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China New M&A Regulation and Its Impacts on Foreign Business in China -- Part II

Posted by attorney Wenzhao Wang

The noteworthy changes in the New Regulation affecting foreign investments in China are as follows:

A.New requirements for compliance with more Chinese laws and mandated approval from MOFOM for foreign acquisitions in China

1) New requirements introduced in the New Regulation call on foreign investors to satisfy the requirements of Chinese laws, and administrative regulations and rules concerning industrial, land and environmental protection policies (Article 4).

2) The acquisition by the foreign companies shall not cause the loss of state-owned asset (Article 3).

3) The New Regulation also stipulates that foreign investors comply with Articles 5 through 8:

a. comply with relevant regulations governing state-owned assets when transfer of the state-owned assets and administration of state-owned equity of a listed company are involved in the foreign acquisition;

b. obtain approval of examination, comply with the procedures for amendment of registration or establishment registration with the registration administration authority;

c. follow the procedures with the securities regulatory authority of the State Council pursuant to the Measures Governing Strategic Investment Made by Foreign Investors in Listed companies when acquiring a China domestic listing company;

d. pay taxes according to tax regulations of China and accept supervision of tax authorities;

e. follow procedures of administration of foreign exchange (“FOREX") for Forex approval, registration, filing and amendment in a timely manner in compliance with Chinese Forex laws and administrative regulations.

4) New Regulation reiterates that the foreign acquisition shall follow the “Foreign Investment Industrial Guidance Catalogue" and the foreign investors are prohibited from acquiring PRC companies in the forbidden areas for foreign companies set in the Catalogue. (Article 4)

5) The most striking change in the New Regulation is the requirement for foreign companies to apply to MOFCOM for examination and approval in advance when:

a. the acquisition may result in transfer of the actual controlling rights of the PRC domestic companies owning any famous trademarks or traditional Chinese brands to the foreign company;

b. such acquisition involves any major industry; or

c. the acquisition has or may have an impact on the state economy security. (Article 12).

This clause empowers MOFCOM together with other authorities to enjoin and reverse an acquisition that fails to do the above required report and may cause impact on the state economic security.

B.New qualification for the FIE Treatment.

New Regulation requires the ratio of foreign investment in FIE to exceed 25% of the registered capital of the FIE established by the foreign acquisition in order to qualify for enjoyment of the preferential treatment of FIE and administrative procedure for borrowing loans by FIEs. (Article 9)

C.Share Swaps--Equity payment-based acquisition of domestic companies by foreign investors.

The 2003 Old Regulation first allowed share swaps in the acquisition by foreign investors in China but did not have any specific rules implementing it. The New Regulation promulgated detailed and restricted guidelines for foreign investors involved in the share swap acquisition to follow, including:

a. the foreign company involved in the transaction should be in compliance with all the requirements on its lawful establishment, the place of its registration must have a complete corporate legal system and free from the punishments from supervision agencies for the past three years;

b. the equity interests are not subject to any dispute of ownership or any lien or otherwise encumbrances;

c. the equity share for the foreign company has to be lawfully listed for public trade on the overseas securities exchange market excluding any sale-counter trade market; and

d. the trading price of the overseas company’s equity shares has been stable for the recent one year. (Articles 27 through 38)

The above detailed provisions are aimed at giving more options for foreign companies in China for the payments of the acquisition, which can be considered as a positive step for China in introducing international M&A norms and encouraging more foreign investments.

For the first time, the New Regulation requires the domestic company or its shareholders to employ a registered agency in China as its acquisition consultant to conduct due diligence with regard to the truthfulness of the application documents and the overseas company’s financial status required for the purpose of such acquisition. (Articles 30 and 31)

3. NEW REGULATION AND ITS IMPACT ON FOREIGN COMPANIES’ PENETRATION IN CHINA MARKET

The New Regulation contains no defined terms on some important matters, such as definitions, factors or criteria used to determine:

a. “major industries", “impact on the state economy security" and “China’s famous trademarks or traditional Chinese brands," which are required to get approval from MOFCOM as mentioned in Article 12;

b. “large market share and other important factors that would materially affect market competition" as mentioned in Article 51; and

c. “improvement and the conditions for fair market competition," “advance technology and management talent," which are qualified for exemption from examination under antitrust provision as mentioned in Article 54.

The above undefined terms give MOFCOM and other government authorities more discretion, power and leverage for deciding whether to approve or deny the foreign investor’s acquisition, thus creating uncertainties and more risks for foreign investors to acquire the Chinese domestic companies. As China remains a country with a planned economy, this is nothing novel to foreign investors. The difference possibly resulting from this new rule may be that China becomes more serious and aggressive in carrying out the rule in restricting foreign investors’ takeover of Chinese domestic companies for the purpose of market entry and Chinese domestic companies can use this rule to block foreign companies’ acquisition of their competitors to avoid competition in the domestic market. It is important to note, though, that whenever there is uncertainty embedded in a government policy, creative strategies can be developed to obtain the required authorization.

With its accumulating and increasing knowledge in western countries’ practice in promulgating laws and regulations, China may introduce more international practice in protecting its domestic industries while technically adhering to the market access schedule it has undertaken as a WTO member. As Vice Prime Minister Wu Yi addressed 160 multi-national business executives in Xiamen during China 10th International Fair for Investment and Trade on September 7, 2006, one day before the adopting of the New Regulation, China continues to promote foreign investment in the fields of agriculture, service industries and traditional manufacturing, research and development centers, new high-technology industries, advanced manufacturing, and the energy conservation and environment sectors. A strategy for focusing on these areas and using well-connected consulting, PR, legal and accounting firms with a good government affairs program in China is critical to help to smooth the process.

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.

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