regulations have an entire chapter to deal with antitrust review. Depending on the different
circumstances, the procedures of antitrust review are divided into three
categories.
Domestic
M&A
In the case
of the M&A of a domestic company, the foreign investor shall report the
M&A to MOFCOM and the State Administration for Industry and Commerce
(“SAIC”) if any of the following occurs:
(1)
the
turnover of any one party of the M&A in Chinese market exceeds RMB 1.5
billion in the year of the proposed M&A;
(2)
the
number of the domestic companies in the similar industry merged or acquired by
the foreign investor is over 10 within one year;
(3)
the
rate of market shares occupied by any one party of the M&A is over 20%
before the M&A;
(4)
the
M&A results in the rate of market shares occupied by any one party
(including the affiliated companies of the foreign investor) of the M&A
exceeding 25%.
It should be pointed out that, even
if none of the above-mentioned circumstances occurs, MOFCOM or SAIC may still
require the foreign investor to report the M&A provided that the competing
PRC domestic companies, the relevant government authorities or industry associations
have brought appeals to MOFCOM or PRC.
If MOFCOM and SAIC think that the
proposed M&A may result in excessive concentration, hindrances to
justifiable competition, or damages to consumers’ interests, they may hold
public hearings of the relevant interested parties to decide whether to approve
such M&A.
Overseas M&A
In the case of overseas M&A,
before publicizing the M&A plan, or reporting the M&A plan to the
government authorities of the jurisdiction where it is incorporated, purchaser
shall report the M&A plan to MOFCOM and SAIC in any of the following
circumstances:
(1)
the
assets of any one party of the overseas M&A in China exceeds RMB 3 billion;
(2)
the
turnover of any one party of the overseas M&A in Chinese market exceeds RMB
1.5 billion in the year of the proposed overseas M&A;
(3)
the
rate of market shares occupied by any one party of the overseas M&A and its
affiliated companies is over 20% before the overseas M&A;
(4)
the
M&A results in the rate of market shares occupied by any one party (including its affiliated companies) of
the overseas M&A exceeding 25%;
(5)
the
number of the domestic FIEs in the similar industry in which any one of the
parties of the overseas M&A holds shares will be over 15 due to the
overseas M&A.
The rationale for the Chinese
government to review overseas M&A is that certain overseas M&A, though
not involving PRC domestic enterprises, may still affect China’s domestic
market since many multinational companies have investment in China.
Exemptions
Under any of the following
circumstances, any party of the M&A may apply for an exemption of the
antitrust review to MOFCOM and SAIC:
(1)
the
M&A may improve the fair competition in the market;
(2)
the
M&A is for the purpose of reorganizing the unprofitable enterprise and
ensure the employment;
(3)
the
M&A may introduce advanced technology and administrative personnel and
sharpen international competitive edge of the enterprise;
(4) the M&A may improve the
environment.
5. Ratios between Registered Capital and
Total Investment
The 2006
Regulations provide for the appropriate ratio between the registered capital
and the total investment of the target company, which will be transformed into
a foreign-invested enterprise (“FIE”) upon the completion of the
M&A transaction. The
ceiling for the total investment (namely, an aggregation of the registered
capital and the allowed borrowings) of the FIE is as follows:
(1) if the
registered capital of the FIE is less than US$ 2.1 million, the total
investment shall not exceed 10/7 of the registered capital;
(2) if the
registered capital of the FIE is between US$ 2.1 million to US$ 5 million, the
total investment shall not exceed 2 times of the registered capital;
(3) if the
registered capital of the FIE is between US$ 5 million to US$ 12 million, the
total investment shall not exceed 2.5 times of the registered capital; and
(4)
if the registered capital of the FIE is more than
US$ 12 million, the total investment shall not exceed 3 times of the registered
capital.
The above ratios are in line with
those provided for under other previous PRC regulations relating to the
appropriate ratios between the registered capital and the total investment
FIEs.
III. Conclusion
The 2006 Regulations are the latest
effort of Chinese government to regulate mergers and acquisitions of domestic
enterprises by foreign investors, and have introduced more flexible options
(for instance, share swaps as a potentially important new financing option
available to foreign investors).
As there are still some ambiguities in the 2006 Regulations, the 2006
Regulations will likely be supplemented with implementing rules in the near
future.
