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December 6, 2006

China Revises M&A Regulations Affecting Foreign Purchasers and Domestic Targets

[We are grateful to Michael Burke for today's post, an update on China's recently enacted M & A regulations. Mike is an attorney with Williams Mullen, where his practice focuses on advising U.S. companies on the structure and operation of investments in Greater China. He is experienced in China-related direct investments, acquisitions, private equity transactions and technology ventures. Mike is currently Co-chair of the American Bar Association, Section of Int'l Law & Practice, China Law Committee, and Visiting Fellow at the Asian Institute of International Financial Law, Hong Kong Faculity of Law.]

On September 8, 2006, the Provisions on Acquisitions of Domestic Enterprises by Foreign Investors (the New M&A Provisions), issued by China’s Ministry of Commerce (MOFCOM) and other agencies, became effective, replacing 2003’s Provisional Rule on Acquisitions of Domestic Enterprises by Foreign Investors. The New M&A Provisions are a significant development in the regulation of mergers and acquisitions in China.

Under the New M&A Provisions, a purchaser may use its own equity (provided it is listed on a foreign stock exchange) to acquire equity interests in a domestic Chinese company. A Chinese-registered advisor must conduct specific due diligence into the purchaser’s financial condition and submit a required report to MOFCOM.

In certain circumstances, the equity in a Special Purpose Vehicle (SPV) (an offshore company directly or indirectly controlled by domestic Chinese companies or residents) may be listed on a foreign stock exchange. Proceeds from such listing must be used only for authorized purposes, including establishing a new foreign invested enterprise (FIE). Such equity, subject to certain conditions, may be used as consideration in a M&A transaction.

The New M&A Provisions reiterate that the foreign-owned equity interests in a target after a foreign-invested M&A transaction must exceed 25% of its registered capital for such FIE to be able to avail itself of any FIE-related incentives or preferences. In addition, the New M&A Provisions clarify the treatment of FIEs established by offshore entities that, in turn, are controlled by domestic Chinese persons or enterprises.

The burdensome antitrust review process created by the 2003 M&A regulations remain in the new M&A Provisions. This process relies in part on vague and undefined terms to determine which M&A transactions should receive antitrust review.

If a M&A transaction would (a) result in any change in control of any domestic company in a key industry; (b) involve the holder of a well-known Chinese mark or brand; or (c) have potential or actual impact on national or economic security, such transaction must be approved by MOFCOM. This approval process is independent of the usual approval processes imposed on all foreign investment in China, including M&A transactions. Note that the New M&A Provisions do not define terms such as “key industry” or “well-known brand” and do not specify the approval procedures or timeline applicable in this context.

The New M&A Provisions are the Chinese government’s latest effort to regulate foreign-invested M&A transactions. In some measure the New M&A Provisions reflect the Chinese government’s concerns over asset stripping of state-owned enterprises and potential abuse of FIE incentives. They also reflect the government’s efforts to enable more forms of M&A transactions in China. The New M&A Provisions likely will be supplemented with implementing rules in the near future, meaning that China’s M&A regime will continue to evolve.

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