When the world experiences a global economic downturn, the pace of foreign investment and capital into China inevitably slows down. In order to attract foreign investment and maintain the growth of China's economy, the Chinese government has relaxed its M&A regulations, delegated more approval powers to local governments, allowed banks to extend loans to finance M&A and developed guidelines and practices for its antitrust law. These developments in Chinese M&A law may be encouraging to foreign investors, but careful deal planning will be very important.
Relaxations Of The Approval Requirements On Round-Tripping Investments Under Decree No. 10
The major Chinese law governing M&A by foreign investors is the Administrative Measures Regarding M&As by Foreign Investors of Chinese Enterprises ("Decree No. 10"), which took effect on September 8, 2006. Decree No. 10 is well-known for imposing extreme stringent requirements on M&A in China on the one hand and its intentionally vague and open-ended language on the other hand. Among the most famous examples in this regard are the requirements of Article 11, which requires that if a mainland Chinese resident or enterprise incorporates or controls an offshore company and the offshore company plans to merge into or acquire an affiliated enterprise in mainland China, such merger or acquisition must be approved by the Ministry of Commerce ("MOFCOM") at the central government level, and "such approval requirement shall not be evaded in any means." In reality, MOFCOM has not granted any approval in this regard since Decree No. 10 became effective on September 8, 2006. Consequently, this requirement put the brakes on a lot of M&A deals, especially those private-equity-backed deals where private equity investors make their investment in the Chinese target company via an offshore joint venture company together with the Chinese owners of the Chinese target company and use the offshore joint venture to acquire either the equity ownership or assets of the Chinese target company (these deals are often deemed as "round-tripping investment").
Another example is that Article 55 of Decree No. 10 requires that if a foreign investor acquires the equity ownership of a foreign-invested enterprise ("FIE") in China, "in addition to other applicable Chinese regulations, the provisions of Decree No. 10 will apply by reference." But MOFCOM never clarified in any publicly available and applicable documents the meaning of "by reference" in this context. As the other Chinese regulations regarding change of shareholders of FIEs set forth much less stringent requirements (e.g., no specific requirement regarding round-tripping investment, no requirement of asset evaluation), it is unclear to what extent the stringent requirements in Decree No. 10 will be applicable to change of shareholders of FIEs, which may include enterprises previously owned by Chinese entrepreneurs and later restructured to FIEs if the entrepreneurs immigrate to other countries or transfer their shares in their Chinese enterprises to affiliated offshore companies.
In December 2008, MOFCOM issued the 2008 Guiding Manual of Administration of Foreign Investment and Market Entry (the "Guiding Manual"). The Guiding Manual clarifies certain issues regarding the application of Decree No. 10 as follows:
1. if a Chinese shareholder of an existing FIE transfers its equity ownership to a foreign investor, such share transfer is not subject to the application of Decree No. 10, regardless of whether such Chinese shareholder is affiliated with the foreign investor; and
2. regarding the approvals by MOFCOM as required for the "round-tripping investments" by Article 11 of Decree No. 10, at this stage MOFCOM will review and decide if it will grant its approval only when the offshore company is a publicly listed company, or its incorporation has been duly approved and it has been in operation and will use profits generated by its operation to carry out the "round-tripping investment."
Theoretically, the Guiding Manual relaxed the provisions of Article 55 of Decree No. 10 by dropping the requirement to obtain the central government's approval for a share transfer from a Chinese shareholder of an existing FIE to a foreign investor, even if the transferee and the transferor are affiliates. Furthermore, while the requirement of Article 11 of Decree No. 10 has been reiterated and MOFCOM for the first time states that it will only approve a round-tripping investment where the offshore company is either a publicly listed company or it has been in operation and will use its profits to invest into China, with the relevant provisions of the Guiding Manual, a round-tripping investment now becomes practically feasible where a Chinese company acquires an offshore company for doing substantive business (e.g., Lenovo set up an offshore company for acquiring IBM's PC business) and such offshore company will be able to generate profits for making investment in China, or where the offshore joint venture has become listed (e.g., in a reverse merger deal, or where a listed offshore company intends to acquire new target companies in China).
Further to the Guiding Manual, in March 2009 MOFCOM issued the Notice on Further Improving the Examination and Approval of Foreign Investment , which explicitly provides that when a foreign investor merges with or acquires a Chinese domestic company, depending upon the acquisition price and the business sector in which the post-acquisition company will engage, no central level MOFCOM approval is required and local MOFCOM approval will be sufficient. Specifically, for the following mergers with and acquisitions of Chinese domestic companies by foreign investors, local MOFCOM approval will be sufficient: if the acquisition price does not exceed US$100 million and the post-acquisition company will engage in the business listed in the "encouraged" or "permitted" category in the PRC Catalogue Guiding Foreign Investment in Industries; or if the acquisition price does not exceed US$50 million and the post-acquisition company will engage in the business listed in the "restricted" category in the PRC Catalogue Guiding Foreign Investment in Industries.
New Regulation On Loans To Finance Mergers And Acquisitions
The long-term prohibition under the Chinese General Principles of Loans of using loans to finance M&A transactions was eventually broken by the Guidelines of Managing Risks Related to M&A Loans Extended by Commercial Banks (the "M&A Loan Regulation") issued by the China Banking Regulatory Commission on December 6, 2008. The M&A Loan Regulation explicitly provides that loans extended under this regulation will be used to pay the price of M&A transactions, including cross-border M&A, and the "M&A transactions" refer to transactions where an enterprise established in China will, by purchase of existing equity interests, subscription of additionally issued capital, acquisition of assets or assumption of debts, acquire or obtain actual control of established enterprise(s) whose business operations are ongoing.
Apparently, this regulation aims to facilitate and will actually help the growth and expansion of Chinese enterprises through M&A in today's economic situation. But, during the first several months after this regulation came into effect such loans were extended only to big state-owned enterprises, not to small enterprises, private companies or FIEs. This may be because Chinese commercial banks lack experience in business evaluation and risk management in relation to extending M&A loans and they are extremely prudent at the very beginning. As their experience grows, Chinese commercial banks should consider extending loans to other types of enterprises, including FIEs, to finance the latter's M&A transactions.
Specification Of The Merger-Control Antitrust Law
Since the Anti-Monopoly Law ("AML") became effective on August 1, 2008, MOFCOM has received 40 filings, of which 23 deals were approved without any restrictions, one deal (the InBev merger with Anheuser Busch) was approved with conditions, and one deal (the Coca-Cola Huiyuan deal) was prohibited. At the same time, the State Council and MOFCOM issued a number of regulations and guidelines regarding the thresholds triggering antitrust review, the documents to be filed, the review procedures, and the pre-filing consultation mechanism between the parties and MOFCOM, etc., and published drafts of six detailed rules to seek public comments and suggestions in order to specify the provisions of the AML.
Under the Chinese antitrust regime, the pre-merger antitrust review is mandatory if the world-wide or China-wide combined turnover of all of the parties to the concentration and the Chinese turnover of two parties to the concentration hit certain thresholds, even if the relevant parties are not Chinese entities; otherwise, the concerned transaction will not become effective in China.
By law MOFCOM can have two phases of review of a filing, which will add up to a maximum of 180 days. The InBev-Anheuser-Busch and the Coca-Cola Huiyuan cases indicate that the clock for MOFCOM to start its review that is subject to the 180-day constraint will not start running "if the filing documents are not complete" from MOFCOM's perspective (in the InBev-Anheuser-Busch case, it took the parties more than 7 weeks to make their application acceptable to MOFCOM, and in the Coca-Cola Huiyuan case, it took 2 months, during which Coca-Cola provided supplemental documents four times). "The impact of the concentration of business operators on the development of the national economy" is one of the angles from which MOFCOM will look at a concerned deal in terms of its antitrust review.
While the decision on the Coca-Cola Huiyuan deal may be disputable under U.S. antitrust standards and theories, we should note the positive indications in the review process of this deal, as MOFCOM followed the timeline provided in the AML, conducted comprehensive investigations and hearings of relevant parties (including suppliers, distributors, consumers, business associations, and other government agencies), and had a number of negotiations with Coca-Cola to try to reach a compromise.
In addition to the above-mentioned developments in Chinese law on foreign investment in the M&A area, there are other relaxations, which include MOFCOM's further delegation of its approval authorities on the establishment of FIEs to its local counterparts. While China's economy will still grow at a comparatively high pace and China remains one of the best choices for investors, these recent relaxations of and developments in the relevant Chinese law should facilitate foreign investment in China in today's economy.
Janet Jie Tang is a Partner and Ning Lu is Counsel at Akin Gump Strauss Hauer & Feld LLP in Beijing. They advise U.S. and western European clients on business transactions in China, including foreign direct investment, mergers and acquisitions, cross-border commercial transactions, and pre-merger antitrust filings.