Foreign Acquisitions and Joint Ventures in China

Transcription

1 Foreign Acquisitions and Joint Ventures in China Li Jiao and Bart Kasteleijn HIL International Lawyers & Advisers Amsterdam/ Shanghai Introduction Since the introduction of the economic reform and opening-up policy in China in the late 1970s, 1 the country has been quite successful in attracting foreign investment. As a matter of fact, the People s Republic of China (PRC) has remained in the top three after it overtook the United States to become the world s largest foreign direct investment (FDI) recipient back in In spite of the global recession, China s economy grew 8.7 per cent in 2009, with a 9.5 per cent GDP growth at the time of writing in As one of the largest transitional economies, the impressive performance of the Chinese market during the recent financial crisis has shown its potential and energy. This explains why inbound investment in China keeps on growing amidst gloomy economic results in most of the world. According to an UNCTAD report, the outlook of FDI in China remains relatively optimistic, while the global FDI flows were dropping in China and Hong Kong are among the handful of economies that continued to get larger capital inflows in the last quarter of 2009 than the quarterly average of When it comes to FDI, foreign investors would prefer cooperating with local partners to setting up a wholly owned business, in hopes of enjoying commercial benefits from using the business network, goodwill, and know-how of local partners. Foreign investors also would 1 In this chapter, China refers to Mainland China, excluding Hong Kong, Macao, and Taiwan. 2 World Bank Office, Beijing, China Quarterly Update (March 2010), at /CQU_march2010.pdf. 3 UNCTAD Global Investment Trends Monitor at webdiaeia20101_en.pdf.

2 30 Foreign Acquisitions and Joint Ventures in China have to cooperate with a local party in a foreign investment enterprise (FIE), subject to certain legal restrictions under PRC law. Some industries are restricted for foreign investors, such as the development and production of seeds and processing of edible oils from soybeans. 4 Without cooperation with Chinese partners, foreign investors are not allowed to invest in these restricted industries. The cooperation can be formed primarily in two ways: acquisitions and new (greenfield) capital investment. Despite its popularity worldwide, the acquisition has not yet become the prevailing way for industrial business to enter into China, but may do so. Compared with greenfield investments, acquisitions by foreign companies are more vulnerable to domestic competition and local uncooperativeness and may be rejected or hindered on political grounds, rather than on legal merits. In comparison, greenfield investment usually attracts less attention from political and regulatory bodies and will be approved more easily. Furthermore, with the introduction of regulations on foreign-invested partnership enterprises, partnership joint ventures (PJVs) have become available for foreign investors. This new investment vehicle provides more leeway for foreign investors compared with the traditional instruments: the equity joint venture (EJV) and the cooperative (also called a contractual joint venture CJV). This chapter first provides a brief introduction on the law and practice of foreign investment in general and then discusses acquisition. Next, joint ventures in China are explained, with emphasis on the corporate governance of the EJV. Finally, the new investment vehicle, the PJV, is highlighted. Overview of Regulations on Foreign Direct Investment Foreign Investment Industry Catalog Foreign investment activities in China are highly regulated. Not all industries are available for foreign investment. According to the Provisions on Guiding Foreign Investment Direction, issued by the State Council on 11 February 2002 and effective from 1 April 2002, foreign-invested projects are divided into four categories: encouraged 4 Under the Foreign Investment Industrial Guidance Catalog, these two businesses are categorized as restricted industries for foreign investment, requiring PRC investors having a controlling interest in FIEs.

3 Li Jiao and Bart Kasteleijn 31 industries, permitted industries, restricted industries, and prohibited industries. 5 The Foreign Investment Industrial Guidance Catalog (the Catalog) is issued by the National Development and Reform Committee (NDRC, formerly called the National Development Planning Commission) and the Ministry of Commerce (MOFCOM, formerly called the Ministry of Foreign Trade and Economic Cooperation or MOFTEC) and amended by the same authorities from time to time. 6 The Catalog sets out the industries falling within the encouraged, restricted, and prohibited categories, respectively. Industries not listed are considered to be in a default category normally referred to as permitted, and are open to foreign investment unless otherwise specified in other PRC regulations. The Encouraged Category The encouraged category contains 351 industrial areas. In a number of industries, the business entity is limited to an EJV or a CJV, or to an EJV and a CJV. In line with China s World Trade Organization (WTO) commitments, the service sector has been opened wider to foreign investors in certain new areas, notably modern logistics and outsourcing services, which were recently added to the encouraged category. The Restricted Category The restricted category contains eighty-seven industrial areas. As in the encouraged category, the business entity is limited to an EJV or a CJV, or to an EJV and a CJV in a number of industries. In some industries, the Chinese party will hold the controlling stakes or the relative controlling stakes. In several industries, the requirements of foreign investment ratio are detailed. These industries include the domestic business and international business in basic telecommunications (where the foreign equity stake limit is forty-nine per cent); insurance (where the foreign equity limit in life insurance companies is fifty per cent); securities companies, confined to A share consignment-in, B share, H share, and 5 Provisions on Guiding Foreign Investment Direction, Article 4. 6 The newly revised version of the Catalog was issued on 31 October This marks the fourth revision to the Catalog since its first promulgation in 1995 (the previous revisions occurred in 1997, 2002, and 2004, respectively).

4 32 Foreign Acquisitions and Joint Ventures in China government and company bonds consignment and transaction (where the foreign equity limit is one-third); 7 and securities investment fund management companies where the foreign equity stake is limited to forty-nine per cent. 8 Under the PRC Securities Law, the term securities company refers to a limited-liability company or a stock-listed company that has been established and engages in the business operation of securities. A securities company may undertake some of or all of the following business operations: (a) securities brokerage; (b) securities investment consulting; (c) financial advising relating to activities of securities trading or securities investment; (d) underwriting and recommendation of securities; (e) self-operation of securities; (f) securities asset management; and (g) any other business operation concerning securities. The Prohibited Category The prohibited category comprises forty industrial sectors, highlighting two overriding policy objectives of the Chinese government: (a) control and elimination of investment in environmental unfriendly industries; and (b) prohibition of foreign participation in industries that are deemed to be politically sensitive. Compared with the previous version of the Catalog, the scientific research, technical service, and geological exploration industry 9 are important additions to the prohibited category. In the culture, sports, and entertainment sectors, radio and television program production and operation companies as well as film production companies have been upgraded from the restricted category to the prohibited category, as have, for example, the construction 7 Shares on the Shanghai and Shenzhen stock exchanges refers to shares that are traded in Renminbi. Some shares on the two stock exchanges in Mainland China, known as B shares, are traded in foreign currencies. H shares refer to the shares of companies incorporated in Mainland China that are traded on the Hong Kong Stock Exchange. 8 Under the PRC Law on Funds for Investment in Securities, a fund management company is one that manages the raising of capital for investment in securities by openly selling fund units. 9 This phrase is not clearly defined, but is likely to cover a variety of activities ranging from development and application of human stem cells, gene diagnosis and treatment technology, to geographic surveys, marine mapping, aerial survey mapping photography, administrative boundary mapping, relief map compilation, and electronic navigation map compilation.

5 Li Jiao and Bart Kasteleijn 33 and operation of golf courses. Foreign investment in news websites, Internet-based video and audio program services, business premises for Internet access services, and Internet cultural operations also have been added to the prohibited category, underscoring the more tight control of the Chinese government over foreign participation in Internet-based news and cultural services. Variable Interest Entity In an effort to circumvent the legal obstacles and invest in industries listed in the restricted or prohibited category, such as Internet-based services, investors create the so-called variable interest entity (VIE) structure. 10 SINA, SOHU, and Baidu 11 are only a few examples of companies that have gone public in the United States by using this structure. The VIE structure involves an offshore entity owned at least in part by PRC entrepreneurs. International investors make their investment in the offshore entity. The offshore entity owns a PRC subsidiary, called a wholly foreign-owned enterprise (WFOE), which is a party to a web of contracts with the PRC operating company. The contracts shift the bulk of the economic benefits and obligations of the operating company to the WFOE and thus (indirectly) to the offshore investors. Some of the operating assets and personnel also may be transferred to the WFOE, depending on applicable regulations. In most cases, the web of contracts results in the WFOE having effective control over the PRC operating company, or at least over major decisions, and the operating company s financials will be consolidated with those of the FIE under the Variable Interest Entity Consolidation Rules (FIN 46R) issued by the Financial Accounting Standards Board. 12 Governing Law of Foreign Direct Investment China does not have unified private international legislation. Instead, the rules on the applicable law are scattered among many statutes, administrative regulations, and judicial interpretations. With respect 10 The VIE structure also can be used by other PRC companies, regardless of whether or not they are in a restricted industry. 11 The three companies are all well-known Internet companies in China. 12 China Rising, Investor Relations Strategic Communications, at E458AEDB.pdf.

6 34 Foreign Acquisitions and Joint Ventures in China to the applicable law in FDI, most Chinese legislation subjects corporate and regulatory matters to the jurisdiction of PRC law. According to the PRC Contract Law, PRC law will apply to EJV and CJV contracts. 13 Furthermore, the Provisions on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (the M&A Rules) also provide that agreements on asset acquisition will be governed by PRC law. These principles have been strengthened by the Provisions on Several Issues Concerning the Application of the Law in Trials of Foreign-Related Civil and Commercial Contract Disputes (the SPC Provisions) issued by the Supreme People s Court. According to the SPC Provisions, agreements on EJVs and CJVs, share transfer agreements, and share purchase agreements will all be governed by PRC law. Any circumvention of the mandatory application of PRC law is null and void. Applicable Regulations and Authorities Applicable Regulations To cooperate with their Chinese peers, foreign investors have three alternatives: EJVs, CJVs and since 2009 PJVs. There is a statute regulating EJVs, the PRC Sino-Foreign Equity Joint Venture Law (the EJV Law), 14 and one regulating CJVs, the PRC Sino-Foreign Cooperative Joint Venture Law (the CJV Law). 15 These two statutes prevail over the PRC Company Law in case of any inconsistency. In addition to these statutes, MOFCOM and the State Administration of Industry and Commerce (SAIC) have both issued and updated multiple regulations. MOFCOM and SAIC further clarify this issue in the Implementing Opinions on Several Issues Concerning the Application of the Law in the Administration of the Examination, Approval, and Registration of Foreign-Invested Companies (Rules Number 81) on 24 April According to Rules Number 81, the ranking of the relevant statutes and regulations is as follows: (a) the EJV Law and the CJV Law; (b) 13 PRC Contract Law, Article 126. In the case of Sino-foreign EJV contracts, Sino-foreign CJV contracts, and contracts for Sino-foreign cooperative exploration and exploitation of natural resources performed within the boundaries of the People s Republic of China, the law of the PRC applies. 14 The EJV Law was promulgated by the National People s Congress in 1979 and was revised by the same authority in 1990 and 2001, respectively. 15 The CJV Law was promulgated by the National People s Congress in 1988 and was revised by the same authority in 2000.

7 Li Jiao and Bart Kasteleijn 35 the PRC Company Law and the Registration Regulations issued by the national SAIC; and (c) in the absence of the provisions (a) and (b), other subalternate administrative regulations prevail. 16 There is no statute on PJVs; alternatively, reference is always made to the Partnership Enterprise Law. 17 Furthermore, the national SAIC, as the competent authority, also has issued rules on foreign-invested partnership enterprises. Authorities There are two types of basic approval requirements for a foreign investment project: (a) project approval by NDRC or its local counterparts; and (b) investment approval by MOFCOM or its local counterparts. MOFCOM is the principal authority responsible for approving the application of EJVs and CJVs. NDRC also plays a prominent role in approving the application of foreign-invested enterprises (FIEs), including EJVs and CJVs. According to the Administration of the Verification of Foreign-Invested Projects Tentative Procedures (the NDRC Measures), 18 almost all foreign-invested projects, such as the establishment, share transfer, and the increase in registered capital of an FIE, require the approval of the competent NDRC. 19 Currently, if the total investment amount for foreign investment in the encouraged or permitted industries is US $300-million or more, the projects must obtain approval from the central NDRC and MOFCOM. 20 In the case of foreign investment in the restricted industries, the project must obtain approval from the central NDRC and MOFCOM if the total investment amount is US $50-million or more. SAIC and its local counterparts are the registration authorities. Separately, according to the designation of the State Council, SAIC is 16 Rules Number 81, Article The Partnership Enterprise Law was promulgated by the National People s Congress in 1997 and was amended on 27 August This law took effect on 1 June The NDRC Measures were issued on 9 October 2004 and took effect on the same date. 19 NDRC Measures, Articles 2 and 18. The approval authority in this case could be the national NDRC or a local NDRC, depending on the investment amount of the relevant FIE. 20 SAIC, Several Opinions on Fully Making Use of the Industry and Commerce Administrative Functions in Order to Better Serve the Development of Foreign-Invested Enterprise (7 May 2010).

8 36 Foreign Acquisitions and Joint Ventures in China in charge of reviewing the application of PJVs. Therefore, the national SAIC also has issued detailed rules on the administration of PJVs. Acquisition by Foreign Investors in China Economic Background In 2007, the minister of MOFCOM said that merger and acquisition by foreign investors in China was still in its infancy. According to the statistics, in 2007, 1,274 foreign-invested enterprises were established by way of mergers and acquisitions, accounting for a mere 3.1 per cent of the total number of FIEs. The amount of foreign capital actually used was US $1.8-million, which accounts for only 2.2 per cent of the total amount. Recently, the Chinese government vowed to vigorously support the participation of foreign investors in the restructuring, reform, merger, and reorganization of domestic enterprises in the form of equity acquisition. 21 Thus, it is foreseeable that acquisitions of domestic companies will become an increasingly popular investment vehicle for foreign investors. Key Government Agencies The agency with the most prominent role in the acquisition process is MOFCOM, which has the primary responsibility for supervising foreign-related transactions, and it is involved in all transactions. It is China s primary foreign investment regulator and approval authority. NDRC also plays a vital role in the acquisition process. It is responsible for both approving and verifying foreign investment project applications and supervising the restructuring of state-owned enterprises. The State-Owned Assets Supervision and Administration Commission (SASAC) also is an important agency in a foreign acquisition process. It is responsible for both approving foreign investment project applications and supervising the restructuring of state-owned enterprises and assets. It closely monitors transaction values and 21 SAIC, Several Opinions on Fully Making Use of the Industry and Commerce Administrative Functions in Order to Better Serve the Development of Foreign-Invested Enterprise (7 May 2010).

9 Li Jiao and Bart Kasteleijn 37 payment schedules. It may act as both regulator and vendor through one of its designated agencies or companies. The China Securities Regulatory Commission (CSRC), which is responsible for monitoring and regulating China s capital markets, will be involved in transactions targeting listed companies. As acquisitions involving listed companies become more common, CSRC will play a greater role in the merger and acquisition process. In addition, inbound monetary exchange control makes the State Administration of Foreign Exchange (SAFE) an important authority in acquisition practices. Under the M&A Rules, when the approval authority decides to approve a foreign investor to purchase the shareholders equity in a domestic company, it must simultaneously make copies of the relevant approval documents separately to SAFE at the equity transferor s locality. The local SAFE will issue the relevant certificate on registration of share transference of foreign exchange earnings and foreign exchange from foreign investment, which is the valid document to prove that the foreign investor has paid the consideration for an equity subscription. 22 Regulations on Acquisitions by Foreign Investors in China In General A foreign investor pursuing an acquisition transaction in China has a choice between an equity purchase, an asset acquisition, or a statutory merger. All three forms of acquisition are recognized by PRC law. The preferred acquisition method will depend on various considerations, such as the financial status of the target, the required governmental approvals, the transaction time, and the tax consequences of the structure. The targets of acquisition by foreign investors can be domestic companies, FIEs, state-owned companies, and listed companies. There are specific regulations for each of these transactions. Acquisition of Domestic Companies The M&A Rules are of paramount importance in this area. The M&A Rules were jointly issued by MOFCOM together with five other authorities: SAIC, SASAC, SAFE, CSRC, and the State Administration of Tax (SAT) on 8 August 2006 and became effective on 8 September Due to the implementation of the Antimonopoly 22 M&A Rules, Article 25.

10 38 Foreign Acquisitions and Joint Ventures in China Law (AML) of the PRC, the M&A Rules were further amended by MOFCOM on 22 June The major features relating to the M&A Rules are addressed in the following paragraph. Application Scope of the Provisions on Acquisitions of Chinese Enterprises by Foreign Investors Under the M&A Rules, a foreign investor may acquire or increase an equity interest in a PRC target company in the following two ways: equity acquisition and asset acquisition. For the purpose of the M&A Rules, an equity acquisition means a foreign investor s purchase of the equity of a shareholder in an enterprise that is not foreign-invested (a domestic company) or subscription to a domestic company s capital increase, resulting in the conversion of the domestic company into a newly established FIE. In the case of equity acquisition, the acquired company has the same status with respect to its debts and claims as before the acquisition. 23 For the purpose of the M&A Rules, an asset acquisition means the acquisition of the assets of domestic companies by FIEs or by foreign investors intending to set up FIEs with the assets so acquired. In the case of asset acquisition, the debts and claims stay with the domestic company instead of being transferred to the acquiring company. 24 In the case of an asset acquisition, the foreign investor cannot use the acquired assets for business purposes before an FIE vehicle is established in China. 25 Foreign investors are not allowed to operate domestic assets. Industrial Control The M&A Rules explicitly state that the foreign investor s acquisition of domestic enterprises must comply with the requirements stipulated by laws, administrative regulations and rules of China, and with policies concerning industry, land, and the environment. According to the Catalog, a merger or acquisition in an industry where a foreign investor is not allowed to operate may not result in a foreign investor holding the enterprise s entire equity. In an industry that needs Chinese participation, the Chinese party will maintain its participation in the enterprise after the enterprise in that industry is 23 M&A Rules, Article M&A Rules, Article M&A Rules, Article 23.

11 Li Jiao and Bart Kasteleijn 39 acquired. A foreign investor is not allowed to acquire any enterprise in an industry where operation by a foreign investor is forbidden. 26 The business scope of the enterprise previously invested by the merged domestic enterprise must meet the relevant requirements on foreign investment industrial policies; it will otherwise be modified accordingly. 27 Payment of Consideration In General The payment of consideration can be made in two ways. Forms of Consideration The foreign investor is allowed to make payment of consideration in the form of cash, assets, 28 and/or shares in a company listed on a stock exchange with a sound regulatory system, 29 or shares in a special purpose vehicle (SPV). 30 Under the M&A Rules, the consideration is not allowed to be notably lower than the valuation of the equity as determined by a qualified Chinese valuator. In the event that the transaction involves state-owned equity, the equity must be valued by a valuator specialized in appraising state-owned assets, and the report must be filed with or approved by SASAC. 31 Generally, the M&A Rules provide that the investor must effect payment of the consideration in full within three months from the issuance of the business license of the resulting FIE; otherwise, if approved by the relevant authorities, payment of sixty per cent of the consideration may be effected within six months and the balance within one year from the issuance of the business license of the FIE. However, the rules impose a shorter schedule on acquisitions affected by capital increase of the target. In such cases, the foreign investor must pay not less than twenty per cent of the capital increase when the target applies for a new FIE business license. 32 Pursuant to the Circular on Relevant Issues Relating to the Administration on Approval Registration, ForeignCurrency,andTaxationof 26 M&A Rules, Article M&A Rules, Article M&A Rules, Article M&A Rules, Article M&A Rules, Article 39. An SPV refers to an overseas company directly or indirectly controlled by a domestic company or a Chinese natural person to realize the interests of a domestic company actually owned by the domestic company or Chinese natural person by means of overseas listing. 31 M&A Rules, Article M&A Rules, Article 16.

12 40 Foreign Acquisitions and Joint Ventures in China Foreign Invested Companies (Circular 575), 33 in the event that the payment of consideration has not been made in full, the foreign investor will only be entitled to the profit proportionate to the percentage of its payment. In addition, the foreign investor will not be allowed to exercise its decision-making power in relation to the target company, if any, and cannot consolidate the assets of the target company into its own financial statement. 34 Commercially Impractical Payment Time Limits Under the M&A Rules, all purchase consideration must be paid to the sellers within three months. Although extensions are permitted with special approval and there is some flexibility as to the form of consideration, this creates a certain tension with commercial realities, impacting many merger and acquisition deals in China. In particular, unless ameliorated in the future implementing rules, this requirement will pose a barrier to arrangements allowing the buyer to a holdback (escrow) and to an earnout period. These payment structures are frequently utilized by buyers to help manage the risks of acquiring targets with compliance or structural problems, or targets that are dependent on key individuals for a successful transition. Share Swaps by Foreign Purchasers In General A welcome development of the M&A Rules is found in Part Four (Use of Equity as the Method of Payment in the Acquisition of a Domestic Company by a Foreign Investor), which contains detailed regulations governing share swaps between foreign purchasers or SPVs and the shareholders of the domestic target. An acquisition paid for with foreign-listed shares is only permitted, however, in the case of share deals in a merger or acquisition. Qualifications of Purchaser Pursuant to Section 1 of Part Four of the M&A Rules, a foreign company intending to use its shares as acquisition currency must: (a) be legally incorporated in a foreign jurisdiction with a well-developed system of corporate law; (b) not have been (including its management team) subjected to sanctions by the relevant authorities in the previous three years; and (c) be 33 Promulgated on 30 December 2002 by the Ministry of Foreign Economic Relations and Trade (formerly MOFTEC). 34 Circular 575, Article 6.

13 Li Jiao and Bart Kasteleijn 41 publicly listed under a mature stock transaction system from which SPVs are exempted. 35 Qualifications of Shares A foreign purchaser s shares to be used as acquisition consideration must: (a) be lawfully held by shareholders and be freely transferable; (b) have undisputed ownership and not have been pledged or subject to any third-party rights; (c) be listed on an overseas public stock exchange (but not on an over-the-counter exchange); and (d) have a transaction price that was stable during the year preceding the transaction. 36 Conditions for the Share Swap Above all, the foreign purchaser must either be an overseas company listed on a market with sound securities trading systems, or must be an offshore SPV established for the particular purpose of realizing domestic interests or assets by means of an overseas listed company. National Security Review Besides the antitrust review, the M&A Rules also incorporate the national security review. MOFCOM approval is required if a key industry is involved, acquisition of which may have an impact on national economic security or result in a transfer of actual control of a domestic enterprise that owns a well-known trade mark or historic Chinese brand name. 37 So far, there have not been any reported cases on the basis of Article 12 of the M&A Rules, but some transactions have been indefinitely delayed for unknown reasons. For example, in October 2005, the Carlyle Group signed an agreement to pay US $375 million for an eighty-five per cent stake in Xuzhou Machinery, a state-owned enterprise and China s largest construction machinery manufacturer and distributor. The transaction was filed with MOFCOM and the hearing was held in July MOFCOM refused to approve the transaction, but neither did it make a decision disapproving the transaction. Although no official opinion has been made public, newspaper reports citing unidentified sources stated that the Ministry believed a foreign investor should not hold a controlling stake in a manufacturer as important as Xuzhou 35 M&A Rules, Article M&A Rules, Article M&A Rules, Article 12.

14 42 Foreign Acquisitions and Joint Ventures in China Machinery. After the purchase details were revised several times, the transaction ended with the Carlyle Group acquiring a forty-five per cent share in Xuzhou Machinery in March Acquisition of State-Owned Enterprises The most important regulatory legislation in relation to the issues of state-owned assets in a merger and acquisition transaction are the Interim Measures for the Supervision and Administration of State-Owned Assets of the Enterprises, the Interim Measures for the Management of the Transfer of the State-Owned Property Right of Enterprises, the Interim Measures for the Administration of Valuation of State-Owned Assets of Enterprises, and the Use of Foreign Investment to Restructure State-Owned Enterprises Tentative Procedures (the Tentative Procedures). Under the Tentative Procedures, except for those areas where foreign investment is prohibited for overriding reasons such as state security or national interest, foreign investors are allowed to restructure state-owned enterprises and unlisted companies with state shareholdings (collectively known as SOEs) in most industries by way of equity or asset transfer. Scope of Application The Tentative Procedures are aimed at regulating the restructuring of SOEs and the subsequent establishment of FIEs. However, the new regulation s scope of application specifically excludes any participation in financial enterprises and listed companies. 38 Five forms of restructuring are governed by the Tentative Procedures. First, foreign investors can restructure a state-owned enterprise into an FIE by acquiring all or part of the state s interest in the enterprise. Second, foreign investors can restructure a company with state shareholdings into an FIE by acquiring all or part of the state s shareholdings. Third, domestic creditors of a state-owned enterprise can transfer the debt owed by the enterprise to foreign investors and restructure the enterprise into an FIE. 38 Tentative Procedures, Article 2.

15 Li Jiao and Bart Kasteleijn 43 Fourth, foreign investors can acquire all the assets or the major assets of a state-owned enterprise or of a company with state shareholdings. With these assets, they can establish an FIE either on their own or jointly with the seller of the assets. Finally, a state-owned enterprise or a company with state-owned shareholdings can take on foreign investors as shareholders by way of capital increase or new shares issue and become an FIE. Foreign Investors There are no minimum asset value requirements for foreign investors. However, foreign investors are generally required to contribute capital, advanced technology, and business management expertise to the SOEs. Additionally, they should be already engaged in the same or similar industries as that of the target SOE, and should have explicit medium- or long-term investment plans. Other broad qualification criteria include a sound commercial reputation, strong financial standing, and economic strength. 39 Approval Authority Approval issues remain among the first and most difficult challenges faced by foreign investors. The Tentative Procedures provide that any SOE proposing to undergo restructuring involving foreign investors must receive the necessary approvals from the government. If the new FIE resulting from a restructuring under the Tentative Procedures would have total assets in excess of US $30 million, approval authority is at the central level. 40 The Tentative Procedures are not clear as to which departments will have the final say in foreign investment issues and do not clarify whether subsequent approval of one department is conditional on the earlier approval of another department. As several government departments may have jurisdiction over various aspects of an acquisition and restructuring transaction, foreign investors may be confused as to which department should be approached first to commence the approval process. Also, it is not quite clear what role MOFCOM may play. 39 Tentative Procedures, Articles 5 and 8(4). 40 Tentative Procedures, Article 9.

16 44 Foreign Acquisitions and Joint Ventures in China Approval Procedures The Tentative Procedures provide a cumbersome and multi-stage approval procedure for restructuring a SOE into an FIE. 41 First, approval by the economic and trade department of the same level is required for the restructuring application and related documentation. This includes the feasibility study, basic information about the parties, audited accounts of the foreign investor for the preceding three years, reorganization plans, the employee arrangement plan, plan for credit and debt settlements, and the future business scope and shareholding structure of the new FIE, among other documents. Second, approval of the acquisition contract by the financial department is required. Finally, based on these two approvals, approval is required for the establishment of the FIE, followed by its business registration. The Tentative Procedures are not clear about how the various procedures interrelate for example, how MOFCOM s existing procedures for the approval of the establishment of FIEs match the procedures described in the Tentative Procedures. Payment of Consideration In general, foreign investors must pay for any acquisition in hard currency remitted from abroad. However, in line with well-established regulations and policies, those foreign investors with existing operations in China can pay in local currency if they have profits or have other legitimate assets in China. 42 The consideration will normally be settled in a single payment, which must be within three months of the date on which the newly established FIE s business license is issued. Alternatively, if there are real difficulties, 43 foreign investors can pay sixty per cent within six months and, subject to the provision of guarantees for the payment, the remaining forty per cent within one year. A foreign investor that intends to make the payment in installments must apply for approval to the SASAC that originally approved the transfer of equity in the target company Tentative Procedures, Article Tentative Procedures, Article This term is not defined under the Tentative Procedures. 44 Tentative Procedures, Article 11.

17 Acquisition of Listed Companies Li Jiao and Bart Kasteleijn 45 Circular 28 is titled Measures for the Administration of Strategic Investment in Listed Companies by Foreign Investors. Before Circular 28 was issued, only a limited number of foreign financial institutions holding a qualified foreign institutional investor (QFII) status could legally purchase tradable A shares of PRC listed companies and H shares in Hong Kong. Foreign investors not holding a QFII status could only acquire a stake in listed companies by privately purchasing non-tradable state holdings. Under Circular 28, a type of equity investment totally different from the comparatively short-term share trading under the existing QFII scheme is targeted. Furthermore, Circular 28 also subjects strategic foreign investments to much lower entry requirements and to fewer investment restrictions than the QFII requirements. For instance, Circular 28 technically allows strategic foreign investors to control a listed company, while QFIIs are not permitted to hold more than ten per cent of the issued share capital of a listed company. Legal Framework of Antitrust Review on Mergers and Acquisitions In General The AML 45 and its implementing regulations together serve as the principal guidelines on the antitrust review on acquisitions by foreign investors in China. Antimonopoly Law Covered Transactions Article 20 of the AML defines transactions (or concentrations) as: (a) a merger of undertakings (b) an undertaking s acquisition of control over another undertaking (or undertakings) by acquiring equity or assets; and (c) an undertaking s acquisition of control over, or the possibility of exercising decisive influence on, another undertaking (or undertakings) through a contract or by similar means. 45 China adopted its Antimonopoly Law at the Twenty-Ninth Meeting of the Standing Committee of the Tenth National People s Congress on 30 August The Law came into effect on 1 August 2008.

18 46 Foreign Acquisitions and Joint Ventures in China Under Article 22 of the AML, consolidations within a group are explicitly excluded when one undertaking involved owns more than fifty per cent of the voting shares or the assets of all the other undertakings, or when more than fifty per cent of the voting shares or the assets of every undertaking involved in the concentration are owned by the same undertaking, which is not a party to the concentration. Under Article 22(2), acquisition of another firm s assets or stock is achieved when the acquisition will result in attaining control of the target. The AML does not set out specific percentage levels or other factors to specify the standard of control; so far, there is no further explanation on the definition of control. Under Article 22(3), in the case of contract or means other than the acquired control, the ability to exert decisive influence also is incorporated as a standard norm. Timing of Notification According to Article 22 of the AML, the merging parties must notify the proposed merger. The closing of the transaction is prohibited if there is no notification. In accordance with the significance of the pre-merger review system, it is necessary that the closing be prohibited while the competition agency reviews the transaction for a specified period following notification. In terms of the intent of notifying parties to consummate the proposed transaction, inferred from requirements for initial notification listed by Article 23, the parties are not permitted to notify a transaction until a definitive agreement has been executed. Filings on the basis of a letter of intent, heads of agreement, or a public announcement of the intention to make a tender offer are not permitted. Substantive Standard The substantive standard in a Chinese mergerreviewisdefinedbyarticle28oftheaml:whethertheproposed concentration will result in, or may result in, the effect of eliminating or restricting market competition. Compared with the substantial lessening of competition test in the United States and the significantly impedes effective competition standard in the European Union (EU), Article 28 of the AML lacks the requirement of substantial or significant effect on competition. However, Article 28 allows the Antimonopoly Enforcement Agency (AMEA) to balance any positive effects of the concentration on competition against potential negative effects. The AMEA also

19 Li Jiao and Bart Kasteleijn 47 may decide not to prohibit the transaction for public interest reasons, which remain undefined. Article 27 of the AML lists some factors to be considered during a substantive review: (a) the market share of the undertakings involved in the relevant market and their ability to control the market; (b) the degree of market concentration in the relevant market; (c) the effect of the concentration on market entry and technological progress; (d) the effect of the concentration on consumers and other undertakings; (e) the effect of the concentration on national economic development; and (f) other factors affecting market competition, as determined by the AMEA. Article 27 appears to be inconsistent with international norms, as it permits consideration of a goal other than the protection of consumers, such as protection of domestic competitors or national economic development. Review Periods Merger transactions usually include complex legal and economic issues; competition agencies therefore need sufficient time to properly investigate and analyze these issues in order to reach a well-informed decision. On the other hand, merger transactions are often time-sensitive, and the completion of merger reviews by relevant competition agencies will normally be a closing condition for a transaction, either by operation of law or contract. Delay in the completion of merger reviews may cause the transaction to break off. Therefore, a reasonably short period for review is critical for a sound merger review regime. Under the AML, the time periods for review of a notification of concentration are stated as: thirty days for the initial review (Article 25), ninety days for a further review (Article 26), with the possibility of an extension of up to an additional sixty days beyond that ninety-day period under specific, defined conditions (Article 26). 46 These periods provide undertakings with the assurance that their proposed transaction will be approved within thirty days or in no more than 180 days. The key question is when the periods of limitation for the initial review and further review start. Based on Article 26 of the AML, the clock for a further review starts ticking on the date on which the 46 These conditions are: (i) the extended period is agreed on by the undertakings; (ii) the documents and materials submitted by the undertakings are not correct and need to be further verified; and (iii) there has been a material change in circumstances after the notification by the undertakings.

20 48 Foreign Acquisitions and Joint Ventures in China AMEA makes the decision to have a further review. When the initial review starts is less clear. According to Article 25 of the AML, it will start from the time all the documents required by Article 23 are lodged at the AMEA. Submission of additional information within the time limit provided by the AMEA is required when the filing is incomplete (Article 24). Thus, the starting point of the time limit for initial review is deemed to be the time of receipt of the additional material. Decisions As with other jurisdictions in the world, a two-phase review procedure is deployed under the AML. In fact, the PRC antimonopoly legislation has many parallels with EU law. Non-problematic transactions are allowed to proceed following a preliminary review undertaken during a brief initial review period. According to Article 25, following the preliminary review during the initial period, the AMEA will decide whether to conduct a further review. If the AMEA decides not to enter into the further review proceedings or the AMEA does not make any decision within the initial thirty-day period, the undertaking may lawfully consummate the notified transaction. Based on Article 26 and Article 29 of the AML, the AMEA can, after further review, make one of three decisions: approval, disapproval, or conditional approval. If the AMEA does not make any decisions by the time the second period expires (150 days at most), the parties may proceed with the transaction. Enforcement Agencies Under the M&A Rules, both MOFCOM and SAIC were empowered to receive and review merger control filings. Under the AML, the Antimonopoly Commission (AMC) is a policy-making and consultation body that will formulate competition policy and coordinate the enforcement activities of the AMEA. The AMEA will be primarily responsible for actual enforcement of the AML. The State Council has designated its enforcement authority to be split among three existing agencies: MOFCOM, SAIC, and NDRC. MOFCOM is the authority in charge of merger review under this framework.

21 Li Jiao and Bart Kasteleijn 49 Implementing Rules under the Antimonopoly Law In General In order to promote more uniform and predictable implementation of the law, MOFOCM has promulgated several rules under the AML, relating to various aspects of the merger review process. These rules are the Provisions of the State Council on Thresholds for Prior Notification of Undertakings (the Thresholds Provisions), the Regulations on Notifications of Concentrations of Undertakings (the Notifications Regulations), and the Regulations of Review of Concentrations of Undertakings (the Review Regulations). In addition, the AMC has formulated the Guidelines for Definition of Relevant Market (the Market Guidelines). Notification Thresholds Article 3 of the Thresholds Provisions names distinct notification thresholds. Notification is required when the combined worldwide turnover of all the undertakings involved exceeded CNY 10 billion in the last fiscal year, and the China-wide turnover of each of at least two undertakings exceeded CNY 400-million; or when the combined China-wide turnover of all undertakings involved exceeded CNY 2-billion in the last fiscal year, and the China-wide turnover of each of at least two undertakings exceeded CNY 400-million. These thresholds are consistent with international practices. The local nexus approach is used. In essence, there are two sets of thresholds: one considering the parties combined turnover (either worldwide or in China); the other considering individual turnover of at least two parties in China. Reporting is required only if both thresholds are exceeded. However, under the Notification Regulations, it is unclear whether the acquired Chinese target must be included as one of the two undertakings. Under the Notification Regulations, the turnover of a party must include the turnover of all other firms directly or indirectly controlled by that party, the turnover of all firms that directly or indirectly control that party. The entire group turnover will be counted to determine whether pre-merger notification is compulsory. However, turnover from transactions between members of the group can be excluded for these purposes. Article 7 of the Notification Regulations provides special rules for the partial acquisition of a target company by limiting the seller s turnover to that derived from the portions of its business that are the subject of the concentration.

22 50 Foreign Acquisitions and Joint Ventures in China Furthermore, the Notification Regulations contain provisions dealing with creeping acquisitions, by means of which multiple transactions made between the same group of undertakings over a two-year period, but which do not individually meet the turnover thresholds, may be considered in aggregate in assessing whether the merger notification thresholds are met. Finally, according to Article 4 of the Notification Regulations, MOFCOM has the right to investigate a merger below the turnover thresholds but in which facts and evidence collected in accordance with prescribed procedures have established that a concentration does effect, or is likely to effect, the elimination or restriction of competition. It is as yet unclear under what criteria MOFCOM will apply when exercising this power. Merger Remedies Under Article 11 of the Review Regulations, the undertakings can offer (and amend) remedies to address the anticompetitive effects identified. These remedies could be structural (such as divestitures of assets or businesses), behavioral (such as opening the infrastructure of online networks and platforms, licensing key technologies, and terminating exclusive agreements), or comprehensive, combining both structural and behavioral remedies. Furthermore, MOFCOM clarifies the time when the merging parties should propose the remedies. It is stated that an objection by MOFCOM is not a prerequisite for the proposal of remedies by the merging parties. A modification to the plan of concentration may be proposed at any time during the process of merger review. 47 Greenfield Foreign Investment Overview Before deciding on greenfield investment in China, 48 the foreign investor must first make a fundamental decision as to which form of legal entity the enterprise should have. Basically, there are four business forms available for foreign investors: WFOE, EJV, CJV, and PJV. 47 Interpretations on Regulations on Notifications of Concentration of Undertakings; Regulations of Review of Concentrations of Undertakings. 48 The definition of a greenfield investment is provided in Introduction, above.

23 Li Jiao and Bart Kasteleijn 51 Since China s entry into the WTO in 2001 and the PRC government s relaxation of FDI regulations, WFOEs have become the most common vehicle for foreign investment (other than a branch office, which has no legal personality and is not meant to be used for capital investment). However, as the PRC government requires participation or control by a Chinese company in a number of industries, foreign investors must turn to setting up joint ventures. Even if the participation of a Chinese company is not mandatory, foreign investors may still choose to enter the market through a joint venture. This is because a joint venture can benefit foreign investors when a Chinese partner has certain strengths such as central or local government support, land use rights, 49 licenses, distribution network, know-how, and access to suppliers which will reduce start-up costs and improve the foreign investor s chance of success. In transitional countries, a joint venture offers an opportunity for each party to benefit significantly from the comparative and complimentary advantages of the other. As an advantage to local partners, foreign partners can offer advanced process and product technology, management know-how, logistics, and access to export markets. It is a popular means for both sides to achieve their objectives. Compared with acquisitions, a new joint venture formed by two or more undertakings has, so far, not been deemed as a concentration of undertakings under the AML. Thus, a joint venture does not need to go through antitrust clearance. Equity Joint Venture In General In China, most joint ventures are EJVs. This section will deal with four key issues concerning this common vehicle for foreign investment. The focus is on corporate governance, which determines which party has ultimate operational control over the joint venture. 49 China has a dual land tenure system under which land ownership is independent of land use rights. Land use rights are the rights for natural or legal persons to use land for a long, fixed period of time, comparable to long-term lease rights in many jurisdictions. The land is owned either by the state or by a rural collective economic organization.