On August 8, 2006, China released a new rule of “Provisions on Acquisition of Domestic Enterprises By Foreign Investors" (“New Regulation" thereafter), with the joint efforts of six PRC regulatory authorities including the Ministry of Commerce (MOFCOM), the State-owned Assets Supervision and Administration Commission (SASAC), the State Administration of Taxation (SAT), the State Administration for Industry and Commerce (SAIC), the China Securities Regulatory Commission (CSRC) and the State Administration of Foreign Exchange (SAFE). The New Regulation took effect on September 8, 2006, and invalidated the “Interim Provisions on Acquisition of Domestic Enterprises By Foreign Investors" (“Old Regulation" thereafter) issued on March 7, 2003. The New Regulation has drawn speculations that China is changing its policy toward foreign investors’ acquisitions of its domestic companies and tightening its restrictions on foreign investments.

This article presents the background giving rise to this new regulatory scheme and provides a comparative analysis of the two regulations, with a particular focus on how foreign companies doing business in China will be impacted.

  1. BACKGROUND

First, since China’s entry into WTO, there is significant growth in the foreign investors’ takeover of PRC domestic companies in China. Even prior to its entry into the WTO, China has been the largest recipient of foreign investment among developing countries for the past 15 years, reaching a record 60 billion US dollars in 2004. With China opening its markets to foreign business pursuant to its WTO commitments, foreign companies have increasingly converted their Joint Ventures (JV) into Wholly Foreign Owned Enterprise (WFOE) by acquiring either their existing Chinese JV partners or other PRC domestic leading companies in order to deepen their penetration in the China market. According to the report of the Development Research Center under the State Council of PRC, foreign investors today control the top five businesses in each of the industrial sectors that are open to foreign investors, and in 21 out of 28 leading industrial sectors in China most assets are now controlled by foreign investors. In 2005, the nationwide debate over “malicious mergers" of Xugong Group Construction Machinery, China’s largest construction machinery manufacturer and distributor, by Carlyle Group, a global private equity firm, stirred nationalism and serious concern over the disappearance of national brand names of some industries in China and loss of state-owned assets. Leading industrial organizations and business communities urged that a new rule regulating foreign investors’ acquisitions of Chinese companies be put in place.

Second, with China’s increasing foreign currency reserves reaching 875.1 billion US dollars in March 2006 and the Chinese government’s policy to encourage domestic companies to “go global," more and more successful Chinese companies have begun to acquire foreign companies to gain access to overseas markets. However, their strategy has had its complications. For the largest Chinese electronic appliances manufacturer, Haier Group, its bid for Maytag, the US microwave oven and vacuum cleaner conglomerate, stumbled. The attempt of China National Offshore Oil Corporation (CNOOC) to acquire Unocal, a US oil company, with a 100 million dollar higher bid than its competitor’s was intervened by the US government and finally blocked because of the serious national security concerns for the US. This gave rise to a feeling in China that the Chinese government should have a reciprocal legal system to evaluate proposed foreign takeovers.

Third, since the early 1980’s, China has adopted “Treatment of Foreign-Invested Enterprise (FIE)," which allows incentives in the aspects of tax, land use, loan conditions and others in order to attract foreign investment in China. There are increasing Chinese domestic companies taking advantage of this policy by registering an offshore company, using its shares to purchase stakes in domestic assets and then injecting the domestic assets into the offshore company for the purposes of being listed overseas afterwards. The New Regulation is targeted at closing the loophole and getting control of those assets.

  1. COMPARISON OF NEW REGULATION AND OLD REGULATION AND HIGHLIGHTS OF THE NEW RULES AFFECTING FOREIGN BUSINESS IN CHINA

Based on a thorough comparison between the 2003 Old Regulation and 2006 New Regulation in the original language, the 61-provision New Regulation does not propose dramatic changes from the Old Regulation. It carries the 26 clauses in the Old Regulation with most provisions remaining unchanged and some with minor modifications. The 24 out of 35 new clauses in Chapter Four of the New Regulation are devoted to laying out detailed requirements, registration procedure and approval conditions for using share-swap for foreign investors’ acquisitions in China, the incorporation of Special Purpose Vehicles (SPVs) by Chinese domestic companies or PRC residents and acquisitions by China domestic companies employing SPVs. The antitrust law provisions are copied from the Old Regulation. Most of the approval procedures and standards for the acquisitions of the Chinese domestic companies by the foreign investors remain unchanged. However, the New Regulation improves the threshold for EIE Treatment. Furthermore, the New Regulation confers enhanced authority on MOFCOM, together with other authorities, to enjoin or reverse the acquisitions of certain businesses. It also reconfirms and strengthens the authorities of approval by the MOFCOM and SAIC for acquisitions possibly threatening China national economic security or its national industries.

--to be continued in Part II

Note: this article was published in Law Journal Newsletter China Trade Law Report of American Lawyer Media (ALM), October, 2006 for general information and should not be taken as legal advice.