ChinaFIG - M&A Policy Update 2006 - Order No. 10 - China Fortune Investment Group
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China M&A Policy Update - 2006
Rules on Acquisition of Chinese Enterprises by Foreign Parties
On September 8th, 2006, Order No. 10 or the “Guidelines for Mergers & Acquisitions of Domestic Enterprises by Foreign Investors” became effective. These rules and provisions were issued jointly by six PRC authorities who oversee activities related to M&A activity and provide more clarity to the Provisional Rules issued in 2003. The government would like to enhance foreign investment, but at the same time protect China’s local industry development.
Summary Points
- STOCK SWAPS - Parameters are established which allow for the swap of shares with overseas companies, as a method of payment. As previously, only currency could be used as consideration, this will certainly have an immediate effect on encouraging deals.
- ACQUISITION ADVISORS - When stock swaps are utilized, the Domestic Companies are required to retain an Acquisition Advisor to perform certain due diligence on the acquiring company.
- IPO/SPV - Provisions to allow the creation of offshore Special Purpose Vehicles (SPV) were described. These SPVs essentially allow for offshore holding companies to be formed for the purpose of holding a public offering and listing the company.
- ANTI-MONOPOLY - Requirements to notify government authorities of transactions which may result in the control or dominant positions in an industry or the sale of famous Chinese brands/trademarks.
A number of the pronouncements restate prior policies and others introduce new concepts to the M&A environment. In the following document, we have taken excerpts and highlight some of the more important topics covered in Order No. 10. For a full translation of Order No. 10, please email us at info@ChinaFIG.com .
1. (Section I – Article 4)
Certain industries described by the “Foreign Investment Industrial Guidance Catalogue” are prohibited from being owned exclusively by a Wholly Owned Foreign Enterprise (WOFE) and a full equity acquisition of these types of Chinese Companies will not be allowed. If an acquisition of a company occurs in an industry which requires a Chinese company to retain controlling or relatively controlling interest, the Chinese company must retain that controlling or relatively controlling interest. A foreign party may not acquire a Domestic Company, which deals in an industry which foreigners are prohibited from.
2. (Section II – Article 9)
When a foreign party invests in a Chinese Company, a Foreign Invested Enterprise (FIE) will be created. Receiving certain preferential tax treatment however, will be determined by the amount of registered capital acquired. If the foreign party’s portion of the registered capital in the newly formed FIE is greater than 25%, then the FIE will be deemed to have met the required ratio. A business license will be marked however, with the phrase “foreign investment ratio is less than 25%”, if the threshold is not met.
Being acquired by a Chinese Company or related party of the Domestic Company, in the name of a overseas/foreign company which was formed outside of China, will not be deemed a FIE. If however, the overseas/foreign company increases the registered capital of the Domestic Company by 25%, FIE treatment could be enjoyed.
3. (Section II – Article 12)
Acquisitions of Domestic Companies which may affect Chinese economical security, which will participate in a major industry or which will result in the loss of controlling interest of a Chinese brand/trademark, require the examination and approval of the Ministry of Commerce. In the event approval for such action is not sought from the Ministry of Commerce and it results or has the potential of resulting in a material effect to the state economic security, the Ministry of Commerce along with other authorities will require that the involved parties terminate the exchange of assets, equity or take any appropriate measure to prevent the effects of such transaction on the national economic security.
4. (Section II – Article 13)
If a Foreign party enters into and Equity Deal, the thus created FIE will be responsible for the claims and debts of the acquired Chinese Company. If a Foreign party enters into an Asset Deal, the Chinese Company that was the seller will retain any claims or debts. The Foreign Party, the Chinese Company being purchased, lenders and outside parties can agree to the disposal of claims and debts of the Chinese Company being purchased, as long as the agreement will not affect the interests of any additional outside/third parties. Any agreement relating to the disposal of debts and claims must be submitted to the examination and approval authority. A Chinese Company which sells its assets must send a notification to its creditors and make a public announcement in a provincial scale or wider level newspaper which is circulated fifteen days prior to when the investor submits the appropriate application forms to the appropriate examination and approval authority.
5. (Section II – Article 14)
The methodology for establishing the transaction price of the assets or equity to be sold must use the valuation findings of the appraisal firm. The appraisal firm must be legally established in China and the selection of this firm is to be determined by the agreement of the parties involved in the transaction. Internationally accepted methods must be adhered to. Assets or equity may not be sold at a price which is clearly below the appraised price for purposes of dissuading the government and transferring capital aboard.
The authority of State Owned Assets has set provisions over the acquisition of a Chinese company, by a foreign party. These provisions must be followed when an acquisition results in an affect to the equity interest of State Owned assets or a transfer of title of State Owned assets occurs.
6. (Section II – Article 16)
Within three months of the issuance of a Business License, for and FIE created in relation to an acquisition, a foreign party is required to make the full consideration payment for the assets or equity of the Chinese Company which was purchased. The examination and approval authority may grant an extension under certain instances, but the foreign party must make a payment of at least 60% of the consideration no more than six months from the Business Licenses issuance and settle the entire balance within one year. During the period of partial payment, profits shall be distributed proportionally to the amount of capital paid.
7. (Section II – Article 19) In relation to an Equity Deal, the maximum ‘Total Investment’ (TI) of a newly formed FIE, in relation to the Registered Capital (RC), shall be in accordance with the following ratios:
(a) <2.1m USD Registered Capital; TI < (10/7 x RC)
(b) 2.1m – 5m USD Registered Capital; TI < (2/1 x RC)
(c) 5m – 12m USD Registered Capital; TI < (5/2 x RC)
(d) >12m USD Registered Capital; TI < (3/1 x RD)
8. (Section II – Article 20)
In relation to an Asset Deal, the ‘Total Investment’ (TI) of a newly formed FIE, shall be in accordance with the acquisition price and the production capacity of the operation. The ‘Total Investment’ ratio must comply with all appropriate rules and regulations.
9. (Section IV – Article 27)
The phrase “acquisition of a Chinese Company, by a foreign party, utilizing equity interest” will refer to the purchase of an equity stake, held by shareholders of a Chinese Company or the issuance of additional stock by that Chinese Company, of which the method of payment shall be additional stock shares or equity issued by the foreign party.
10. (Section IV – Article 28)
Foreign companies mentioned in Section IV are required to have adhered to the regulations regarding its legal existence. The country of abode must have established proper business law environment and the applicable regulatory authorities must not have administered sanctions on the foreign company or administration personnel for the past three years. The company foreign company must be publicly listed and the listing board must be a fully functioning and developed trading system. Noted exception for Special Purpose Vehicles to be discussed a later sections.
11. (Section IV – Article 30)
In relation to a foreign company acquiring a Chinese Company through the use of equity, the Chinese Company or investors are required to enlist the services of an outside company to act as its “Acquisition Advisor.” The Acquisition Advisor firm must be registered in China and is required to draft a professional opinion in regards to the foreign company. The research in regard to obtaining the opinion must entail certain Due Diligence, whereas the truthfulness of the foreign company’s registration/application, the foreign company has the financial means to perform such an acquisition and that the transaction is in accordance with Articles 14, 28 and 29 mentioned above.
12. (Section IV – Sub Section 3 – Article 39)
A Special Purpose Vehicle (SPV), with regards to these provisions, is a company held overseas which is directly or indirectly controlled by a Chinese Company/Chinese individual residing in China, for the purpose of an listing shares abroad, of a Chinese Company.
The regulations in this sub-section refer to transactions involving the equity interests in the possession of shareholders of Chinese Companies or additional stocks distributed by Chinese Companies, with consideration in the form of equity interests of a Specialty Purpose Vehicle or additional stocks distributed by the Specialty Purpose Vehicle, in order to list shares abroad.
When a Foreign Company holds an equity stake of a SPV and the Foreign Company is the actual organization which will be taken public; it is required to be in accordance with the SPV provisions in this sub-section.
12. (Section IV – Sub Section 3 – Article 40)
Acquisitions involving listings abroad and the use of Specialty Purpose Vehicles (SPV) as subject to the Securities Regulatory Commission under the State Council. The foreign country or administrative region where an SPV intends to list is required to have a fully developed legal and oversight system. The security exchange commission of the listing location is required to have agreed to a Memorandum of Understanding with the China Securities Regulatory Commission, under the State Council.
13. (Section V – Article 51)
The Ministry of Commerce (MOFCOM) and the State Administration of Industry and Commerce (SAIC) must both be notified in the event that any Foreign Party transaction involves any of the following items:
(a) if any of the companies involved in the deal had revenue in China, greater than 1.5Billion RMB, over the past year;
(b) the Foreign Party purchased more than 10 operations, in similar industries, in China, over the past year;
(c) if any of the companies involved in the deal control greater than 20% of a certain market;
(d) the deal will result in any of the companies involved to control 25% or more of the market in China.
Even in the event that none of the above items are met, other Chinese companies or trade groups may petition and if MOFCOM or SAIC conclude that the transaction by a Foreign Party would entail a significant market share or that additional issues would have a material impact on competition, they can insist that the Foreign Party submit notification.
The phrase “any of the companies involved in the deal” also entails an affiliated groups of the Foreign Party.
14. (Section V – Article 53)
In the event a transaction involves any of the items noted below, the buy-side party is required to provide an acquisition plan to the Ministry of Commerce (MOFCOM) and the State Administration of Industry (SAIC), prior to making a public notification or concurrently with a submittal of notification to the appropriate government body from its home country. MOFCOM and SAIC will determine if the transaction will create a dominant position in the Chinese market, which hampers competition and negatively impacts consumers, and make a determination as to if approval will be granted:
(a) any of the participants involved in the acquisition of assets by a Foreign Party, holds assets in China with value greater than 3Billion RMB;
(b) any of the participants involved in a Foreign Party acquisition had revenue in China, in the most recent year, of greater than 1.5Billion RMB;
(c) any of the participants (or related parties) involved in a Foreign Party acquisition in which they already hold greater than 20% of a certain Chinese market;
(d) an acquisition by a Foreign Party which will result in any of the parties (and related parties) to hold Chinese market share achieve 25% or more; or
(e) an acquisition by a Foreign Party will result in more than 15 FIEs, in a related industry, in China, in which it has a direct or indirect equity interest in.
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