Corporate M&A 2021

Last Updated April 20, 2021

China

Law and Practice

Author



Jingtian & Gongcheng was founded in the early 1990s and was one of the first private and independent partnership law firms in China. The firm is headquartered in Beijing, with offices strategically located in Shanghai, Shenzhen, Chengdu, Tianjin, Nanjing, Hangzhou, Guangzhou, Sanya and Hong Kong. It is active in a wide variety of practices and has more than 100 partners in its M&A team. Areas of focus include mergers and spin-offs, tender offerings, leveraged acquisitions, MBOs, joint ventures and strategic alliances, cross-border M&A and M&A financing.

Inbound M&A

Despite the COVID-19 pandemic, the Chinese M&A market rebounded strongly in 2020 after a significant drop in 2019. Transaction volume increased to USD733.8 billion and reached its highest level since 2016. The increase in value was driven by strong state-owned enterprise (SOE) participation in both strategic and financial investment transactions. The reported number of transactions continued to increase in the second half of 2020. The number of "mega-deals" (those whose value exceeds USD1 billion) completed in 2020 reached 93, compared to 80 in 2019. This reflects an acceleration of the SOE reform process and government support in response to the economic turbulence.

Additionally, due to China’s successful handling of the COVID-19 pandemic and continuing efforts to attract foreign investment, the foreign investment flow into China has also increased.

Outbound M&A

The outbreak of the COVID-19 pandemic, the escalation of the China-US trade war and the tightening of review standards for Chinese investment by foreign countries (as a result of the reversal of globalisation and revival of trade protection) have jointly impacted and slowed Chinese outbound investment activities, particularly in the US and European markets. As a result, quite a few transactions have been postponed or even cancelled. In 2020, total outbound transaction value dropped to USD42 billion, the lowest since 2010, and the number of deals fell to 403, down by 40%, the lowest since 2015 (as set out in the latest report released by PwC).

Despite all the challenges, Asia became the most preferred destination for Chinese outbound M&A activities. Saudi Arabia, Kazakhstan and member states of the Association of Southeast Asian Nations (ASEAN) became the top target countries for Chinese outbound M&A. Furthermore, investments in Asian countries are fostered by the “One Belt One Road” initiative proposed by the Chinese government.

European and American Multinationals Driving Inbound M&A

Multinationals have become the main driving force in respect of Chinese inbound M&A. The Chinese government released a revised version of Negative List for investments by foreign investors (as we mentioned in 2.3 Restrictions on Foreign Investments) and lifted certain restrictions on foreign investment in several industry sectors such as the manufacturing of automobiles and life insurance and multinationals have responded to the new policy and have benefitted from these market liberalisations.

As regards the automotive sector, foreign investment restrictions on the manufacturing of gasoline commercial vehicles have been removed from the Negative List. Furthermore, the restrictions regarding the manufacturing of gasoline passenger vehicles are scheduled to be removed in 2022. Therefore, automotive assets have become one of the most popular targets of inbound M&A by foreign investors.

M&A Transactions among Listed Companies

M&A transactions by A-share listed companies have fallen io a low point. Both M&A deals submitted for approval and the deals approved have declined to a historic low. In 2020, the M&A Committee of the China Securities Regulatory Commission (CSRC) reviewed 79 major asset restructurings of listed companies, 64 of which were approved and 15 of which were rejected. The pass rate was 81%, lower than the 83% pass rate in 2019.

STAR Market and PE/VC-Backed Companies

In contrast, a sympathetic regulatory framework and high valuations have seen the IPO market boom in 2020. There were 386 PE/VC-backed companies that completed IPOs in 2020, representing 68.3% of Chinese IPOs (as set out in a report released by Chinaventure Source). As capital markets can afford a relatively high valuation of businesses, the STAR market (a science and technology-focused equities market based in the Shanghai Stock Exchange) has become the most attractive stock market in China. This has encouraged VC-baked firms to list and financial investors rely heavily on it as an exit strategy.

In 2020, M&A transactions were concentrated in the finance, consumer goods, and biotechnology/healthcare sectors. Continuous deleveraging and financial supply-side reform have motivated the restructuring processes of relevant enterprises since 2018. In addition, the furthering of the foreign investment policy reform removed most restrictions in the finance sector to foreign investors, serval international players have taken advantages. In the first half of 2020, JP Morgan, Goldman Sachs and Morgan Stanley each announced the acquisition of residual equity stakes in Chinese securities joint ventures. These reforms and market liberalisations also pushed up the total amount of M&A in the financial sector in 2020.

Consumer goods was another noteworthy sector. Chinese consumers remained confident, optimistic, and ready to spend. As Chinese consumption habits shifted to online shopping, M&A has also reflected such trends. For instance, JD.com acquired Gome Retail Holdings and PepsiCo Inc. acquired Hangzhou Haomusi Food Co, Ltd (Be&Cheery), one of the largest online snack companies in China, for a consideration of USD700 million.

The biotechnology/healthcare sector has also been a popular sector for M&A. According to a report released by Deloitte, China is estimated to be the world's second-largest pharmaceutical and biopharma market in 2020. The most noteworthy deal was Shionogi & Co and Ping An Life Insurance establishing two joint ventures in China and Hong Kong, with a total investment of USD466 million.

In addition to the aforesaid sectors, due to the influence of industry cycles, the manufacturing and energy and minerals sectors have achieved a scale of over CNY100 billion in M&A transactions (as set out in a report from Chinaventure Source).

The COVID-19 pandemic’s influence on the M&A market in 2020 was reflected in the market preference for hi-tech enterprises. The three most sough-after industries in 2020 were advanced machinery manufacturing, IT and biotechnology/healthcare. In addition, semiconductor and electronic equipment, chemical materials and processing were among the top industries to be acquired.

A company can be acquired in several different ways in China. For mergers and acquisitions among state-owned enterprises, allocation or free transfer on the State-Owned Assets Supervision and Administration Commission (SASAC) is the norm. Transactions relating to public companies, as in other jurisdictions, can be achieved through share swaps or payment by shares. However, for other transactions, payment by cash and assumption of debt are commonly used. Public companies can also issue convertible bonds or priority shares to purchase assets.

It is worth mentioning that asset transactions are rarely used in M&A in China, given various regulatory issues and heavy tax burdens. For instance, transactions relating to property, if conducted through an asset transaction, will be subject to land VAT that is likely to amount to up to 60% of its increased value.

The Chinese M&A market is highly regulated, partially as a result of the legacy of the planned economy. Reform of the market has been gradual rather than sudden. Primary regulators for M&A activities include:

  • the State Administration for Market Regulation, formerly the Anti-monopoly Bureau of the Ministry of Commerce, which will be responsible for approving M&A transactions that have met the antitrust threshold;
  • the China Securities Regulatory Commission (CSRC), which is responsible for supervising and approving M&A transactions relating to listed companies in China;
  • the National Development and Reform Commission (NDRC), the Ministry of Commerce (MOFCOM) and the State Administration of Foreign Exchange (SAFE), which will review and approve outbound investment by Chinese entities (MOFCOM and the SAFE will also review and approve Chinese inbound investment by foreign investors); and
  • the SASAC, which will review and approve transactions relating to state-owned enterprises before all other external legal procedures (normally the SASAC will require an asset appraisal by a recognised appraiser to ensure that the proposed transaction is fair). The importance of the SASAC has been emphasised recently by the Chinese central government as a policy priority.

There are also certain approvals that are required by industrial supervision authorities, for instance, M&A involving financial and insurance institutions will require approval by the China Banking and Insurance Regulatory Commission.

The “Negative List”

All foreign investment into China will be subject to the Special Administrative Measures for Foreign Investment Market Access (Negative List). China has vowed to deepen its reform and energise the market. In 2020, China issued a much shortened Negative List of industries in which foreign investment is prohibited or limited. The list contains 33 industries that are restricted for foreign investment, seven fewer than the previous year. Restrictions on foreign shares in securities companies, securities investment fund management companies, futures companies, and life insurance companies were scrapped. As mentioned in 1.2 Key Trends, foreign investment share ratios in commercial vehicle manufacturing will be removed, and regulations prohibiting foreign investment in the smelting and processing of radioactive minerals, and the production of nuclear fuel will also be eliminated.

Catalogue of Technologies Prohibited or Restricted From Export

China has a small and very rarely used set of export controls, which have so far been most notably deployed in relation to rare earth metals which may be used in consumer electronics such as smartphones. In 2020, MOFCOM and Ministry of Science and Technology amended the export rules and restricted the export of “technology based on data analysis for personalised information recommendation services.” The amended rules have affected ByteDance’s proposed sale of its offshore video subsidiary, TikTok. It should be noted that, as there are very few precedents, it is not clear how the Chinese government will use the new rules to influence cross-border deals by tech companies in the future.

In China, the main regulations governing antitrust issues in business combinations include the Anti-monopoly Law of the PRC, the Regulation on Declared Threshold for Concentration of Business Operators issued by the State Council, Measures for the Declaration of the Concentrations between Undertakings issued by MOFCOM and Guiding Opinions on Declaring the Concentration of Undertakings issued by MOFCOM.

On 2 January 2020, the State Administration for Market Regulation (SAMR) publicised the draft amendment to the Anti-Monopoly Law for public opinion. The draft amendments to the Anti-Monopoly Law propose establishing an anti-monopoly regulatory framework for internet service providers and internet platforms. The draft amendment would also articulate a more precise definition of “control”. Moreover, penalties for illegal concentration have been raised significantly. Merger and acquisition activities by IT giants and online platforms will be subject to more stringent control.

The main labour law regulations in China include the Labour Contract Law of the PRC, the Implementing Regulations of the Labour Contract Law of the PRC, the Social Insurance Law of the PRC and the Law of the PRC on Mediation and Arbitration of Labour Disputes.

The strengthening of labour protection in China has significantly amplified the risk of labour disputes in M&A activities because (i) the M&A itself is not a legitimate reason for termination of a labour contract, and (ii) the acquirer may be required to bear the risk of paying the unpaid social insurance and housing provident funds of the target company. A plan for labour force arrangements may need to be submitted for government approval and when disputes arise, the government-backed labour arbitration institutions will normally take the employee’s side for reasons of protecting social stability.

In 2006, MOFCOM implemented the national security review of M&A transactions by foreign investors. In 2020, the NDRC and MOFCOM jointly issued the Measures for the Security Review of Foreign Investment. The new measures, effective from 18 January 2021, provided that a joint office be established by the NDRC and MOFCOM, which will be responsible for the national security review (NSR) work. The new measures also expanded the scope of NSR. Foreign investment in military equipment manufacturing, locations adjacent to military bases, military equipment production facilities, material agricultural products – and the energy, infrastructure, financial and internet sectors – which may affect Chinese national security, will now be subject to NSR review.

The new measures are also intended to cover both direct and indirect foreign investment in China, in contrast to the existing NSR that applies only to direct foreign investment. As such, it seems that any investor acquiring indirect "actual control" of a Chinese target covered by the new measures in an offshore transaction will be likely to be subject to NSR in China.

Under the new measures, the security review contains three stages: the jurisdiction review, the general review and the special review.

In 2020, the Chinese government articulated its intent for more stringent antitrust control. A series of new laws and guidelines have been promulgated or publicised for public comment, including the draft amendments to the Anti-monopoly Law and the new antitrust rules promulgated by the SAMR. The new regulations have established a framework and measures for control of internet platform concentration and unfair market practice, while significantly increasing punishment for noncompliance. M&A by technology giants, which has been a significant feature of the market in the past a few years, will be seriously impacted. Moreover, following the promulgation of the new rules, the government authorities fined (though the amount was not significant) several technology giants for not seeking government approval before M&A activities between 2014 and 2018.

In 2020, the CSRC amended the Administrative Measures on Material Assets Reorganisation of Listed Companies and the Administrative Measures on Takeover of Listed Companies, mainly to reflect the changes to the new Securities Law promulgated in 2019. The main amendments include the following:

  • eligible acquirers who are exempted from making a tender offer will not be required to attain an exemption approval from CSRC;
  • the lock-up period of the acquirer's shares in the acquisition of a listed company has been extended (from 12 months to 18 months);
  • shareholders holding 5% or more shares now have a duty to disclose such information when changes in their shareholding exceed 1%; and
  • a purchaser of shares who has not fulfilled the information disclosure obligation now cannot exercise voting rights attached to the newly acquired shares within 36 months after the purchase.

Generally, bidders will build a stake in the target company before contacting it or making an announcement about their proposed acquisition. However, Chinese law requires bidders to fulfil the disclosure obligations when they obtain a certain percentage of the target company’s equity. According to the Measures for the Administration of the Takeover of Listed Companies (the M&A Measures), amended by the CSRC in 2020, where the change in equity of the investor, and any persons acting with the investor, amounts to 5% of the issued shares of a A-share listed company through securities transactions on a stock exchange, a report on the change in equity must be prepared within three days of the event and a written report to the CSRC and the stock exchange must be submitted.

According to the Measures for the Administration of the Takeover of Listed Companies:

  • if the equity owned by the investor and persons acting with the investor (collectively, the investor) in the listed company amounts to 5% of the issued shares, the investor must prepare a report on a change in equity within three days of the event and submit a written report to the CSRC and the stock exchange, notify the listed company and make an announcement;
  • for every increase or decrease of 5% in the proportion of the shares the investor holds of the listed company, the investor shall also perform the same reporting and announcement obligations as above;
  • if the equity owned by the investor in the listed company amounts to or exceeds 5% of the issued shares but is less than 20%, the investor must prepare a simplified report on changes in equity;
  • if the equity owned by the investor in the listed company amounts to or exceeds 20% of the issued shares but is less than 30%, the investor must prepare a detailed report on changes in equity;
  • if the shares held by an acquirer in a listed company amount to over 30% of the issued shares through securities transactions on the stock exchange or agreement acquisition and the acquirer continues to increase its shareholding, the acquirer shall propose a tender offer, either a general offer or a partial offer.

A listed company can prevent malicious acquisitions by modifying the company's articles of association, to, for instance, lower the threshold for disclosure, changing the terms of directors, and increasing the proportion of voting shares. Some listed companies, such as World Union and Yahua Shares, have stipulated in their articles of association, respectively, reducing the 5% shareholding ratio attached to reporting obligations to 3%, and stopping trading within the relevant period, to prevent malicious acquisitions.

Modification of companies' articles of association has increased in recent years. Although they have not violated the articles of the law, this has attracted the attentions of the exchanges. After announcing amendments to their articles of association, listed companies may receive an amendment Letter of Concern from the relevant exchange.

Derivatives were recently introduced to the Chinese stock market and only very limited types of derivatives, for a limited number of listed companies, are traded. Even though derivative dealings are allowed in M&A transactions with respect to listed companies in China, dealing in derivatives as a means of pursuing M&A or as a risk control mechanism is only tentatively used in a small number of transactions.

For instance, the Shenzhen Stock Exchange (Shenzhen SE) issued the Shenzhen SE Pilot Trading Rules for Stock Options. Stock option contracts can be listed, traded, and exercised on the Shenzhen SE. The buyer of an option can decide whether to exercise the option within the contract period; one can buy or sell a corresponding amount of the contract at a specific price. In addition, both the Shenzhen SE and the Shanghai Stock Exchange allow listed companies to issue warrants and trade them. Members should exercise warrants through the exchange trading system. The exchange will also publish the tradable amount of each warrant, and publish lists of holders who possess 5% or more of the tradable amount of each warrant before the daily opening.

In general, reporting obligations cover all securities issued by Chinese listed companies. However, the Takeover Rules only expressly apply to holdings in shares and convertible bonds and are otherwise silent as to how interests in other forms of securities and derivatives should be disclosed (and aggregated) for reporting purposes.

In the case of derivatives, to the extent they are convertible into actual shares of the company, it is arguable that their treatment should be similar to the case of convertible bonds and that they are therefore reportable. Conversely, cash-settled derivatives that do not allow the holders to obtain actual shares of the company should arguably not be reportable.

Regulations Published by Shenzhen and Shanghai Stock Exchanges

Regulations issued by the Shanghai and Shenzhen Stock Exchanges have explicitly included private XB in the regulatory framework, and clarified the scope and implementation details of private XB.

However, the current laws and regulations do not place restrictions on private XBs. Shareholders of listed companies who want to issue private XBs only need to attain approval from the exchange, and for filing on the exchange. The conditions are that the stocks used to exchange must not be subject to judicial restrictions or other rights restrictions before the bond issuance, and there must be no restrictions on sales and no breach of the issuer's commitment to the listed company. The bond can be converted six months after issuance.

If dealings in derivatives constitute a merger of businesses, they may still be subject to an antitrust review.

Shareholders have to make the purpose of their acquisition and their intention regarding control of the company known. According to the M&A Measures, where the equity in which the investor and persons acting with the investor amounts to 5% or more of the issued shares of a listed company, the investor and persons acting with the investor shall prepare a simplified report on changes in equity containing the purpose of the shareholding and whether there is an intention to increase the equity held in the listed company continuously within the next 12 months.

Where there is a takeover of the listed company’s shares by way of a tender offer, the investor must prepare a report explaining the purpose of the takeover.

If the tender offer method is adopted, the acquirer must make an indicative public announcement of the key contents of its tender offer report at the time it notifies the target company of the offer.

If an acquisition by agreement is adopted, when the agreement is reached, the acquirer must report the agreement to the securities regulatory authority of the State Council and the stock exchange within three days, and make an announcement. The acquisition agreement shall not be fulfilled before the announcement.

Market practice on timing varies. The general practice is that listed companies will not disclose potential transactions prematurely. In some cases, the listed company does not perform the obligation of information disclosure in a timely manner even if the investor and the listed company have signed a share purchase agreement. In this instance, the CSRC and the stock exchange will censure the chairman and/or secretary of the board publicly and will impose a penalty on the company.

Due diligence mainly fulfils two purposes, one is for the buyer's need to further understand the vendor, the other is meeting the competent authority's requirements on acquisition disclosure/report.

Commonly, in the first phase (before the price and transaction structure is confirmed), the vendor will provide no internal due diligence documents except some publicly available materials and the bidder will usually be largely reliant on relevant market information.

In the second phase (once the transaction structure and price have been confirmed), the due diligence documents provided by the vendor are more extensive in scope and usually cover all issues during the reporting period, including a company's history, assets, finances, taxes, compliance matters, pending litigation and arbitration, administrative penalties and other matters relating to its existence and operation.

Effect of the Pandemic

As a result of the pandemic, online methods such as virtual data rooms, remote meetings and digital investigation are more commonly used in the due diligence process, as an alternative to on-site visits and face-to-face meeting. Buyers can even use apps which use drone-generated imagery to view target assets. Management due diligence can be set up in Zoom meetings or through equivalent software. 

In China, exclusivity is usually demanded in M&A transactions. However, the period of exclusivity usually ranges from a few weeks to several months. The exclusivity period may also be extended in certain circumstances.

With regards to standstill, pursuant to the M&A Measures, in the case of a tender offer, the purchaser shall not, after the announcement is made and before the takeover term expires, sell any share of the target company, nor may it buy any share of the target company by any means other than those stipulated in the tender offer or that go beyond the conditions as stipulated in the tender offer.

In addition, if, by trading securities on a stock exchange, an investor holds equity shares accounting for 5% of the issued shares of a listed company, they shall not trade the stock within three days of the occurrence of the fact. And if, by a transfer agreement, the investor owns equities in a listed company that reach or exceed 5%, or after the shares whose entitlements are held by an investor reach 5% of the issued shares of a listed company, if the proportion of the investor's shares increases or decreases by 5%, they shall perform the obligations of reporting and announcing discussed in 4 Stakebuilding. Before the said investor gives a report and makes an announcement, they shall not buy or sell the shares of the listed company again.

According to the M&A Measures, in the case of an acquisition of shares of a listed company by a tender offer, the bidder shall prepare a tender offer report and engage a financial consultant and notify the target company. The report must include the price, quantity and proportion of the shares under consideration, plus the takeover period. Where an offeror needs to make changes to a takeover offer, the offeror shall promptly make an announcement, state the specific changes in question, and notify the target company.

Upon expiry of the takeover period, the bidder must purchase the shares pursuant to the terms agreed in the tender offer. Generally, no other agreement or contracts will be implemented.

Chinese domestic M&A is generally speedy. Most deals will be closed within three to six months. Cross-border transactions, since various approvals will be required, may take an additional three to six months. Occasionally, transactions are announced and transaction documents are quickly signed, but actually closing the deal takes a long time because of the various approvals required and also the lack of scrutiny involved in preparation for the operation.

Effect of the Pandemic

To prevent the spread of the COVID-19 pandemic, travel has been subject to tighter restrictions. For transactions which fall within the scope of government approval, the review periods for government have been extended due to the inconvenience of communication or the changes of office hours. Both of these changes may create delays or impediments to the deal-closing process. However, considering China’s successful handling of COVID-19, the impact of the above-mentioned matters is within a controllable range.

According to the Securities Law and the M&A Measures, unless exempted by the CSRC, if the shares held by an acquirer in a listed company amount to 30% of the issued shares through securities transactions on the stock exchange or agreement acquisitions, and the acquirer continues to increase their shareholding, the acquirer must propose a takeover by way of an offer, which may be general or partial.

Cash, including cash plus an assumption of debt, is the most commonly used form of consideration in China. For tender offers relating to listed companies, only a public floating of shares may be used as consideration, otherwise cash must be provided as an alternative. In an acquisition by a listed company, the use of shares, though normally not preferred on the seller’s side, is common.

Valuation adjustment mechanisms (VAMs) and earn-out mechanism (EOMs) are common tools to bridge value gaps between parties in the PRC in a deal environment or industry with high valuation uncertainty. It is even a mandatory requirement for M&A transactions when the buyer is a listed company. When using a VAM, the consideration for the transaction is fixed, and the acquirers gain their compensation through equity repurchase and/or a monetary payment arrangement if the corresponding conditions are triggered. When using an EOM, the consideration for the transaction is contingent on the target company achieving a predetermined level of future earnings, and the acquirer pays the consideration in instalments. If the corresponding conditions are triggered, the acquirer can adjust the unpaid part of the consideration. However, there are concerns that by relying on VAMs and EOMs, the target value may be exaggerated and that this may be causing bubbles in the price of listed companies.

Takeover offers which are conditional on approval being obtained, divestiture and/or the incorporating of certain assets plus third-party consent are extremely rare in China. For takeovers of Chinese listed companies, the conditions of a takeover offer generally include the number of shares to be acquired, the price, the terms, the conditions for taking effect, etc. Conditions attached to the offer are not prohibited by PRC laws and regulations. In PetroChina’s takeover of Liaohe Oilfield (000817), for example, PetroChina set the standard for delisting as a condition of the offer. Namely, if Liaohe Oilfield failed to delist, PetroChina would abandon the acquisition.

Conditions for the effectiveness of a tender offer shall be set forth in a takeover offer. It is a relatively common condition that the proportion/number of shares to be purchased shall reach a certain amount or proportion. That is, if the proportion/number of shares to be purchased fails to meet the required number upon the expiration of the tender offer period, the tender offer shall not be effective and the shares to be purchased will not be acquired.

According to the M&A Measures, if a listed company is taken over by means of a tender offer, the proportion of shares to be purchased shall not be lower than 5% of the issued shares of the said listed company.

Although a merger or acquisition being conditional on the bidder obtaining financing is not prohibited or restricted by PRC laws and regulations, it is not feasible in general practice. Commonly, obtaining financing is a precondition for a business combination. As the M&A Measures provide that the acquirer shall engage a financial consultant to conduct due diligence on the acquirer’s capacity to pay the takeover price and their source of funds, a business combination may not be approved by shareholders if it is conditional on the bidder obtaining financing.

Break-up fees are commonly used in China as security measures. However, they are normally not very high and may simply recover the expenses paid to intermediaries. Other security measures – including match rights, force-the-vote provisions and non-solicitation provisions – are rarely used and may be regarded as violating the interests of shareholders and the fiduciary duties of directors.

Chinese domestic M&A mainly involves acquisition by tender offer and by agreements. In general, break-up fees may not be a condition attached to the tender offer. For acquisitions by agreement, break-up fees borne by the principal shareholders of a listed company may be one of the conditions attached to the acquisition. But the listed company may not agree to bear the break-up fees as it may impair the interests of minority shareholders.

Effect of the Pandemic

For the management of “pandemic risk” in the interim period, a bidder can use force majeure clauses to avoid performing its contractual obligations; however, only to the extent that such performance is prevented by objective conditions which are unforeseeable, unavoidable, and insurmountable. Moreover, a bidder can seek the help of third parties such as the China Council for the Promotion of International Trade (CCPIT) to issue a certificate to provide supporting collateral evidence of such objective conditions.

Considering the impact of Sino-US trade friction and the COVID-19 pandemic on the global supply chain, the governments of many countries have heightened their regulatory review of foreign investment, especially in sensitive fields that closely relate to state security risks. The regulatory environment mentioned above may extend the length of interim periods and bring more uncertainty to transactions.

If a bidder does not seek 100% ownership of a target company, they may seek an "acting in concert" agreement from other major shareholders so as to ensure control of the target company. Acting in concert refers to the act or fact of an investor working together with other investors through an agreement, or any other arrangement, to jointly increase the quantity of voting shares under their control in a listed company.

According to the Company Law, a shareholder may appoint a proxy to attend a shareholders’ meeting. The proxy appointed shall present a proxy form issued by the shareholder to the company and shall exercise the shareholder's voting rights within the scope of their authorisation.

According to the Securities Law, the board of directors, independent directors, shareholders holding 1% or more of voting shares of a listed company or an investor protection institution formed in accordance with the provisions of the laws, administrative regulations or the provisions issued by the securities regulatory authority of the State Council may, as a solicitor, publicly request that shareholders of the listed company entrust them to attend the shareholders' meeting and to exercise the right to make proposals, the right to vote and other rights of shareholders on their behalf or entrust a securities company or a securities service institution to do so.

When shareholders’ rights are solicited as mentioned above, the solicitors shall disclose the solicitation documents, and the listed company shall co-operate. In addition, it is forbidden to publicly solicit shareholders' rights in a paid manner.

Squeeze-out mechanisms and short-form mergers are extremely rare in China, as a listed company is delisted if shares held by the public are less than a certain proportion, and listed company status is very valuable in the Chinese market. According to the Stock Listing Rules respectively published by the Shanghai Stock Exchange and the Shen Stock Exchange, if an acquirer holds more than 75% of the acquired company with a total equity of CNY30 million to CNY400 million, the acquired company will be delisted; if the acquirer holds more than 90% of an acquired company with a total equity of more than CNY400 million, the acquired company will be delisted.

In transactions involving the purchasing of three listed companies, Jilin Chemical, Jinzhou Petrochemical and Liaohe Oilfield, by PetroChina, the three listed companies were delisted due to the non-compliance of their equity distribution with the listing conditions under the Securities Law. After delisting, there were still a small number of remaining shareholders who were unwilling to sell their shares. However, due to the lack of a squeeze-out mechanism, PetroChina was not able to compulsorily acquire the relevant shares.

Obtaining irrevocable commitments is not prohibited by PRC laws and regulations. But, in practice, it is rare that a major shareholder of a listed company issues a letter of commitment to the purchaser in Chinese domestic M&A as this may be deemed to impair the interests of minority shareholders from the perspective of the regulatory authorities. However, major shareholders of a listed company may still issue a letter of commitment to the purchaser without publicising that commitment.

As mentioned in 4 Stakebuilding, according to the relevant laws and regulations of PRC, if an investor and the persons acting in concert hold equity shares accounting to 5% or more of the issued shares of a listed company, they shall perform the obligations of reporting and announcement.

Furthermore, as described in 4.5 Filing/Reporting Obligations, the listed company shall disclose the bid according to the Disclosure Measures, in certain cases.

Takeovers

In a takeover of a listed company, if the proportion of acquired shares is between 5% and 20%, the investor, and parties acting in concert, shall formulate a simplified report on the alteration of entitlements, which shall generally include general information of the acquirer and the portion of target shares.

If the proportion of shares reaches or exceeds 20%, but does not exceed 30%, the investor shall formulate a detailed report on the alteration of entitlements, which shall generally include the information required in Articles 16 and 17 of the M&A Measures.

Tender Offers

If the proportion of shares of a listed company held by an investor reaches 30% and the investor continues to increase its shareholding or if the investor adopts the means of the tender offer to purchase the shares of a listed company, that takeover shall be disclosed by preparing a tender offer report, as stipulated in the M&A Measures, and by publishing an announcement.

Bidders need to disclose financial statements. Specifically, bidders must disclose their financial statements for the previous three years, among which, the one for the most recent year must have been audited. If the financial condition of a bidder has changed materially in the most recent fiscal year, that bidder shall provide the latest financial statement. If a bidder has existed for less than one year or was set up for the special purpose of the acquisition, it shall disclose financial statements relating to its actual controllers or controlling companies. If bidders are domestic listed companies, the disclosure of financial statements for the most recent three years may be waived, but the name of the newspaper publishing the annual report and date of publication shall be specified. If bidders are overseas investors, their financial statements must be produced in accordance with international accounting standards.

It is not necessary to disclose transaction documents in full. In the acquisition, or the material assets reorganisation, of a listed company, the basic background and the key factors of the transaction – such as the subject matter, counterparty, quantity of shares, price, method of payment, conditions of transactions and approval issues – need to be disclosed but it is not mandatory to disclose any transaction document in full.

Generally, the directors in a business combination bear a duty of loyalty and a duty of diligence to the company and shall treat all acquirers fairly. Specifically, the board of directors of the target company shall make investigations, analyse the terms of the offer, propose suggestions to shareholders, engage an independent financial consultant to issue a professional opinion and announce a report in respect of the acquisition. Without the approval of the shareholders' general meeting, the board of directors shall not take actions which will have a significant impact on the assets, liabilities, interests or operating results of the company. Essentially, the directors’ duties (including independent directors) are owed only to the company and the shareholders, instead of all stakeholders. The establishment of an independent director system, however, is aimed at protecting the interests of minority shareholders.

Separate from the board of directors, there should be a certain proportion of employee representatives (not less than one third) on the board of supervisors. Therefore, to a certain extent, the supervisors represent the interests of stakeholders, in addition to the interests of the company and its shareholders.

It is not common for boards of directors to establish special or ad hoc committees for the purpose of reviewing business combinations. However, when some directors have a conflict of interests, the said directors shall recuse themselves. Besides, independent directors in a listed company also sometimes take on the roles of special or ad hoc committees.

Specifically, if the directors, supervisors, senior management, or employees of a listed company – or a company controlled by or entrusted to such directors, supervisors, senior management, or employees – propose(s) to acquire a listed company, a resolution on the acquisition shall be passed by non-related directors and be approved by two thirds or more of the independent directors before being approved by non-related shareholders at the shareholders' general meeting. The independent directors shall, prior to making a presentation of their opinion, engage an independent financial consultant to issue a professional opinion.

Independent directors of a listed company shall present independent opinions on material assets reorganisations. If the material assets reorganisation constitutes a related-party transaction, independent directors may engage an independent financial advisor separately to express an opinion on the impact of the present transaction on the non-related shareholders.

There is no "business judgement rule" in China. In China, the duty of diligence imposed on directors is demanding. Under China's corporate governance structure, decision-making powers over important matters generally belong to shareholders, and the authority of the board of directors is limited. As far as takeovers are concerned, the ultimate decision-making powers – on whether to accept the takeover and whether to take anti-takeover measures – belong to the general meeting of shareholders. Thus, directors' liabilities in takeover situations are not as prominent as there is not much room for discretion on the part of the management or board.

Although the business judgement rule has not been officially introduced into China, the essence or notion of the business judgement rule has been reflected in certain court rulings. That is, as long as a director has not violated applicable laws and regulations or a company's articles of association, follows relevant rules and procedures, and the questioned result was not caused by the director intentionally or with gross negligence, that director shall not be liable for their decision, even if the decision resulted in losses to the company. The M&A Measures, however, specify the standard for the duty of diligence for directors – including directors' duties to investigate, report and make suggestions as well as certain behaviours that are prohibited (see 8.1 Principal Directors' Duties) – which provides certain standards for courts dealing with directors' liabilities in takeover situations, and a basis for the possible introduction of a business judgement rule in the future.

In the acquisition of a listed company, the board of directors of the target company shall engage an independent financial consultant, normally an investment bank, to issue a professional opinion. In the case of an acquisition of a listed company by its directors, supervisors, senior management or employees, the listed company shall engage a qualified asset valuation institution to issue an asset valuation report, and the independent directors shall separately engage an independent financial consultant.

In the material assets reorganisation of a listed company, the listed company shall engage an independent financial advisor, a law firm, and an accounting firm that has the relevant securities business qualifications to issue opinions. The independent financial advisor and law firm shall, in a prudent manner, verify whether or not the material assets reorganisation constitutes a related-party transaction. If the pricing for the asset trading is based on the asset evaluation result, the listed company shall engage a qualified asset evaluation institution to issue an asset evaluation report.

According to China’s Enterprise State-Owned Assets Law, if the transaction involves any transfer of state-owned assets, the minimum transfer price shall be determined in a reasonable manner on the basis of a price that has been evaluated in accordance with the law and recognised by an organ that performs the duties of an investor or approved by the people's government at the same level after being reported by such an organ.

Conflicts of interest have been the subject of judicial scrutiny and also of scrutiny by securities regulators. Generally, no controlling shareholder, actual controller, director, supervisor or senior officer of a company may damage the interests of the company by taking advantage of their affiliated relation; otherwise, they shall be liable for compensation.

If a transaction constitutes a related-party transaction, a listed company shall:

  • follow principles of impartiality, voluntariness and compensation for equal value;
  • guarantee the impartiality and fairness of the transactions;
  • go through corresponding procedures of deliberation in accordance with the laws, administrative regulations, CSRC provisions and the company's articles of association; and
  • make timely disclosures.

Any director of a listed company involved in a related-party transaction shall not exercise their voting right on the board of directors in relation to the transaction either on their own behalf or on behalf of any other director. Any shareholder of a listed company involved in a related-party transaction shall not exercise their voting right at the general meeting of shareholders in relation to the transaction either on their own behalf or on behalf of any other shareholder.

Hostile tender offers targeting listed companies are not prohibited by law, but are still not that common due to the special equity structure of listed companies in China.

Generally speaking, the decentralisation and liquidity of the target company's equities are the premises of a hostile takeover. Unlike the decentralisation of shareholding and market-oriented management of public companies in much of the rest of the world, most Chinese listed companies have a concentrated shareholding structure. Large, listed companies are mainly state-owned companies or family-owned companies, in which there is normally a major shareholder holding the controlling position, and these major shareholders often hold restricted shares. Under this kind of equity structure, hostile takeovers rarely occur as, without the consent of the controlling shareholder and the management, the acquirer cannot take actual control of the listed company.

However, with the great changes seen in the corporate governance environment, the market itself as well as the legal environment in recent years, especially in the modern and market-oriented development of Chinese listed companies, the incidence of a hostile takeover may increase.

Defensive measures in general (such as disposal of assets, the issue of new shares, etc) were prohibited by the CSRC in 2002 through provisions in the M&A Measures. This regulation, however, was revised in 2006 with the prohibition provisions deleted. Directors are currently allowed to use defensive measures in China.

As noted in 9.1 Hostile Tender Offers, hostile tenders are not that common in China, therefore generally there is not much call for defensive measures. According to our observation of hostile takeover cases in recent years, common defensive measures include suspension strategies, litigation strategies, "white knight" plans, "shark repellent" strategies and "golden parachute" clauses.

Suspension Strategy

By adopting a suspension strategy, the target company makes an announcement of a trading suspension of its shares after receiving tender offers. On the one hand, it offers time for the target company to find a white knight and take other defensive measures, and, on the other hand, it will increase the costs for the acquirer of keeping shares of the target company, which may cause the acquirer to abandon the acquisition plan due to lack of funds.

Litigation Strategy

A litigation strategy refers to winning time and preventing acquisition by initiating legal proceedings or other proceedings against the acquirer. In both the classic hostile takeover cases discussed below, the target companies adopted litigation strategies to try to prevent hostile takeovers.

White Knight Plan

In a white knight plan, when hostile acquisitions occur, the target company actively seeks friendly persons or companies with good intentions and will take opportunities to be acquired by them, so as to rescue the target company and expel the hostile acquirers. Such bona fide third parties, the so-called white knights, will compete with the hostile bidders, resulting in third parties and malicious buyers bidding for shares of the target company. In the case of Baoneng's acquisition of Vanke (discussed below), China Resources was identified as a white knight by Vanke.

Shark Repellent Strategy

In a shark repellent strategy, a listed company, by amending the articles of association, limits the proportion of directors to be re-elected or the right of directors to be removed by the general meeting of shareholders, aiming to prevent possible hostile takeovers.

Golden Parachute Clause

A golden parachute clause generally refers to an agreement entered into by senior executives (including directors, supervisors and management) and the company, in which the company agrees that senior executives will get large severance compensation when they leave the company, and generally it can be triggered only when the company is acquired or merged or other events involving a change of control occur. Golden parachute clauses are rare in China.

Examples

In the process of fighting against a hostile takeover, often several kinds of defensive measure are employed. For example, both the hostile takeover of Vanke Group Co, Ltd by Baoneng Group Investment Co, Ltd in 2015, and the hostile takeover of ST Tiochemical by Hangzhou Zhemingtou Tianhong Investment Partnership in 2016, simultaneously or successively adopted the suspension strategy, the litigation strategy and the white knight plan.

Defensive Measures and the Pandemic

Firstly, the pandemic situation may obstruct listed companies from arranging auditing, updating financial information or preparing other corporate actions, the CSRC and Chinese stock exchanges have relaxed the policy on the filing time limit for M&A and reorganisations, which could be taken advantage of by the target company to postpone the acquisition process, and thus obtain time to prepare other defensive measures.

Secondly, as a result of the impact of the pandemic, it seems that disputes among companies have increased while at the same time the efficiency of courts/arbitration tribunals in handling disputes has decreased. Therefore, it is a common phenomenon in the corporate merger market to see the target company take advantage of these opportunities to initiate lawsuits against the acquirers.

Thirdly, according to the new Securities Law promulgated in 2019, the defending party can directly announce that the shares illegally purchased by the purchaser have no voting rights for 36 months from the date of purchase, which has a significant impact on the purchaser's strategy for control in the future.

Furthermore, at the directors’ level, upon the promulgation of the Provisions of the Supreme People's Court on Several Issues Concerning the Application of the Company Law of the People's Republic of China (V) (Judicial Interpretation of Company Law (V)) on 28 April 2019, the application of such defensive measures as "director rotation", "director qualification restriction" and golden parachute clauses have been greatly reduced. Judicial Interpretation of Company Law (V) has established the basic principle of director's dismissal without cause. Even if the director's term of office has not expired, the general meeting of shareholders can also decide to dismiss the director from their post on a no-fault basis, and a provision in the articles of association otherwise will not be acceptable. Therefore, the director rotation clause will no longer be effective. In addition, according to Judicial Interpretation of Company Law (V), the court may support the effectiveness of a parachute clause but, in the case of dispute, the court may adjust the amount of compensation at its own discretion, thus greatly reducing the deterrent power to the purchaser.

A high standard of fiduciary duty will be applied to directors when taking defensive measures. Only a few defence measures can be adopted, and the directors may be required to justify the reasonableness of the measures to the supervisory authorities. Specifically, in the acquisition of a listed company, the board of directors of the target company shall make investigations, propose suggestions to shareholders and formulate and announce a report in respect of the acquisition. Without the approval of the shareholders' general meeting, the board of directors shall not take actions which will have significant impact on the assets, liabilities, interests or operating results of the company.

Shareholder representative litigation is the major means by which shareholders can sue the directors, supervisors and/or other senior management of a public company for failing to fulfil their duties and obligations. However, as a practical matter, in the past, local courts have set various pre-conditions as well as plaintiff qualification standards to bar such shareholder representative litigation.

However, we note that in current judicial practice, courts tend to make a substantive review of the necessity of any pre-procedures/conditions before accepting the case, and more emphasis is put on the protection of shareholders' interests. 

According to the M&A Measures, it is the power and authority of the general shareholders’ meeting to make a decision on whether to accept the tender offer. The directors’ rights to take actions that prevent a business merger are limited. Therefore, directors cannot "just say no".

Litigation is common in connection with M&A deals in China. According to our observation, litigation related to M&A deals may happen when dealing with the following issues.

  • The effectiveness of earn-out clauses in the acquisition of listed companies, for example, the lawsuit on the acquisition of the listed company Yinjiang Co, Ltd by Li Xin (2017).
  • The former management’s requests for payment of economic compensation upon occurrence of a hostile takeover, for example, the lawsuit on listed company acquisition and labour dispute between Zhang Baizhong and China Southern Glass Group Co, Ltd, Qianhai Life Insurance Co, Ltd (2019).
  • Enforcement action on payment of cash or equity consideration initiated by a target’s shareholders; on the one hand, it is general practice in China to pay for M&A in cash and in instalments, and in many cases the payment of the instalments post-closing will have to be resolved through litigation; on the other hand, the acquisition of listed companies may include multiple transactions, therefore, disputes related to determination and payment of consideration may happen.
  • Fraud and defect liability involved in the merger and acquisition of listed companies; due to the lack of experienced professionals to conduct thorough due diligence, information about the situation of the target company may not be fully disclosed, resulting in disputes related to false disclosure of financial status, financial fraud, false increase of profits, etc.
  • The claims by minority shareholders who have been squeezed out during M&A against the target company or the management for infringement of shareholders' rights and interests, for example, the first M&A litigation in STAR Market brought in the USA.

Litigation typically occurs post-closing. Disputes related to M&A deals, as mentioned in 10.1 Frequency of Litigation, normally happen after completion of the transaction and, as acquisition of a listed company shall be subject to disclosure procedure and review by the CSRC, disputes rarely happen until the completion of the transaction. Significant changes in the target company may prevent the transaction proceeding.

Many business activities suffered massive damage due to COVID-19, which may legally constitute force majeure. However, we note that in judicial practice, despite the massive impact of the pandemic:

  • it is difficult for investors or acquirers to terminate M&A transactions or to change price on grounds of force majeure; and
  • it is difficult for target companies to be relieved of obligations or liabilities under a valuation adjustment mechanism (VAM) agreement on the grounds of COVID-19.

Therefore, we have the following advice for target companies and investors.

  • If a party is unable to perform the transaction obligations temporarily due to COVID-19, and has to delay the performance, the party should:
    1. timely inform the other party, explain the causes of force majeure, and negotiate to delay the performance in good faith;
    2. actively take measures to prevent the loss from expanding, and actively negotiate with the other party on how to find alternative methods to perform the relevant obligations; and
    3. collect the corresponding evidence that the agreement cannot be performed temporarily due to force majeure, including notice or announcement from government authorities.
  • If a company is unable to complete a VAM agreement due to the impact of COVID-19, it should:
    1. timely inform the other party and at the same time take appropriate measures to prevent the loss from expanding;
    2. retain legal experts to review, analyse and summarise all the relevant provisions of force majeure and change of circumstances, which may constitute the basis of negotiation for changing the VAM clause or claiming to be exempt from VAM responsibilities;
    3. assess the impact of COVID-19 on company operation and VAM performance, and carefully collecting relevant evidence; and
    4. actively communicate with the investors or acquirers to see whether a supplementary agreement can be reached.

Shareholder activism is not yet an important force in China. However, with the modern development of the Chinese stock market, the prosperity of institutional investors and the improvement in securities regulations, it is foreseeable that such activism will likely become an important force in the near future.

Shareholder-derived litigation has happened from time to time in recent years. When the legitimate rights and interests of a company are infringed illegally – and the directors, supervisors and senior managers fail to initiate a lawsuit – then the shareholders of the company may sue in their own name, for the benefits of the company, and the compensation claimed will be attributed to the company. This is also an important manifestation of shareholder activism in China.

Activists in China have largely focused on the unfair disposal of corporate assets and financial or accounting fraud.

As described in 11.1 Shareholder Activism, activists generally focus on unfair transactions and fraudulent behaviour, which affects the rights of companies detrimentally. M&A transactions, in contrast, generally help to enhance the value of companies and are normally encouraged. Spin-offs or major divestitures generally result in a complicated response since there is a lack of sufficient information to make an accurate judgment.

Effect of the Pandemic

During the period of COVID-19, the awareness of individual investors of their rights, and the number of claims initiated by those investors against listed companies, has increased. The number of litigation cases involving listed companies, the number of individual investor claims and the cumulative amount of claims hit a new record in both 2019 and 2020.

Therefore, in early 2020, the Supreme Court and the CSRC jointly established the People's Court Mediation Platform and the China Investors Network Securities and Futures Dispute Online Resolution Platform as a co-ordinated, efficient and convenient online litigation and mediation platforms for securities and futures disputes, through which to realise data exchange and interconnection and promote protection of minority shareholders’ rights.

There are more and more cases where not only institutional investors, but also individual minority shareholders, successfully interfere with the completion of an announced M&A and restructuring transaction, even though it is not a major challenge for most listed companies where the majority of individual and institutional shareholders remain passive. Institutional investors' active participation in corporate governance may be common abroad, but in China it has still not developed as a mature practice.

Jingtian & Gongcheng

34th Floor, Tower 3
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77 Jianguo Road
Chaoyang District
Beijing 100025

+86 10 5809 1000

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jingtianbj@jingtian.com www.jingtian.com
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Trends and Developments


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Global Law Office has more than 460 lawyers practising in its Beijing, Shanghai, Shenzhen and Chengdu offices and is one of China's leading law firms. GLO’s corporate M&A practice covers a wide range of transaction types and the entire process of transactions, including unlisted/listed companies’ mergers and acquisitions, and transactions from initial investment to equity exit, with special expertise in handling cross-border transactions and state-owned assets-related transactions and restructuring matters. The firm provides comprehensive services to align industry sectors’ needs, which include financial services, manufacturing, trade, energy and mining, automotive, real estate and construction, transportation, life sciences and healthcare, food and beverage, entertainment and sports, and TMT. The firm's experience and capabilities allow for the provision of one-stop services on complex M&A transactions covering foreign investment access, industry compliance, state-owned asset governance, taxation, foreign exchange regulatory, intellectual property, labour and national security review.

Outbound M&A

Suffering from the COVID-19 crisis and increasingly rigorous foreign investment control, worldwide outbound M&A by Chinese investors in 2020 declined by 27.59% in value (USD42 billion) compared to 2019 based on disclosed deal volume, and the number of transactions (403) declined by 39.58% according to statistics released by PwC. The most popular economic sectors for Chinese outbound M&A activity by deal value were industry, hi-tech and consumer products. Driven by the “Belt and Road” initiative, Chinese investment in parts of the world including India, Latin America and the ASEAN countries is increasing year-on-year and this is likely to continue going into 2021.

Meanwhile, with the special purpose acquisition company (SPAC) booming in the USA in 2020, the SPAC has also become a popular outbound M&A choice for Chinese investors in 2020. Ucommune, United Family Healthcare and Faraday Future all chose to be listed in the USA by means of a merger with a SPAC. As SPAC deals are a fast, low-cost, low-threshold way of financing, and Asia-focused SPACs are emerging, more and more Chinese investors may seek mergers with suitable SPACs for overseas listing purposes in 2021.

In 2017 the China National Development and Reform Commission (NDRC), the Ministry of Commerce (MOFCOM) and the State Administration of Foreign Exchange intensively promulgated a series of rules and regulations attempting to streamline governmental procedures and guide Chinese investors towards rational investment. In the following years of 2018, 2019 and 2020, China outbound M&A activities displayed a tendency towards greater rationality. Overall, there have not been material revisions or updates to the regulations governing overseas direct investment in 2020.

Inbound M&A

China inbound M&A by foreign strategic investors in 2020 (USD14.6 billion) increased by 30.81% in value over 2019 based on disclosed deal volume, though the number of transactions (181) declined by 27.02% according to statistics released by PwC. Following the implementation of the Foreign Investment Law and its implementing regulations (Foreign Investment Law) on 1 January 2020, China has been attracting more foreign investment in the past year. Figures released by MOFCOM show that China attracted CNY999.98 billion of foreign investment in 2020, reflecting a 6.2% year-on-year increase despite the fact that global cross-border investment encountered a sharp decline in the face of the COVID-19 pandemic. The number of new foreign-invested enterprises set up in China in 2020 reached 39,000, making China the world's largest recipient of foreign investment.

One of China’s commitments upon its entrance to the WTO was the opening-up of its economy and the facilitating of foreign investments. This was the keynote of 2020 M&A policy and is also essential to China’s economic development. To further improve the environment for foreign investors in China, material revisions to the rules and regulations governing inbound M&A have been made in the past year.

The Administrative Measures for Strategic Investment in Listed Companies by Foreign Investors

On 18 June 2020, the MOFCOM promulgated the revised draft of the Administrative Measures for Strategic Investment in Listed Companies by Foreign Investors (Strategic Investment Regulation) for public comment. The Strategic Investment Regulation regulates M&A involving A-share listed companies. The 2020 draft mainly indicates the following potential revisions of the Strategic Investment Regulation.

  • In light of the new information reporting mechanism under the Foreign Investment Law, replacing the ex-ante MOFCOM examination and approval of foreign strategic investment with an ex-post reporting requirement.
  • Further clarifying that in stock-swap M&A transactions, except for implementing foreign strategic investment by means of a contractual transaction (as opposed to other means including tender offers), the foreign entity as a party to the swap transaction is no longer required to be a foreign listed company.
  • Clarifying that the proportion of shares scheduled to be purchased in foreign strategic investment, by contractual transaction or by tender offer, shall not be less than 5% instead of 10%.
  • Adding additional requirements in terms of information disclosure and expert opinion on compliance with the Strategic Investment Regulation.
  • Specifying that foreign strategic investment in the companies listed on the National Equities Exchange and Quotations may be made with reference to the Strategic Investment Regulation.

Foreign investment in specific regulated industries

On 23 June 2020, the 2020 version of the List of Special Administrative Measures for Foreign Investment Access (the so-called Negative List) was promulgated and implemented.

Compared with the 2019 version, six items, which used to be subject to prohibitions or limitations, were entirely removed from the new Negative List, including the following.

  • Foreign investment in the smelting and processing of radioactive minerals and the production of nuclear fuel was prohibited.
  • The construction and operation of urban water supply and drainage pipelines and networks for cities with an urban population of 500,000 or more was required to be controlled by Chinese shareholders.
  • Foreign investment in air traffic control was prohibited.
  • Foreign shareholders were not permitted to hold more than 51% of the shares of securities companies or securities investment fund management companies – this restriction will be eliminated in 2021.
  • Foreign shareholders were not permitted to hold more than 51% of the shares of futures companies – this restriction will be eliminated in 2021.
  • Foreign shareholders were not permitted not hold more than 51% of the shares of life insurance companies – this restriction will be eliminated in 2021.

Another six items were revised, among which developments in the fields of manufacturing and agriculture are of particular interest.

In the field of manufacturing, the 2020 version of Negative List cancelled the restrictions on the foreign shareholding percentage in the manufacturing of commercial vehicles

In the field of agriculture, the requirement that the Chinese party must hold a controlling stake in the breeding of new varieties and seed production of wheat was amended to a requirement that the shareholding percentage of the Chinese party shall not be less than 34%.

In addition, the 2020 version of the List of Special Administrative Measures for Foreign Investment Access in Pilot Free Trade Zones and the Catalogue of Encouraged Foreign Investment Industries were also promulgated in 2020 to facilitate foreign investment in China, with the former removing six items from the negative list and the later adding 127 to the encouraged list.

Measures for the Security Review of Foreign Investment

On 19 December 2020, the NDRC and MOFCOM jointly promulgated the Measures for the Security Review of Foreign Investment (Security Review Regulation), which was implemented on 18 January 2021. The Security Review Regulation marks a new era of national security review in China and will have far-reaching impact on foreign M&A in China.

Under the Security Review Regulation, where an acquisition of Chinese enterprises’ equity or assets by foreign investors through M&A falls within any of the following categories, the acquisition shall proactively be reported to the NDRC before closing:

  • investment in the military industry, facilities supporting the military industry or other fields concerning national defence and security, as well as investment in the surrounding areas of military facilities and military industry facilities; or
  • investment in important agricultural products, important energy and resources infrastructure, important equipment manufacturing, important infrastructure, important transportation services, important cultural products and services, important information technology and internet products and services, important financial services, key technologies and other important fields concerning national security, and obtaining actual control of the invested enterprise.

When it is decided that the reported inbound M&A affects national security, the foreign investor may not make the investment, and where the investment has been made, the foreign investor shall dispose of equity or assets within the prescribed time limit and take other necessary measures to restore the pre-investment state and eliminate the impact on Chinese national security.

Rules on handling complaints of foreign-invested enterprises

The Rules on Handling Complaints of Foreign-Invested Enterprises was promulgated on 18 August 2020 and came into force on 1 October 2020. Under these rules, foreign investors may apply for MOFCOM or local government co-ordination when their legitimate rights are infringed by administrative agencies, as well as reporting issues and suggestions concerning the Chinese investment environment. These new rules are expected to facilitate foreign inbound M&A in China with more practical dispute resolution choices, which is consistent with the legislative purpose of the Foreign Investment Law to promote foreign investment activities in China.

The Potential Impact of the Blocking Rules and the Unreliable Entity List Rules

The Blocking Rules and the Unreliable Entity List Rules

Against the backdrop of a rapidly changing international trade environment, and US-China relations in particular, it is worth noting two new rules recently promulgated by MOFCOM:

  • the Rules on Blocking Unjustified Extraterritorial Application of Foreign Laws and Measures, effective as of 9 January 2021 (Blocking Rules); and
  • the Rules on Unreliable Entity List, effective as of 19 September 2020 (Unreliable Entity List Rules).

Although these rules may be more related to trade sanctions and export control administration, it appears that parties to M&A transactions have taken these rules into account when negotiating M&A deals.

The Blocking Rules do not specify which foreign laws or measures (collectively blocked foreign laws) are subject thereto, but it could be reasonably anticipated that recent US laws and measures (eg, sanctions and export control) would be the main subjects. The Blocking Rules do not clearly state what specific circumstances are regulated either. Article 2 of the Blocking Rules only provides that they apply to circumstances where the extraterritorial application of foreign laws and measures is against international laws and basic norms of international relations and unjustifiably prohibits or restricts Chinese parties from conducting normal business activities with third-party country counterparts.

According to a press conference held by MOFCOM shortly after the release of the Blocking Rules, a typical scenario contemplated under the Blocking Rules is where a Chinese company is prohibited under the US laws from engaging in an M&A transaction with its counterparts in a third-party country (eg, countries within the Belt and Road initiative), subject to sanctions by the Office of Foreign Assets Control of the US Department of the Treasury (OFAC).

What seems to be relatively clear is the scope of the entities and individuals subject to the Blocking Rules. The Blocking Rules mainly apply to Chinese entities and individuals (including foreign-invested companies in China), and it prohibits, through injunctions imposed by the MOFCOM, Chinese entities and individuals from complying with the blocked foreign laws. Foreign companies are generally not subject to the Blocking Rules, but they may be required to compensate their Chinese counterparts under the judicial remedies available to Chinese parties under the Blocking Rules if such foreign companies benefit from foreign judgments or awards against their Chinese counterparts based on the blocked foreign laws.

With respect to the Unreliable Entity List Rules, a typical unreliable entity contemplated thereunder would be a foreign company ceasing its supply of goods or services to its Chinese counterparts blacklisted by the OFAC or the Bureau of Industry and Security of the Department of Commerce (BIS). In which case, that foreign company’s business and trade with China could be substantially affected.

The authors' observations

As of the date of this article, there have been no unreliable entities publicly identified by Chinese government authorities, nor have any cases involving the blocked foreign laws been publicly released. Given the low legislative level of these two sets of rules (both were formulated by MOFCOM as departmental rules), the absence of a detailed implementation mechanism, and unclear enforcement practices by Chinese government authorities up till now, it remains to be seen how and to what extent the Blocking Rules and the Unreliable Entity List Rules will impact M&A transactions involving Chinese parties. Nevertheless, the following might reasonably be anticipated.

Deal certainty

These rules may affect deal certainty in various ways. First, as we have seen in some transactions, parties have put in place stricter deal protection mechanisms. For example, the buyer may require the seller and targets to provide representations and warranties and a corresponding indemnity mechanism with respect to trade sanctions and export control, as well as requesting clear exit mechanisms (either through termination for convenience or by requiring the seller to repurchase the purchased equity or assets). Second, in deals where buyers have financing needs, such financing might be denied by financial institutions because of the blocked foreign laws.

Vertical M&A

Given the changing landscape of US-China relations, it may be reasonably anticipated that, in response to the US sanctions and export controls, Chinese companies may pay more attention to vertical M&A deals in order to secure safe supply chains.

Dilemma

Concerns have been raised as to whether these rules would put Chinese and foreign parties to transactions into an awkward dilemma (ie, either they observe the blocked foreign laws or follow the injunctions imposed by the Blocking Rules). Although the Blocking Rules stipulate, in principle, that injunctions may be suspended, revoked or exempted under certain circumstances, detailed implementation of these mechanisms remains unclear. In other words, this may essentially force foreign companies (including their Chinese subsidiaries) to take sides with either the USA or China, which could have a serious impact on future M&A transactions.

Merger Control and National Security Review

China promulgated its Anti-monopoly Law in 2007 and, since March 2018, the PRC State Administration for Market Regulation (SAMR) has been the authority administering all anti-monopoly enforcement matters, including merger control. Within the Anti-monopoly Bureau of the SAMR, three divisions are tasked with reviewing merger control filings while another division is responsible for investigating illegally conducted concentrations of business operators. 

In October 2020, the SAMR issued Interim Provisions on Review of Concentration of Business Operators (Interim Provisions), consolidating and also replacing six regulations and normative documents previously issued by MOFCOM, then the authority in charge of merger control administration. The Interim Provisions, with 7 Chapters and 65 Articles in total, provide comprehensive rules regulating the filing and review of concentration of business operators, the determination and implementation of restrictive conditions (also called merger remedies), and the investigation of illegally conducted concentrations of business operators.

In 2020, the SAMR, in total, initiated reviews over 481 merger control filings and concluded reviews over 473 filings. Among the 473 concluded filings, no case was prohibited, four cases were approved with restrictive conditions, while all the remaining 469 cases were approved without conditions (accounting for 99.2%). All the four cases approved with restrictive conditions are concentrations between US companies or between US companies and European companies. In 2020, the SAMR rendered punishment decisions in 13 cases where concentrations of business operators were illegally conducted. Notably, three of these cases involved the variable interest entity (VIE) structure that has been used in industries where foreign investment is prohibited or restricted, which demonstrates the determination of the SAMR that concentrations of business operators with VIE structures be equally subject to the merger control rules.

COVID-19 and merger review

In responding to the outbreak of COVID-19, the SAMR introduced off-site review of filings in February 2020. In particular, notifying parties may send electronic copies of notification materials as well as replies to the SAMR’s requests for further information (RFI), and the SAMR may also send notices and decisions to the notifying parties via email or fax. The SAMR also established a green channel to expedite the review process for transactions facilitating the prevention and control of the epidemic (eg, pharmaceutical manufacturing, medical instruments, equipment and device manufacturing) and the resumption of work and production. By taking these measures, the SAMR has ensured that the efficiency of its merger control work has not been impacted by the epidemic. According to the SAMR’s statistics, the average time periods for initiating a review and for completing a review have been reduced by 27% and 14.5%, respectively. Specifically, a larger number of simple cases are approved within a very short period (eg, less than 15 days) after the initiation of the review.

Global Law Office

15&20/F Tower 1, China Central Place
No.81 Jianguo Road
Chaoyang District
Beijing 100025
China

+86 10 6584 6688

+86 10 6584 6666

global@glo.com.cn www.glo.com.cn
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Jingtian & Gongcheng was founded in the early 1990s and was one of the first private and independent partnership law firms in China. The firm is headquartered in Beijing, with offices strategically located in Shanghai, Shenzhen, Chengdu, Tianjin, Nanjing, Hangzhou, Guangzhou, Sanya and Hong Kong. It is active in a wide variety of practices and has more than 100 partners in its M&A team. Areas of focus include mergers and spin-offs, tender offerings, leveraged acquisitions, MBOs, joint ventures and strategic alliances, cross-border M&A and M&A financing.

Trends and Development

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Global Law Office has more than 460 lawyers practising in its Beijing, Shanghai, Shenzhen and Chengdu offices and is one of China's leading law firms. GLO’s corporate M&A practice covers a wide range of transaction types and the entire process of transactions, including unlisted/listed companies’ mergers and acquisitions, and transactions from initial investment to equity exit, with special expertise in handling cross-border transactions and state-owned assets-related transactions and restructuring matters. The firm provides comprehensive services to align industry sectors’ needs, which include financial services, manufacturing, trade, energy and mining, automotive, real estate and construction, transportation, life sciences and healthcare, food and beverage, entertainment and sports, and TMT. The firm's experience and capabilities allow for the provision of one-stop services on complex M&A transactions covering foreign investment access, industry compliance, state-owned asset governance, taxation, foreign exchange regulatory, intellectual property, labour and national security review.

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