On February 12, 2011, the State Council of the People’s Republic of China issued a notice announcing the establishment of a Ministerial Panel to review proposed foreign mergers and acquisitions ("M&A") involving local companies that could give rise to PRC national security concerns. The Notice lays the ground for China’s first formal national security scrutiny procedure, a review process similar to those performed by the Committee for Foreign Investment in the United States ("CFIUS") and Australia’s Foreign Investment Review Board.
China’s new M&A security review will focus on foreign investments in the following broad areas:
- Domestic military industrial enterprises or military-related ancillary enterprises; enterprises located near key or sensitive military facilities; and other entities related to national defense; and
- M&As involving domestic enterprises in key industry areas, such as agricultural products, energy and resources; those involving basic infrastructure, transportation services, technology, and equipment manufacturing; and those involving situations where a foreign investor could acquire actual control of a domestic enterprise.
The Notice lists four types of foreign M&A transaction structures that could come under scrutiny:
- A foreign investor purchases the equity of a non-foreign-invested enterprise, or subscribes for the capital increase of a non-foreign-invested enterprise, thereby transforming the target into a foreign-invested enterprise (“FIE”).
- A foreign investor purchases equity held by Chinese shareholders in an FIE, or subscribes for the capital increase of an FIE.
- A foreign investor establishes an FIE, purchases the assets of a domestic enterprise through such FIE, and operates those purchased assets, or purchases the equity of a domestic enterprise through the FIE subsidiary.
- A foreign investor directly purchases the assets of a domestic enterprise and uses the purchased assets to invest in a newly established FIE in order to operate such assets.
The Notice contemplates that actual control of a domestic target could be achieved by foreign investor(s) in an M&A scenario in a number of ways, including:
- A foreign investor or its parent company or subsidiary holds 50% or more of the total equity interest in the target company;
- More than one foreign investor holds an aggregate of 50% or more of the total equity interest in the target company;
- A foreign investor holds less than 50% equity interest in the target company, but possesses sufficient voting rights to materially impact the decision-making of the target company’s shareholders or its board of directors; or
- Foreign investor(s) acquire de facto control of the target company’s business decision-making, finance, human resources, and technologies by other means.
The Ministerial Panel will be established under the leadership of the State Council. The National Development and Reform Commission ("NDRC") and the Ministry of Commerce ("MOFCOM") will take the lead in conducting M&A security reviews and coordinating with relevant governmental authorities, depending on the industries and sectors involved.
According to the Notice, in assessing a transaction’s national security impact, reviewers will consider the effect of the proposed deal on (i) national defense, including defense-related domestic product manufacturing capability, domestic service provision capability, facilities and equipment; (ii) the nation’s economic stability; (iii) "society’s basic order of life"; and (iv) research and development capability for national security-related key technologies.
An M&A security review will be initiated when a foreign investor voluntarily file(s) an application with MOFCOM or when another stakeholder (including relevant authorities under the State Council, nationwide trade associations, and companies in the same trade or upstream and downstream sectors of the target company) files an application.
The Notice sets forth procedures and timing for the review. The Ministerial Panel will conduct an initial general review and will proceed to a special review if the proposed transaction fails to pass the first stage. The entire review process will take from 35 to 95 working days, depending on the number of procedural steps required. During this process, the applicant can apply to MOFCOM to amend the original transaction plan or cancel the proposed transaction.
In order to eliminate any potential negative influence of the proposed M&A on national security, the Ministerial Panel can require MOFCOM, in conjunction with other relevant departments, to order the cessation of the transaction, or to take measures such as a transfer of relevant equity or assets.
The new rules will not apply to foreign M&As of domestic financial institutions which are subject to separate regulations that are yet to be issued. If a foreign M&A involves a change to the equity of a State-owned enterprise, the relevant provisions governing State assets will apply.