In 1993, as Russian oligarchs snapped up valuable state assets at a discount, China’s legislators set out to draft laws to guard against the same happening in the PRC. Fifteen years and multiple redrafts on, the Enterprise State Assets Law (the “Law”) was passed on October 28 this year and is due to become effective on May 1 2009.
The Law sets out a comprehensive framework for the treatment and preservation of “State-Owned Assets”, defined widely as “the rights and interests derived by the state from its investment in various forms in any enterprise”, and extending to cover “State- Invested Enterprises”, i.e. enterprises owned or invested by the state. The Law also contains an array of regulations and punishments aimed at those managers of State- Owned Assets who may be tempted to exceed their powers or abuse their position for personal enrichment. However, while its purpose is more to preserve assets’ value than to prevent their sale, Article 72 of the Law raises serious issues for acquisitions involving State-Owned Assets or State-Invested Enterprises.
Article 72 applies to transfers of State-Owned Assets, and to other transactions that involve related persons of a State-Invested Enterprise. It provides that “malicious collusion” (a concept without a fixed definition) in such a transaction would render the transaction invalid if State-Owned Assets are harmed as a result. Although the prohibition of “malicious collusion” already exists under PRC contract law, its inclusion in the Law underlines the government’s determination to use all available measures to preserve the value of State-Owned Assets.
In order to minimize the risk that transactions involving State-Invested Enterprises or State-Owned Assets may be cancelled due to “malicious collusion”, we suggest that parties:
- Be transparent in all discussions and negotiations, and keep a full and contemporaneous record that can be produced as evidence;
- Ensure the valuation of any State-Owned Assets being acquired will stand up to close scrutiny by regulators; and
- Conduct thorough due diligence into onshore sellers and management, and consider the benefits that may flow through to management or their family, directly or indirectly, at the expense of benefits to the State.
Legislators have informally acknowledged that Article 72 creates uncertainty, and further guidance may eventually be forthcoming. Until then, once the Law becomes effective, caution must be exercised in such transactions.