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Print articleChina: Acquisition of Domestic Enterprises by Foreign Investors
January, 2007 -
The Ministry of Commerce (“MOFCOM”), the State-owned Assets Supervision and Administration Commission of the State Council, the State Administration of Taxation, the State Administration for Industry and Commerce, the China Securities Regulatory Commission (“CSRC”) and the State Administration of Foreign Exchange jointly issued the Regulations Regarding the Acquisition of Domestic Enterprises by Foreign Investors on 8 August 2006. Effective from 8 September 2006, the Regulations supersede the 2003 Provisional Regulations for the Acquisition of Domestic Enterprises by Foreign Investors (“Provisional Regulations”) (as discussed in the 2003.4 issue of China Legal Update) and govern both equity acquisitions and asset acquisitions of domestic companies by foreign investors (“domestic acquisitions”).
While the Regulations largely reiterate the procedures set out under the Provisional Regulations, they do introduce some important new procedures and concepts, creating new structuring opportunities while reasserting the Ministry of Commerce’s control over the acquisition process.
Compliance with Foreign Investment Policies
Foreign acquisitions of domestic enterprises are still required to comply with the foreign investment regulations applicable to the targeted industry sector. The Regulations clarify that the business scope of any subsidiary of the domestic target must also comply with China’s foreign investment policies. An acquisition cannot be used to circumvent foreign investment restrictions.
If the post-acquisition foreign shareholding is at least 25% of a target’s registered capital, the target will be eligible to enjoy the benefits of FIE status. Acquisitions under 25% are still subject to the FIE approval process but are not eligible to enjoy FIE benefits.
“Round Trip” Investments
The Regulations impose new restrictions on “round trip” investment. FIE treatment for the results of “round trip” investment is now subject to restrictions. If a domestic company, enterprise or individual carries out the acquisition of an affiliated domestic company through use of an overseas company established or controlled by it, the FIE established as a result of the transaction shall not be eligible to enjoy the preferential policies applicable to FIEs without the injection of additional foreign funds.
Such related party “round trip” investment now requires Ministry of Commerce approval regardless of the approval level that would otherwise be applicable. These transactions cannot be approved locally.
Acquisitions Involving Affiliated Companies
Further disclosure concerning connected party acquisitions is now required. Under the Regulations, parties to a domestic acquisition are required to declare whether or not they are affiliated companies. If both parties are controlled by a single entity, the identity of the entity should be disclosed and an explanation provided as to the purpose of the acquisition and whether the transaction value represents the price recognised by the market. The Regulations expressly prohibit the evasion of these requirements by means of arrangements such as trusts or nominee shareholders.
Share Consideration
The Regulations clarify the permitted use of share consideration. The Provisional Regulations permitted the use of equity consideration without offering any procedural guidance, making the approval of its use difficult. The Regulations should make the use of share consideration practically feasible, although subject to significant restrictions. The foreign investor whose shares are to be used as consideration must satisfy certain restrictive criteria:
• the foreign investor must be lawfully registered and it and its management shall have not been penalised by its competent supervisory authority in the most recent three years;
• the jurisdiction in which the foreign investor is registered must have a complete corporate law system;
• the foreign investor must be a listed company (not OCT traded) unless it is a special purpose vehicle (see discussion below); and
• the jurisdiction where the foreign investor is listed must have a complete securities exchange system.
The share price of the consideration shares must also have been relatively stable in the year prior to the transaction. The domestic company or its shareholder(s) must also appoint a China-registered intermediary organisation to investigate and verify compliance with the Regulations. The opinion of the China-registered intermediary will be required in the approval process.
Interim approvals are used to monitor these transactions. These transactions require sequential approval first for use of share consideration and then for the overseas investment by the Chinese party receiving the shares. Both sets of approval requirements must be satisfied. The use of share consideration is not a short cut to offshore investment for Chinese entities. The offshore investment approval process remains applicable in such transactions.
Special Reporting
The Regulations also require that acquisitions involving key industries, impacting national economic security or resulting in the change of control of an entity with a well-known or famous domestic trademark be reported to MOFCOM. No guidance is provided on the meaning of such terms, but failure to satisfy the reporting requirement can result in the unwinding of an otherwise properly approved transaction. MOFCOM now has potentially broad discretion to review transactions.
Special Purpose Vehicles
The Regulations also further regulate the use of special purpose vehicle shares in the restructurings of domestic enterprise where the ultimate purpose is an offshore listing of the special purpose vehicle. Fairly stringent criteria have been introduced for such reorganisations. The provisions shall be applicable if a domestic shareholder uses shares of an offshore special purpose vehicle controlled by it as consideration for the acquisition of shares it controls in a domestic company with the purpose of the special purpose vehicle offshore, thus indirectly listing the PRC assets.
MOFCOM and CSRC approval is required and the listing must take place within one year, otherwise the transaction must be unwound. The CSRC previously did not have approval authority over such offshore listings. The proceeds from the financing exercise shall be repatriated to China.
Individual Shareholders
The restrictions on individual PRC shareholders in FIEs have also been relaxed under the Regulations. Chinese law generally does not permit individual Chinese nationals to hold equity in FIEs. The Provisional Regulations permitted an individual to retain his equity with MOFCOM approval provided that the shareholder had held the shares for a year. The Regulations eliminate these requirements allowing existing shareholders to retain their interests without any special approvals. The change of nationality of any individual shareholder will not affect the status of the company.
While the Regulations largely reiterate the procedures set out under the Provisional Regulations, they do introduce some important new procedures and concepts, creating new structuring opportunities while reasserting the Ministry of Commerce’s control over the acquisition process.
Compliance with Foreign Investment Policies
Foreign acquisitions of domestic enterprises are still required to comply with the foreign investment regulations applicable to the targeted industry sector. The Regulations clarify that the business scope of any subsidiary of the domestic target must also comply with China’s foreign investment policies. An acquisition cannot be used to circumvent foreign investment restrictions.
If the post-acquisition foreign shareholding is at least 25% of a target’s registered capital, the target will be eligible to enjoy the benefits of FIE status. Acquisitions under 25% are still subject to the FIE approval process but are not eligible to enjoy FIE benefits.
“Round Trip” Investments
The Regulations impose new restrictions on “round trip” investment. FIE treatment for the results of “round trip” investment is now subject to restrictions. If a domestic company, enterprise or individual carries out the acquisition of an affiliated domestic company through use of an overseas company established or controlled by it, the FIE established as a result of the transaction shall not be eligible to enjoy the preferential policies applicable to FIEs without the injection of additional foreign funds.
Such related party “round trip” investment now requires Ministry of Commerce approval regardless of the approval level that would otherwise be applicable. These transactions cannot be approved locally.
Acquisitions Involving Affiliated Companies
Further disclosure concerning connected party acquisitions is now required. Under the Regulations, parties to a domestic acquisition are required to declare whether or not they are affiliated companies. If both parties are controlled by a single entity, the identity of the entity should be disclosed and an explanation provided as to the purpose of the acquisition and whether the transaction value represents the price recognised by the market. The Regulations expressly prohibit the evasion of these requirements by means of arrangements such as trusts or nominee shareholders.
Share Consideration
The Regulations clarify the permitted use of share consideration. The Provisional Regulations permitted the use of equity consideration without offering any procedural guidance, making the approval of its use difficult. The Regulations should make the use of share consideration practically feasible, although subject to significant restrictions. The foreign investor whose shares are to be used as consideration must satisfy certain restrictive criteria:
• the foreign investor must be lawfully registered and it and its management shall have not been penalised by its competent supervisory authority in the most recent three years;
• the jurisdiction in which the foreign investor is registered must have a complete corporate law system;
• the foreign investor must be a listed company (not OCT traded) unless it is a special purpose vehicle (see discussion below); and
• the jurisdiction where the foreign investor is listed must have a complete securities exchange system.
The share price of the consideration shares must also have been relatively stable in the year prior to the transaction. The domestic company or its shareholder(s) must also appoint a China-registered intermediary organisation to investigate and verify compliance with the Regulations. The opinion of the China-registered intermediary will be required in the approval process.
Interim approvals are used to monitor these transactions. These transactions require sequential approval first for use of share consideration and then for the overseas investment by the Chinese party receiving the shares. Both sets of approval requirements must be satisfied. The use of share consideration is not a short cut to offshore investment for Chinese entities. The offshore investment approval process remains applicable in such transactions.
Special Reporting
The Regulations also require that acquisitions involving key industries, impacting national economic security or resulting in the change of control of an entity with a well-known or famous domestic trademark be reported to MOFCOM. No guidance is provided on the meaning of such terms, but failure to satisfy the reporting requirement can result in the unwinding of an otherwise properly approved transaction. MOFCOM now has potentially broad discretion to review transactions.
Special Purpose Vehicles
The Regulations also further regulate the use of special purpose vehicle shares in the restructurings of domestic enterprise where the ultimate purpose is an offshore listing of the special purpose vehicle. Fairly stringent criteria have been introduced for such reorganisations. The provisions shall be applicable if a domestic shareholder uses shares of an offshore special purpose vehicle controlled by it as consideration for the acquisition of shares it controls in a domestic company with the purpose of the special purpose vehicle offshore, thus indirectly listing the PRC assets.
MOFCOM and CSRC approval is required and the listing must take place within one year, otherwise the transaction must be unwound. The CSRC previously did not have approval authority over such offshore listings. The proceeds from the financing exercise shall be repatriated to China.
Individual Shareholders
The restrictions on individual PRC shareholders in FIEs have also been relaxed under the Regulations. Chinese law generally does not permit individual Chinese nationals to hold equity in FIEs. The Provisional Regulations permitted an individual to retain his equity with MOFCOM approval provided that the shareholder had held the shares for a year. The Regulations eliminate these requirements allowing existing shareholders to retain their interests without any special approvals. The change of nationality of any individual shareholder will not affect the status of the company.
