III. Laws and Regulations of Mergers and Acquisitions in China
There are two important regulations governing the acquisition of assets and shares of State-owned enterprises and wider general regulations on mergers and acquisitions by foreign investors in China:
1. Interim Provisions on the Takeover of Domestic Enterprises by Foreign Investors (“M&A Rules”)
On 8 August 2006, MOFCOM, State Assets Supervision and Administration Commission of the State Council (“SASAC”), the State Administration of Taxation (“SAT”), the State Administration of Industry and Commerce (“SAIC”), the China Securities Regulatory Commission (“CSRC”) and the State Administration of Foreign Exchange (“SAFE”) jointly issued the M&A Rules, which became effective on 8 September 2006. The M&A Rules regulate all types of mergers and acquisitions involving foreign investment under the supervision of the MOFCOM.
This is one of the most important regulations in relation to mergers and acquisitions by foreign investors in China. The key features of the M&A Rules are:
Article 2 of the M&A Rules provides that they are applicable to acquisitions of domestic non-foreign-funded PRC enterprises (hereinafter referred to as “domestic company”) by foreign investors. They apply to:
(a) Share Acquisitions (“equity-based takeover”)
- To transform a domestic company into a foreign-funded enterprise by acquiring equities of shareholders in a domestic company by agreement entered into between the domestic company and the foreign investor ; or
- to transform a domestic company into a foreign-funded enterprise by subscribing of additional registered capital in a domestic company by the foreign investor.
(b) Asset Acquisition (“asset-based takeover”)
- To establish a new foreign-funded enterprise and purchase assets in a domestic company by agreement entered into between the domestic company and the newly established foreign-funded enterprise and to operate the assets in the domestic company through the newly established foreign-funded enterprise; or
- to purchase assets in a domestic company by agreement entered into between the domestic company and the foreign investor and to invest those assets into a newly established foreign-funded enterprise for operating the assets in the domestic company.
MOFCOM takes the view that the M&A Rules shall apply to any target company incorporated as a company under PRC Company Law. Therefore, the M&A Rules apply to limited liability companies and companies limited by shares, including State-owned enterprises incorporated as limited liability companies and companies limited by shares.
(B) Foreign Investors Qualifications
The M&A Rules do not replace any existing foreign investment laws and regulations, in fact, the M&A Rules provide guidance and implementation techniques in mergers and acquisitions. Along with other foreign investment laws and regulations in the PRC, all foreign investments must follow guidelines provided in the Catalogue of Industries for Guiding Foreign Investment (“Industry Catalogue”) which delineate the categories of encouraged, permitted, restricted and prohibited industries for foreign investment. An enterprise engaged in an “encouraged” business, for example, development and production of food for baby, elderly and functional food may qualify for local (and generally more lenient) approval processes. The M&A Rules do not serve as an exception to the Industry Catalogue, which means that no acquisitions of either shares or assets are allowed if the target industry falls within the prohibited category and there are different restrictions set upon the acquisition if the target industry falls within the restricted category.
(C) A New Type of Foreign Invested Enterprise
Article 9 of the M&A Rules provides that in the event a foreign investor’s contribution falls below 25%, this will be noted as a remark on the approval certificate, business licence and a Foreign Exchange Register Certificate of the foreign-funded enterprise. Such type of foreign-funded enterprise would not be able to take advantage of any preferential treatment available to a foreign-funded enterprise with 25% or more of contribution by the foreign investor.
(D) Asset Assessment
Article 14 of the M&A Rules provides that the acquisition price of the equities to be transferred or the assets to be sold, must be based on an asset assessment given by an asset assessment institution. In order to reflect the government’s sensitivity to tax evasion and prohibit diversion of any capital abroad in any disguised form, the M&A Rules expressly prohibit setting an acquisition price significantly below the assessed value of the equities to be transferred or the assets to be sold. Within these boundaries, existing laws and regulations generally allow the parties to freely negotiate the transfer price. However, transactions involving state-owned equity interests or assets must comply with special regulations on the management of state-owned assets. There are also separate regulations governing the disposal of assets of state-owned interests.
Under the M&A Rules, an asset assessment institution which is lawfully established within the PRC may be used. However what often happens is that a foreign investor will also appoint an international assessment institution to provide a benchmark for the value of the assets and to assist in the negotiations with the domestic asset assessment institution.
(E) Creditors’ Rights
Under the M&A Rules, a disposal of shares does not affect the creditors’ rights of a domestic enterprise. Article 13 of the M&A Rules provides that for a share-based takeover, the foreign-funded enterprise established after takeover will succeed to all the credits and debts of the domestic company.
For an asset-based takeover, the domestic company shall undertake its former debts and credits. In addition, the domestic company is required to send a notice to its creditors and publish an announcement in a newspaper circulated nationwide not later than 15 days before the foreign investor submits the application documents for approval. The foreign investor, the domestic company, creditors and other parties concerned can enter into separate contractual agreements regarding the disposition of the obligations and creditors’ rights of the domestic company provided that these agreements do not impair the interests of any third party or the public interest. These agreements must also be submitted to the approval authorities in the PRC.