China requires mandatory notification of mergers that meet certain thresholds. This notification duty is coupled with a standstill obligation, that is an obligation not to put a merger into effect until it is approved. Violation of the obligation to notify a merger and of the standstill obligations are commonly called gun-jumping and can subject to severe legal consequences. Business sometimes still have big incentives to partly or fully implement the merger before approval, even being aware of those negative effects of being penalized. Especially when there is no detailed provision about what amount to gun jumping, it creates incentives for businesses to test the limits of gun jumping prohibitions and circumvent standstill rules. Through explaining the Canon/Toshiba Medical case, this article introduces the legal consequences of Gun-jumping in China and exemplify the risks of implementing the transaction by steps with the view to circumvent the standstill rules. Lastly, recent tendency of strengthened enforcement observed is briefly noted.
- Legal Consequences of Gun-Jumping
To be specific, gun-jumper faces three types of punishments in China. Firstly, it is monetary punishment, which is the fine of no more than 500,000 RMB, roughly 70,000 US dollars. Can such tiny amount of fine produce deterring effects? In reality, there indeed had been a lot of voices in China advocating to lift the statute fine level for gun-jumping. The Anti-monopoly Law is in the process of modification right now, and whether the statute fine amount will be changed deserves further observation.
The second type of potential punishment is behavioral, including divestitures or dissolution of the unlawful concentration, such as transfer of shares or assets, or adopting other measures to return to status before the concentration. Although this punishment sounds terrifying, they have not been used yet by Chinese authorities so far, because it is only applied for concentrations with the serious competition concerns, and such cases after all are in the very minority.
The third type of punishment is reputational, which means that SAMR will publish every penalty decision on its official website. This practice started since May of 2014, and indeed impelled a larger number of merger filings since then.
In spite that the statue fine level is low, penalties on gun-jumping do have a few spill-over negative influences on companies that could produce some deterring effects. For instance, if the merging parties filed the notification but partly or fully implemented the merger during the waiting period, and during that period SAMR initiated an investigation, then the merger review procedure will be slowed down because of the parallel time-consuming investigation procedure. In addition, since the penalty will be released, company reputation will be more or less damaged. If the penalized company is a listed company, its stock prices may react negatively. Even for unlisted companies, such penalty may also affect their future financing.
II. Canon/Toshiba Medical Case: Transaction by Steps Being Found Gun-Jumping
In China, there had been three precedents where the merging parties deliberately designed the transaction by steps and implemented a few steps before the approval, but unfortunately were still found as gun-jumping. They are the acquisition of Toshiba Medical by Canon, the acquisition of CiMing Health Checkup by Meinian Da Jiankang; and the acquisition of Tokuyama Malaysia by South Korea OCI. In the following, the Canon/Toshiba Medical case is illustrated as an example in detail, to help the reader’s better understanding of China’s approach on gun-jumping enforcement.
In order to solve financial difficulties, Toshiba intended to sell its 100% equity shares in Toshiba Medical. On March 9, 2016, Canon obtained the exclusive right to negotiate this transaction. The relevant parties made the following pre-transaction preparations: On March 8, three natural persons established a special purpose vehicle call company “M”. One week later, Toshiba converted all the issued ordinary shares of Toshiba Medical into three types of shares: (i) 20 shares with voting right, called A-type Shares; (ii) 1 share without voting right, called B-type Shares; and (iii) 100 warrants, with the option to purchase ordinary shares.
On March 17, the SPV, Company M, signed an agreement with Toshiba to purchase the 20 A-type shares of Toshiba Medical with voting right; Canon signed an agreement with Toshiba to purchase 1 B-type Share without voting right and 100 warrants of Toshiba Medical. And they implemented the above agreements on the same day. This is illustrated as “Step One”, which has been implemented before Toshiba Medical filed the notification with the MOFCOM, China’s former merger review authority.
In addition, according to the agreement between Canon and Toshiba, after obtaining anti-monopoly approvals from various jurisdictions, including China, Canon would exercise the right to reserve new shares (the consideration is 100 Japanese yen, approximately RMB 5.76), and the warrants would be converted into ordinary shares with voting right. Toshiba Medical would repurchase A-type Shares and B-type Shares from company M and Canon respectively and cancel these shares. At this point, Canon would have completed the acquisition of 100% equity shares in Toshiba Medical. The aforesaid is depicted as “Step Two” and has not been implemented before the investigation.
The transaction in this case is the acquisition of entire equity in Toshiba Medical by Canon. MOFCOM considered that although the transaction is divided into two steps, but the two steps are closely related, which are both integral parts of Canon's acquisition of entire equity in Toshiba Medical, which constitutes one concentration. When Step One has been implemented, since the entire equity and the rights to reserve new shares of Toshiba Medical have been transferred, and all the corresponding payments have been paid, the implementation of the concentration therefore already commenced, even though not fully completed yet, which is in violation of Chinese Anti-Monopoly Law.
As such, MOFCOM imposed a fine at RMB 300,000 on Canon by taking the following factors into account. Firstly, the investigation was initiated by whistleblower, and the parties agreed to notify and receive the clearance globally and in China before the Step One has been implemented. The purpose of the package transactions is to solve Toshiba’s financial difficulties, which proves that the parties fully understood their filing obligations and escaped the notification intentionally.
III. Conclusion: Strengthened Gun-Jumping Prohibition in China
The Canon/Toshiba Medical case indicates designing the transaction by Steps may not well circumvent Standstill rules of China, since the authority had made clear its standpoint in several precedents. In addition, based on the published information on penalties since 2014, there were in total 15 penalties being issued in 2018, which is nearly the same as the total sum of previous three years, from 2015 to 2017. In this year to date, there were also already 13 penalties being released. As such, it can be observed that the gun-jumping prohibition in China had been strengthened from last year, after the new agency, SAMR, was established. Business having operation in China or appreciable turnover from China are therefore suggested to be more cautious in this regard when planning big deals.