During the early parts of China’s transition to a modern economy, the underperforming State Owned Enterprises (“SOEs”) were market liabilities. In the course of opening up to the West and joining the WTO, China overcame its fear of foreign acquisitions of these SOEs; now, the Chinese government realizes that properly monitored and regulated Mergers and Acquisitions (“M&A”) of State owned assets are important to China’s development plans.
Today, the Chinese government sees M&A activities as a way to drive foreign investments, better manage underperforming assets, induce continued growth, and reduce unemployment rates. Since China’s initial adoption of regulations and guidance on the M&A process, China remains one of the prime targets for market entry; foreign companies continue to pursue acquisition of equity interest in the fastest growing economy despite analysts’ reservations; and sectors of the Chinese industries remain off limits to M&A activities while others are strongly encouraged by the government for strategic reasons.
The sectors that are seeing increased activity in the Chinese M&A arena are the financing and insurance services industry, food and beverage industry, and manufacturing industry. The automobile and aviation sectors are of particular interest to China’s strategic development in the next decades. Some notable recent M&A deals include: Nestle’s $1.7 billion acquisition of Hsu Fu Chi (a Chinese sweets company), Chow Tai Fook Nominee Limited’s $2.5 billion acquisition of a 3.4% stake in Ping An Insurances Group of China, Goldman Sachs’s acquisition of a 12.02% stake in Taikang Life Insurance Co., and France’s automotive manufacturer Valeo’s acquisition of 80% of China’s Chery Group.
The Chinese Foreign M&A Regulations Regarding Foreign Investor’s Merger with or Acquisition of Domestic Enterprises (“Foreign M&A Regulations”) was jointly issued in 2003 by the Ministry of Foreign Trade, the Ministry of Commerce, the State Taxation General Office, the State Administration of Industry and Commerce, and the State Administration of Foreign Exchange.
In terms of acquisition, the rules allow a foreign investor to acquire equity interests in a domestic company, purchase outstanding equity of shareholders in a domestic company, or subscribe to newly-issued shares of a domestic company. If foreign shareholding in a domestic company is greater than 25%, the new entity is classified as a Foreign Invested Enterprise (“FIE”). Indirect acquisition is possible through an off-shore purchase of some or all of the shares of a Chinese target company’s foreign parent(s). The off-shore jurisdictions commonly used for holding Chinese companies are Hong Kong, the Cayman Islands, and the British Virgin Islands. Asset acquisitions are more complicated and more risky because a new FIE will have to be set up; injection of capital may trigger currency exchange control issues; transfer of land or intellectual property may trigger government approval; and titles to assets are difficult to obtain at times. There are also environmental concerns in asset acquisitions given China’s recent tightening of its Environmental Protection Laws. Documents required for the approval process include (but are not limited to):
- Unanimous resolution passed by shareholders of the domestic company with respect to share transfers to foreign investors or resolution passed at a general meeting of the domestic company limited by shares with respect to share transfers to foreign investors;
- Application for reestablishment of the domestic company as a foreign investment enterprise upon the merger and acquisition;
- Contract and articles of association of the FIE established upon the merger and acquisition;
- Agreement on transfers of shares in the domestic company to foreign investors or acquisition of increased capital of the domestic company by foreign investors, (there are mandatory language provisions required under the Foreign M&A Regulations for these agreements);
- The latest financial audits of the domestic company;
- Identification documents or business certificates and credit certificates of the investors;
- Description of invested enterprises of the domestic company;
- Duplicate business licenses of the domestic company and its invested enterprises;
- Employee redeployment plan of the domestic company; and
- Other documents as required by the Foreign M&A Regulations such as land-use rights documents, agreement concerning creditor rights, public notices, market reports, etc.;
- (All documents are to be submitted in the Chinese language).
In terms of mergers, under the FIE Merger/Division Regulations, there are two means of merger: merger by absorption, where the absorbed company is dissolved, and merger by new establishment, where both premerger companies are dissolved. In either case, the dissolved company does not need to go through formal liquidation procedures. All assets, liabilities, and shareholders’ interests will be carried forward in the merger. The shareholders and creditors of the original companies will become the shareholders and creditors of the postmerger company and all debts and liabilities are assumed by the postmerger company. Careful due diligence by both parties is required not only in the financials of the premerger companies but also in the compliance of environmental laws and any anti-foreign corrupt practice laws applicable. Documents required for the approval process include (but are not limited to):
- Application statement on the company merger signed by legal representatives of all merging companies;
- Agreement for the company merger;
- Resolutions of the board of directors of the merging companies regarding the merger;
- Merger agreement and Articles of Association of all merging companies (requiring mandatory language set forth by FIE Merger/Division Regulations);
- Approval documents and copies of business licenses of all merging companies;
- Capital verification reports of all merging companies;
- Balance sheets and property inventories of all merging companies;
- Most recent audit reports of all merging companies;
- List of creditors of all merging companies;
- Company contract and Article of Association of the merged company;
- List of members of the board of directors of the merged company; and
- Other documents as required by law.
Given China’s relative immature capital market, cash is still the preferred consideration. The China banking Regulatory Commission recently (2008) issued guidance on the Issuance of Acquisition Loans by Commercial Banks (Circular 84); Chinese commercial banks now are allowed to provide loans for acquisitions.
The 2011 Catalogue for Guiding Foreign Investment provides guidance on what industrial areas are encouraged for M&A activities and what areas are restricted to foreign investors. Potential FIEs should also take note of the new (2008) Anti-Monopoly Law that requires mandatory review when threshold is triggered. The Chinese Ministry of Commerce is responsible for reviewing M&A activities under applicable Anti-Monopoly Law as well as potential national economic security concerns. Provincial authorities may also issue their own rules regarding M&A activities and careful review of the national and local laws is necessary before considering any M&A transactions.
There are many other concerns in considering M&A deals in China. Because the concept of due diligence is relatively new, many of the target companies in China may not have adequate records for review. The Chinese regulations are often vague and ambiguous giving authority room to wiggle; valuation of assets is often difficult; various approval agencies are difficult to coordinate in a determinable timeframe. Foreign participants in M&A deals should expect paying premium in terms of time and efforts required by both Chinese local legal counsel and firms with expertise in dealing with the Chinese legal system. Flexibility, patience, and trust in competent legal representations are necessary in any successful M&A deal in China. The rewards are incredible.