Cross-Border M&A and Protectionism –
A Review of Laws and Practice in China

Daniel He, JunHe LLP

1. The New PRC Foreign Investment Law

On March 15, 2019, the National People’s Congress of the People’s Republic of China (“PRC” or “China”) approved the PRC Foreign Investment Law (“FIL”) which will be implemented on January 1, 2020.

The main objectives of the FIL are to “open up and actively promote foreign investment; the healthy development of the socialist market economy; protect the legitimate rights and interests of foreign investment; and regulate foreign investment management”.  Within that context the FIL will reshape the regulatory regime that has governed foreign investment in the PRC since the 80s and form a new framework for foreign investment in the PRC.  It will not, however, completely remove certain core elements of the existing limitations imposed on foreign ownership.

The FIL will apply in the PRC to any foreign investor that:

1. Establishes a foreign-invested enterprise, either independently or jointly with any other investor;
2. Acquires shares, equities, property shares or any other similar rights and interests;
3. Makes an investment to initiate a new project, independently or jointly, with any other investor; and
4. Makes an investment in any other way stipulated by the laws, administrative regulations or provisions of the State Council.

The FIL will have a limited impact, if any, on wholly foreign-owned enterprises.  This is because they have previously applied the Law of the PRC on wholly foreign-owned enterprises, which to a large extent is in line with PRC Company Law.  The biggest impact will be on Chinese-foreign equity joint ventures.  In addition to the change of corporate governance structure through amendments of the joint venture contract and articles of association, it is possible for the parties to take advantage of this opportunity to propose to revisit additional terms that may have been agreed many years before.  In other words, the FIL may open the door for the re-negotiation of joint venture contracts and articles of association.  In the event that a Chinese partner proposes amendments to a joint venture contract and the articles of association in addition to those required by the FIL, such a situation should be carefully addressed with appropriate legal advice.

The FIL provides for a five-year transition period, during which these joint ventures may continue to retain their existing organizational form, corporate structure and bylaws/articles of association.  It is our expectation that the five-year transitional period will allow joint venture parties to revise the existing joint venture contracts and articles of association and to go through the relevant approval (if required) and filing procedures.  If the transition period expires while the parties still have not reached agreement or have not gone through the relevant approval or filing procedures, the consequences thereof are not yet stipulated in the FIL and are expected to be addressed in the implementing regulations to be released by the State Council.

Pre-market access national treatment plus negative list is the core of the FIL.  There is a national negative list.  The 2019 version of the national negative list, which came into effect on July 30, 2019, includes 40 industries which are either “restricted” or “prohibited” for foreign investment purposes, and this list is much shorter than the previous versions of the Guiding Catalogs of Industries for Foreign Investment.  In addition, certain free trade zones adopt their own negative lists which may differ from the national one and are generally less restrictive than the national one.  Under this system, the state shall treat foreign investors in a way which is no less favorable than that given to their domestic counterparts in the pre-market access stage, except for certain industries stipulated in the applicable negative list (which is expected to be amended from time to time), and foreign investments (including green field investments and acquisitions) are no longer subject to Chinese government approval unless the industry is on the negative list.

2. Impact of the M&A Rules

Under the FIL, the acquisition by a foreign investor of a Chinese domestic company is no longer subject to Chinese government approval, unless the business of the target company falls onto the applicable negative list.  This represents a major progression.  However, as an overview, the legal regime governing cross-border acquisitions in China remains complicated and restrictive.  Foreign investors still have to overcome restrictions under The Regulations on Mergers with or Acquisitions of Chinese Domestic Companies by Foreign Investors (as amended and restated in 2009, the “M&A Rules”), the primary legislation governing acquisitions of Chinese companies by foreign investors, which remains effective and has existed for 10 years.

Generally, the acquisition of Chinese companies by foreign investors is subject to the M&A Rules, which requires, among other things, that:

1. the acquisition must be approved by the local counterpart of the Ministry of Commerce (MOFCOM), to the extent the target company’s business falls onto the negative list;
2. the purchase price must be determined based on the valuation of the target by a Chinese appraisal firm;
3. the form of consideration is limited to cash only (i.e., the seller cannot be paid in the form of buyer’s stock or other equity interest);
4. the payment must be paid within three months after the closing (or a maximum of one year in special cases); and
5. as a matter of practice, the purchase price has to be a fixed amount, and price adjustment or earn-out is not feasible due to foreign exchange controls.

3. Merger Control Filing under PRC Anti-Monopoly Laws

Under the PRC Anti-Monopoly Laws (“AML”) enacted in 2008, where the acquisition triggers a change of control and the combined and respective global or Chinese turnover of the parties exceeds certain filing thresholds (which are relatively low and have not been updated since 2008), the deal must be filed with the State Administration for Market Regulation (“SAMR”) and the completion of the transaction must be conditional upon clearance from SAMR (with or without remedy).

The procedure for an anti-trust review by SAMR can be categorized into simple case procedure and normal procedure.  The total timeline required for a filing under a simple case procedure is about two to three months after the submission of application, while the timeline required for a filing under normal case procedures will range from four to 10 months, depending at which phase of the filing the process will be completed.  A typical merger control filing process under normal case procedures will include the time required for: (i) preparing the filing report; (ii) pre-review before official acceptance by MOFCOM; and (iii) MOFCOM’s official review process.  It is worth noting that only step (iii) is subject to a statutory time limit provided under the AML, and in practice it may take longer than expected to collect the comprehensive information to produce a report acceptable to SAMR.

Even if the timeline under the simple case procedure is significantly shorter, it is not always a desirable choice.  This is because a summary of a simple case will, after acceptance by MOFCOM of the application, be published on the website of the Anti-Monopoly Bureau of SAMR (http://fldj.mofcom.gov.cn) for 10 days, with certain information disclosed, including, among other things the name of the transaction, an overview, a simple introduction of the parties participating in the concentration, and the reason for applying for the simple case review.  During these 10 days, any third party is permitted to comment on whether the case should be eligible for a simple case review.  If there are no comments from a third party or the comments do not affect the qualitative determination that it is a simple case, the case will be further processed for a simple case review, and it is likely that clearance will be granted by MOFCOM within Phase I (maximum 30 days) or in the early stage of Phase II (maximum 90 days).  If any third party raises sufficient evidence showing that the case should not be eligible for a simple case review, or MOFCOM finds such ineligibility during the review process, MOFCOM may revoke the simple case determination and require it be re-filed for a non-simple case review.  In our practice, we would be prudent in recommending simple case procedure especially for high-profile transactions which are more likely to be subject to challenges from third parties such as competitors and industrial associations.

In 2018, 444 filings were unconditionally cleared, four were conditionally cleared and none were prohibited.  Qualcomm/NXP was aborted by the parties to the concentration pending an outcome of notification.  Among the transactions conditionally cleared, the SAMR imposed structural and behavioral remedies on Bayer/Monsanto, Linde/Praxair, UTC/Rockwell Collins, and behavioral remedies on Essilor/Luxottica.  The Qualcomm/NXP transaction was noteworthy.  It was reported that, “Earlier this year, Mr. Trump blocked Broadcom’s $142bn hostile bid for rival chip company Qualcomm. China retaliated by suffocating Qualcomm’s $44bn acquisition of Dutch-owned NXP. Tensions between the two countries thawed ahead of the G20 truce, with China signing off on a number of deals, including Walt Disney’s $85bn takeover of 21st Century Fox and United Technologies’ $30bn Rockwell Collins deal.”[1]

In 2019, only two transactions were cleared with conditions imposed and there have been no blocked cases this year.

According to the latest press release issued by SAMR[2], as of August 30, 2019, SAMR (including formerly MOFCOM) has completed the review of 2,792 cases, among which, 41 cases (approximately 1.47%) were passed with conditions, and only two cases (approximately 0.07%) were blocked.

In light of the foregoing, foreign investors should be generally optimistic about their chances to obtain clearance for merger control filings, but they should also be prepared for undergoing the filing process, which may be time-consuming.

4. National Security Review

There is a national security review system for foreign investment, and for any foreign investment affecting or having the possibility of affecting national security.

Since early 2011, the acquisition of Chinese companies by foreign investors has been subject to a national security review, if the industry of the target is military-related or involves potential national security concerns such as significant agricultural products, significant energy or natural resources, significant infrastructure and transportation services, key technologies and the manufacturing of material equipment.

There is no clear-cut definition or clarification of the terms “significant”, “key technology” and “sensitive”, and there is no published list of specific industries which are covered in the scope of a national security review.  In practice, the government retains significant discretion as to whether a national security review is required for a particular transaction.  If the target’s industry falls within a grey area and the parties decide not to undergo the review, there is always a risk that the deal may not be closed, or if closed, may be required to unwind.  The enforcement of a national security review is still not well tested — the timeline is difficult to manage, the process is not fully transparent, the number of precedents remains very limited, and the result of the review does not need to be publicized.

Nevertheless, there was a landmark case in 2019, which is still ongoing.  It was reported that the National Development and Reform Commission (“NDRC”) asked Yonghui Superstores (a major player in China’s retail sector), to file for a foreign investment security review and to submit supplementary documents in connection with its proposed acquisition of additional shares to raise its stake from 29.86% to a maximum 40% (less than a majority) in Zhongbai Group – a local state-invested retailer, after the transaction has obtained clearance of a merger control filing.  Hong Kong perennial Jardine Matheson, the sprawling British conglomerate, holds a roughly 20% stake in the majority Chinese-owned Yonghui Superstores through its subsidiary Dairy Farm International.  As far as we know, this is the first time NDRC has required a national security review for this type of investment, especially where Yonghui Superstores had clarified in a statement announcing the goal of the tender offer was not to seek control.  The market was surprised to see a transaction in the retail industry being considered as triggering national security issues and some people worried that this was a step towards China closing the door on opening-up.

5. Acquisition of Equity or Assets from an SOE

The acquisition of equity or assets from a state-owned enterprise (“SOE”) is generally difficult and complicated.  In China, selling equity or assets held by an SOE is subject to statutory listing procedures – i.e., the transfer needs to be conducted through an open bidding process at an equity/asset exchange.  In addition, the equity in question must be appraised by a qualified appraiser and the sale must be approved by the State-owned Assets Supervision and Administration Commission (“SASAC”).  These requirements create a huge degree of uncertainty as to the outcome of any proposed acquisition of equity or assets held by an SOE.

The purpose of the law requiring the sale of state-owned assets through a bidding/auction process is to maximize the value of the equity or assets being sold.  The SOE’s position is to sell the equity or assets for the highest price, regardless of who the buyer is, which means that even if the SOE has a foreign investor as a preferred buyer, they are not able to enter into a purchase agreement directly.  In practice, any measures intended to impose restrictions on such a bidding/auction process will be considered contradictory to the aforesaid purposes, and according to our experience in dealing with SOEs they usually have a strong push back when the counterparty wants to impose such restrictions in the contract or otherwise.  In addition, the representatives negotiating the contract on behalf of the SOE will be concerned about their personal liabilities (including any internal disciplinary actions) if they feel that they may be challenged for failing to achieve the terms that can fulfill the said purposes.  As such, generally speaking it would be difficult to address the protective measures desired by the foreign investor.

6. Other Observations

6.1 – Longer timeline

One of the most critical challenges when acquiring in China is to manage the timeline. Many Chinese sellers and targets are not sophisticated when it comes to completing an acquisition.  It may take a few months to negotiate an international standard purchase agreement in dual languages, and several more months to obtain regulatory clearance.  We hear complaints that international buyers may have to “educate” a Chinese seller before they can talk on the same page, and Chinese regulatory clearance becomes the mitigating factor on some global deals and in such cases the parties have had to close the China part of the transaction separately after closing the global deal.

6.2 – Language Barriers

Other than the contracts which need to be approved by or registered with the PRC authorities, most contracts with foreign parties do not have to be written or translated into Chinese.  Nonetheless, SOEs with a strong economic position and bargaining power increasingly request that contracts are executed in the Chinese language or in bilingual versions which are equally effective, and in some cases, SOEs require that the Chinese version be the prevailing version in the case of conflict or discrepancy.  In these circumstances, full consistency between the two language versions is critically important.

Language issues can result in negotiating delays if the Chinese and English versions of the transaction documents have to be reconciled after each round of negotiations.  It would be even worse if inconsistencies are not discovered prior to signing, which may result in potentially adverse misunderstandings or disputes that lead to arbitration or litigation between the parties.  For this reason, it is essential to make adequate allowances for a thorough translation process in the transaction timetable, using qualified legal translation professionals.

6.3 – Local Expertise

Acquisition by its very nature is a high-risk business activity, and becomes more challenging for foreign investors that do not have much experience in China. Foreign investors should envisage the challenges and pitfalls of acquisitions in China in advance, and address the issues proactively. Ambitious investors who rely too much on their own intuition and experience in other jurisdictions are often frustrated by the unique business and regulatory environment in China and find it onerous to sign and close a transaction.  We recommend that foreign investors do their homework with patience and caution before making decisions, and engage experts with appropriate local experience and expertise to provide practical advice and guidance.

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[1] https://www.ft.com/content/8ee1cbde-f816-11e8-af46-2022a0b02a6c

[2] http://www.samr.gov.cn/xw/xwfbt/201908/t20190830_306428.html