The current technology M&A market in China is more active than it was 12 months ago, which corresponds to a general increase in M&A markets globally.
The COVID-19 pandemic has affected the pace of deal activity in the past 12 months in China. In the first six months of 2020, the M&A market was quite slow due to the pandemic, but more M&A deals have been carried out and closed in the past 12 months since COVID-19 was brought under control in China. In addition, another reason for increased M&A deal activity is the reasonable valuations of many M&A targets in industries that were adversely affected by the pandemic.
Key trends in the M&A market in China in 2020–21 include:
New start-up companies are typically advised to incorporate in China. However, where entrepreneurs intend to seek an overseas listing in the future, they may be advised to incorporate or restructure into an offshore holding company, principally in the Cayman Islands.
China has relaxed its incorporation requirements over the years, and it now usually takes one or two weeks to incorporate a purely domestic company, and one or two months to incorporate a foreign-invested company. Generally, there is no initial paid-in capital requirement for a company incorporation unless the company will be engaging in certain specified business activities.
New start-up companies are typically advised to incorporate in China as limited liability companies. The partnership form is usually chosen for the purposes of setting up an investment fund or holding vehicle.
Entrepreneurs and many venture capital firms typically provide early-stage financing to a start-up company. If the funds are provided by venture capital firms, simplified investment agreements will be entered into to set forth the typical preferred rights for venture capital firms.
Typical sources of venture capital in China include funds of funds, wealthy entrepreneurs, government-sponsored funds, large corporations, etc. Both local and foreign venture capital firms are active in China. Government-sponsored funds have also been quite active recently, which has meant funding has been relatively easy to obtain.
Well-developed standards exist for venture capital documentation in China, including for deal terms. Since 2017, Han Kun Law Offices has issued an annual VC/PE Deal Data Analysis Report, which recaps the most common terms in VC/PE deals in China each year and has become the market standard in this field.
Start-ups are typically advised to restructure their corporate forms from an onshore structure to an offshore structure if they intend to list overseas and vice versa. In addition, in the case of domestic listings, PRC law provides that only joint-stock companies can be publicly listed. Therefore, start-ups that intend to list in mainland China (A-share listing) or in Hong Kong (H-share listing) must change their corporate form from a limited liability company to a joint stock company.
Typically, start-up investors may look for a liquidity event after the start-up has operated for more than five to six years. In the past, investors preferred IPOs over a trade sale, but it currently appears that investors are more flexible as to exit options and are open to either an IPO or a trade sale, depending on the specific terms of the transaction.
Chinese companies choose to list domestically rather than overseas, based on a variety of factors. Among others, companies need to consider:
If the company chooses to list on a foreign exchange (neither A-share nor H-share), it must conduct its business through an offshore structure. Use of an offshore structure may complicate a future sale if the buyer is a purely domestic company, and it may give rise to other implications, such as cross-border tax issues, scrutiny by multiple jurisdictions, etc.
If the sale of a company is chosen as a liquidity event, the sale process will more typically be run as a bilateral negotiation with a chosen buyer than as an auction. An auction sale is more common if it is a cross-border deal.
The typical transaction structure in China is either to buy the entire company or to buy a controlling interest, where the buyer buys out the VC funds but requests the management or entrepreneurs to keep a portion of their shares after the sale for the purposes of having a smooth transition period.
Most M&A transactions in China are conducted as a sale of the entire company for a combination of stock and cash, especially in the TMT sector.
Founders are usually expected to stand behind representations and warranties and certain liabilities after closing. VC investors are typically expected to stand behind limited representations, warranties and liabilities only with respect to themselves. An escrow/holdback (ranging from 10–30% of the consideration) is customary for these purposes. Representations and warranties insurance is not customary in China.
Spin-offs are customary in China in the technology industry.
Key drivers for considering a spin-off include:
Chinese tax law allows spin-offs to be conducted in a tax-deferred manner, ie, the spin-off price is set at net book value instead of fair market value. Certain criteria must be met, eg, the shareholding structure must remain unchanged, business operations of the spun-off entities must remain unchanged, and cash payments may be no more than 15% of the total transaction consideration.
Chinese law permits spin-offs to be immediately followed by a business combination. There are no specific requirements for this.
Spin-offs typically take between several months and one or two years to complete, depending on how the spin-off is structured. There is no need to seek tax authority pre-approval for spin-off arrangements, but in practice it is recommended that the arrangements be discussed with a competent tax authority before the transaction is executed, especially for large-volume restructurings. Such discussions may take one to two months.
It is customary for buyers in China to acquire stakes in listed companies before making an offer to acquire; stakes are often built through negotiated transfers or by other means. Acquisitions of listed technology companies are predominantly conducted by way of transfer agreements, supplemented by a tender offer or other arrangement.
Buyers are obliged to report their stake in a listed company within three trading days once the stake reaches 5% of the shares of the listed company (eg, upon acquiring shares on the open market or after the execution of a transfer agreement). Buyers must thereafter report each additional 5% increase or decrease in ownership in accordance with the same three-day time limit. In addition, once the buyer acquires a 5% stake in the target listed company, the buyer must notify the target of every 1% increase or decrease in shareholding on the trading day following the occurrence of such change. The target listed company will then publicly announce the buyer’s change in shareholding.
Buyers are not allowed to trade shares of the listed company prior to submission of these reports and the making of an announcement. In addition, when making these reports, each buyer must disclose the purpose of its acquiring a stake in the target listed company and whether it intends to continue its stakebuilding within the next 12 months. If the buyer has acquired 20% or more of the shares in the target, it must also disclose its future plans for the listed company, including whether it intends to adjust the company’s business, organisation and structure, personnel arrangements, and other matters. The buyer may not break any disclosed plans and commitments in its subsequent actions.
Buyers who acquire a listed company are not allowed to transfer the acquired listed company’s shares within 18 months of completion of the acquisition (if the buyer is an offshore investor, the restriction period is three years). However, transfers between different entities controlled by the same overall controller are not restricted.
Buyers must make a tender offer to all shareholders of a listed company once their stake in the company reaches 30%, if the buyers intend to continue increasing their shareholdings, according to the relevant provisions of administrative measures. This is also called a mandatory offer. It is noteworthy that if a buyer intends to acquire listed company shares other than by way of a tender offer, such as, acquisition by a negotiated transfer agreement from a specific seller or indirect acquisition of an entity that holds certain shares of the listed company, and the acquisition will cause shares owned by the buyer to exceed 30% (eg, from 26% to 31%), a tender offer to acquire all the shares held must be made to all the shareholders of the company. Exceptions exist where the buyer satisfies special conditions, such as transfers between entities under the same control or where the 30% shareholding threshold is passively exceeded due to the listed company’s targeted share buy-backs, etc.
General Acquisition Structures
As previously discussed, acquisitions of listed companies in China are principally conducted by way of transfer agreements (direct or indirect) and supplemented by other means, such as by subscription of shares issued by the listed company via private placement; tender offers; purchasing shares via stock exchange trading systems; becoming the actual controlling party by way of an investment relationship, agreement or other arrangement (eg, by accepting voting rights proxy or agreeing to carry out concerted action with other parties) or other means.
Acquisition by Merger
Acquisitions of listed companies may also be completed by merger, although such transactions are rare in China. Mergers in this context are uncommon because the China Securities Regulatory Commission (CSRC) and the relevant exchange must pre-approve operational matters, which usually includes the buyer applying for an IPO on the A-share market (where the buyer is an unlisted domestic company); the buyer issuing shares (where the buyer is a listed company); and stock-for-stock mergers. The approval process is complicated and more restrictive as it requires compliance with a number of laws and regulations on listing and restructuring.
Consideration and Payment Methods
Public company acquisitions in the technology industry are more typically structured as cash transactions, rather than stock-for-stock, a combination of cash and stock, or other legal methods. Cash is favoured in these acquisitions because securities (including stocks) used as consideration must meet certain requirements, such as, that the shares can be traded conveniently and have a reasonable valuation, and tender offers require three years of annual audit reports and a securities valuation report. The cash option must be provided where the securities are not listed on a stock exchange. It should be noted that, in some cases, cash consideration is mandatory or may be offered. Cash consideration is mandatory where the buyer is required to issue a tender offer for all the shares with the intention of terminating the company’s listed status or due to a failure to satisfy the conditions of exemption for a tender offer. Additionally, as mentioned above, if the buyer should also provide a cash option where it pays with securities other than the shares of a non-listed company as the consideration, a cash option should be provided to the counterparty.
Minimum Price Requirements
Acquisitions and business combinations in China are subject to minimum price requirements, which vary depending upon how the transaction is structured.
Agreements and tender offers
The minimum pricing in an acquisition by agreement must not be lower than 80% or 90% (depending on the listed market) of the closing price of the listed company on the last trading day preceding the execution of the agreement. For tender offers, the minimum price must not be less than the highest price paid by the buyer within six months prior to the date the tender offer is announced. In practice, this price is generally not lower than the arithmetic average of the daily weighted average price of the 30 trading days prior to the date of announcement.
The pricing of stock-for-stock merger transactions must not be lower than 90% of any of the following: the average trading price of the company's shares for the past 20, 60 or 120 trading days prior to the announcement date of the board's resolution of the listed company with respect to the merger transaction (there is usually some premium based on the listed company’s share price average over the previous 20 trading days).
Use of contingent value rights
Buyers and sellers generally do not agree on mechanisms to adjust transaction consideration because the Chinese securities regulators impose a minimum price requirement for the acquisition of listed companies and regulate the overall arrangements for such transactions. However, in some cases, the parties will agree through commercial negotiations on performance commitments for the listed company. In such cases, the exiting controlling shareholder or the actual controlling party of the listed company may undertake to achieve certain performance commitments with respect to the listed company within a certain period of time, and compensate the buyer accordingly if the company fails to achieve these performance commitments.
The buyer usually chooses to make minimum acceptance conditions according to relevant provisions of administrative measures to make mandatory offers, which will be discussed in 6.7 Minimum Acceptance Conditions. However, when a buyer makes a voluntary tender offer, it usually sets up some other conditions, related to the acquisition price and ratio, in order to acquire shares.
Generally, the buyer would like to offer a relatively high price based on the expectations of the existing shareholders of the listed company, and if a voluntary tender offer is made to obtain control of a listed company, then the agreement usually sets forth a certain percentage of pre-offer shares as a condition precedent to the execution of the offer.
Chinese securities regulators implement restrictions with respect to the ratio (percentage of shares to be acquired) and price, but only limited to achieving minimums, not maximums.
Voluntary tender offers are rare in comparison to mandatory tender offers triggered by a 30% shareholding threshold, mentioned in 6.2 Mandatory Offer. The circumstances under which voluntary tender offers occur are generally:
It is customary in China for the parties to enter into a transaction agreement in connection with the acquisition of control rights of a listed company via a transfer agreement or merger. However, for tender offers, it is not customary to enter into an agreement with the listed company or the seller; instead, the buyer usually puts forward a tender offer that is then accepted by the original shareholders.
When acquiring a listed company by agreement, the parties may agree in the transaction agreement on certain obligations that the listed company is to undertake. These obligations usually include:
The minimum acquisition threshold for an acquisition by tender offer of a listed company is based on a combination of factors, such as the concentration of the shareholding structure of the listed company, the buyer’s purpose in making the acquisition, the capital status of the buyer, and the cost of the acquisition. However, regardless of these factors, the following minimum requirements need to be satisfied.
The period of a tender offer may be no less than 30 days and no more than 60 days, and the buyer will not be allowed to modify the offer before the expiry of the offer period. Apart from this, there are usually no strict requirements about the time limitation for other takeover offers.
Chinese law does not provide for squeeze-out mechanisms or ownership thresholds whereby a buyer can buy out the shareholders of a listed company who have not tendered, following a successful tender offer. Upon completion of the tender offer, the remaining shareholders who refused to tender their shares are entitled to continue as shareholders of the company.
In an acquisition of a listed company, if the buyer intends to make the acquisition in cash, “certain funds” are required to launch the offer in China if the buyer has sufficient funds to implement the bid, but the buyer also needs to disclose the source of its funds and submit relevant documents to prove that the funds are sufficient and legitimate. The Chinese securities regulators will usually focus on the source of the funds of the buyer and its ability to perform contractual obligations. Generally, the funds of the buyer must not stem from the listed company, the seller or its affiliates. In any case, the buyer itself should make the offer.
Buyers are also permitted to use bank loans or borrowings, but the procurement of such bank loans or borrowings cannot be a prerequisite for the acquisition. Additionally, if there is a possibility that the buyer will not be able to obtain the corresponding loans or borrowings, it is required to propose a plan to replenish or secure the funds.
In an acquisition of a listed company, the buyer and the target company or its selling shareholders may negotiate certain deal protection measures. These measures include:
In an acquisition via transfer agreement, the selling shareholders usually assume the corresponding obligations, whereas in a merger transaction, the target company usually assumes these obligations.
A successful bidder that obtains less than full ownership of a public target company may find it difficult to obtain additional governance rights. The circumstances differ depending upon whether the target company remains publicly listed or becomes private.
Company Remains Public
Target companies that remain public are subject to A-share regulatory independence requirements and buyers are often unable to obtain additional rights beyond those entitled to them by their shareholdings. To enhance control, buyers may negotiate with other shareholders of the target company to agree on certain governance arrangements.
Company Becomes Private
If a target company becomes private, the buyers may negotiate with other shareholders of the target company to agree on certain governance arrangements, such as profit-sharing. Subject to the provisions on joint stock companies, however, the same shares have the same rights and therefore, the buyer may be unable to obtain more voting rights than the number of shares they hold, in which case, the target company could be restructured into a limited liability company after it becomes private in order to obtain additional rights, but this may also require the consent of the other shareholders.
To reduce uncertainty, it is customary in China for buyers to seek to obtain irrevocable commitments from the principal shareholders of the target company to tender or support the transaction. The parties usually execute a term sheet to reach consensus on essential terms, and the principal shareholder is usually required to perform certain co-operative obligations, and may not transfer or negotiate with another third party (eg, a competitor) with respect to the transfer of shares in a specified period. Principal shareholders who agree to the term sheet will generally comply with the commitments unless they are willing to assume liability for breach of contract.
Takeover and tender offers may be subject to approval depending on how the proposed transaction is structured.
Acquisitions by Merger
The CSRC and the stock exchange must pre-approve acquisitions by merger, as discussed in 6.3 Transaction Structures. Under current policy, this review period is no less than six months. Additionally, the Ministry of Commerce (MOFCOM) approval is required if the buyer in a stock-for-stock acquisition is a foreign investor, (this is extremely difficult to arrange in practice).
Acquisitions by Tender Offer
In an acquisition of a listed company by way of tender offer or transfer by agreement, pre-approval from the Chinese securities regulators or the stock exchanges is not required, but the relevant agreements and announcements will be disclosed and may be reviewed and scrutinised by the stock exchanges during the transaction. If the buyer is a foreign investor, whatever the method of acquisition, pre-approval from MOFCOM will be required.
Approval of Offer Terms
The CSRC and the stock exchange do not usually pre-review other offer terms, such as timing and price, provided that the offer is in compliance with the relevant PRC laws and regulations on the acquisition of listed companies, which are generally described in 6.5 Common Conditions for a Takeover Offer/Tender Offer.
The buyer is entitled to establish the timeline for the offer free of regulatory supervision, provided that the offer is valid for no less than 30 days and no more than 60 days. If a competitive offer is announced, and the buyer modifies the offer less than 15 days before the expiry of the original offer period, the offer period should be extended by more than 15 days, but not later than the expiry of the other competitive offer.
As previously discussed, the acquisition period for a tender offer must be no less than 30 days and no more than 60 days, and the acquisition period may be extended, but not reduced, after the offer is made. Such extensions do not, generally, exceed 60 days unless there is a competitive offer. There are usually no strict requirements about the time limitation for the other takeover offer.
As discussed before, pre-approval from the Chinese securities regulators or the stock exchanges is not required in a tender offer or transfer by agreement. If the procurement of other pre-approval from the State-owned Assets Supervision and Administration of China, the State Administration for Market Regulation, and MOFCOM (if the buyer is a foreign investor) is necessary for an acquisition, this is usually set as a condition precedent to the offer and its closing if the merger and acquisition transaction of a listed company requires this. Regulatory approvals should be obtained after the announcement of the offer and before the offer is officially made or before the agreement becomes effective. Therefore, the offer period is not affected by regulatory pre-approvals.
Setting up a new company in certain sectors of the technology industry in China is subject to specific regulations. For example, value-added telecoms operators must obtain a value-added telecoms business licence from the competent telecoms administration bureau, which may take several months depending on the specific scope of the licence. Also, online game operators must obtain an online publishing permit from the competent publication authority, which may take several months in practice.
The CSRC and the relevant PRC stock exchanges are the primary regulators for M&A transactions in China’s public securities markets.
Foreign investment is generally welcome and permitted in China, and foreign direct investment filings, which are mandatory under Chinese law, are straightforward and easy to complete.
Additional requirements or restrictions may apply if the foreign investment is to be made in certain industries as set forth in the Special Administrative Measures for Foreign Investment Access (Negative List), which is amended from time to time.
National Security Review
China’s new national security review process, which was reformed by the Measures for Security Review of Foreign Investment, came into effect on 18 January 2021. The measures provide for a systematic review process for foreign investment from a national security perspective.
Forms and scope
All forms of foreign investment are covered, including Sino-foreign equity joint ventures established through M&A, newly established wholly foreign-owned enterprises or projects, and other forms of investment (including foreign-to-foreign transactions where the target has Chinese subsidiaries).
The scope of national security is also expanded to cover industries involving the military and military support, important agricultural products, important energy and resources, major equipment manufacturing, important infrastructure, important transportation services, important cultural products and services, important information technologies and internet products and services, important financial services, critical technologies and other important sectors related to national security.
China’s Export Control Law, which unified the framework for China’s export control regime, took effect on 1 December 2020.
The Export Control Law applies to the export of “controlled items”, which are defined as “dual-use (both civil use and military use) products, military products, nuclear materials and other products, technologies and services relating to the protection of national security, national interest or the fulfilment of anti-proliferation and other international obligations”.
Those who wish to export controlled items are required to obtain a licence from the enforcement authority. Moreover, a licence may be required for the export of goods that fall outside the list of controlled items but could:
End user and end use
Exporters must provide certificates for the end user and end use of controlled items. The certificates must be issued by the end user or the government authorities in the country or region where the end user is located. The end user must commit not to change the end use of the controlled items or to transfer them to any third party.
Those importers and end users who breach these requirements, or who endanger national security or national interest, or who use controlled items for terrorist purposes, will be put on a blacklist and prohibited from dealing with Chinese exporters.
In addition, China also recently enacted other laws and departmental rules that play an important role in establishing China’s export control and international trade regime, including the Law on Countering Foreign Sanctions, the Provisions on Unreliable Entities List, and the Rules on Counteracting Unjustified Extraterritorial Application of Foreign Legislation and Other Measures.
Mergers and acquisitions and business combinations are subject to antitrust filing obligations according to China’s Anti-monopoly Law. If a transaction should lead to a concentration of undertakings that reaches specific thresholds, it must be notified to the State Administration for Market Regulation (SAMR) for antitrust review.
Concentrations of Undertakings
The Anti-monopoly Law defines “concentration of undertakings” as:
The establishment of a joint venture with two or more shareholders having joint control will be deemed a concentration of the controlling shareholders.
The thresholds that trigger the obligation to notify mainly focus on the turnover of undertakings participating in the concentration. In particular, concentrations that reach the following thresholds must be notified:
The primary labour law regulations in China concerning M&A transactions include the Labour Contract Law, the Social Security Law and other employment-related legislation, administrative regulations, departmental rules, local regulations and judicial interpretations.
Employers are required to consult with trade unions under many circumstances in connection with M&A transactions, including the formulation and amendment of certain policies, retrenchments, unilateral termination of employment contracts, or extension of working hours.
Provisions of the Labour Contract Law apply in an M&A transaction where the employer decides to retrench 20 or more employees or fewer than 20 but more than 10% of the employer’s workforce. In such cases, the employer must:
The trade union’s opinion is not binding on the employer as it is merely a procedural requirement, and it is not required that such retrenchment should be approved by the board, according to Article 41 of the PRC Labour Contract Law.
In an M&A transaction, where the employer formulates or amends policies affecting employees related to remuneration, working hours, labour safety and health, and labour discipline, etc, the employer is required to disclose and discuss the amends with the employee representative congress or all the employees in the first instance, then to negotiate them with the trade union or employee representatives.
The trade union has the right to raise its concerns with the employer on any issues and such issues should be addressed through negotiation. The employer will disclose this formulation and amendment of certain policies with all its employees.
China has currency control regulations that limit the convertibility of the country’s official currency, the renminbi, into foreign currencies and vice versa. In China, foreign exchange in connection with an M&A deal is permissible as long as the necessary filing procedures have been completed with the competent foreign exchange authority or its designated commercial banks.
In recent years, the SAMR has stepped up administrative investigations and enforcement actions in connection with historical merger notification filing compliance in the TMT sector. This has had a significant impact on M&A deals in China’s TMT sector and parties to these deals now regard antitrust clearance as being more important than ever before.
A public company is allowed to provide due diligence information to bidders with respect to its operations and other relevant matters. Certain information may not be provided, such as confidential information not yet publicly disclosed, information pertaining to state secrets, etc. If it is a public bid, the public company will generally provide the same information to all bidders. The company may allow for a reasonable level of technology due diligence, which will vary on a case-by-case basis depending on the specific requirements of the bidders and the negotiations between the parties.
The recently adopted Data Security Law (DSL) and the Personal Information Protection Law (PIPL) are the major PRC data laws that set certain limitations on the due diligence of a technological company.
The DSL and Its Implications
On 10 June 2021, the 29th meeting of the Standing Committee of the 13th National People’s Congress formally adopted the DSL, which took effect on 1 September 2021. The DSL is the first dedicated and comprehensive Chinese law on data security.
Enhanced protection obligations for important data and core data
The DSL lays down the framework for data classification and multi-level data protection requirements. Certain data crucial to national security and public interests is to be categorised as important data requiring enhanced protection. On top of data classification, graded protection and important data catalogues, the DSL requires a more stringent administrative system for national core data, which is created by the DSL and vaguely defined as data related to national security, the lifeline of the national economy, people’s livelihoods in important areas, significant public interests, etc.
In light of this, enhanced data protection requirements will apply where a technology company subject to due diligence may be deemed as a critical information infrastructure operator (CIIO) or where the due diligence involves important data or core data.
Limitations on cross-border data transfers under the DSL
Relevant restrictions under the DSL apply where due diligence data comprises important data and export of such data, including transferring a copy abroad or allowing remote access from another jurisdiction outside of mainland China.
The DSL requires the competent authorities to conduct a security assessment before important data collected and generated by CIIOs can be transferred cross-border. The DSL further stipulates that the cross-border transfer of important data pertaining to non-CIIOs is subject to security assessment or restrictions issued by the Cyberspace Administration of China (CAC) and other relevant departments.
The PIPL and Its Implications
On 20 August 2021, the 30th Meeting of the Standing Committee of the 13th National People’s Congress formally adopted the PIPL, which came into effect on 1 November 2021. The PIPL is the first dedicated and comprehensive PRC law on personal information protection and is considered to be the Chinese counterpart of the EU General Data Protection Regulation (GDPR).
Advisability to obtain consent from relevant individuals
Similar to the GDPR, personal information under Chinese law refers to any information, excluding anonymised information, that is related to identified or identifiable natural persons and has been recorded, electronically or otherwise. Anonymised information which does not identify particular subjects is not considered to be personal information.
Where personal information is used in the due diligence of a technology company, it is advisable to obtain the relevant individuals’ consent for processing the personal information, despite the availability of other legal bases for processing, such as the performance of contracts. If the personal information is indirectly obtained from third-party vendors for such due diligence work, the contract with such vendors should include representations and warranties that the vendors will ensure the lawful collection and sharing of the personal information.
Cross-border data transfer limitations under the PIPL
The PIPL requires separate consent from individuals whose data will be transferred outside Mainland China. Furthermore, the PIPL requires that CIIOs and certain high-volume personal information handlers pass a security assessment by the CAC before making such cross-border transfers. The aforementioned volume threshold has not yet been designated.
Information related to a bid (including its pricing) is required to be made public promptly in accordance with relevant PRC laws and regulations. Public disclosure of a bid is generally required either upon the execution of a term sheet or an official agreement by and between the parties with respect to the acquisition of the listed company, or after a relevant resolution has been adopted by the company’s board of directors or board of supervisors.
A prospectus is required to be issued for the issuance of shares in a stock-for-stock takeover offer or business combination involving a listed company under certain circumstances. This includes where the buyer is an unlisted domestic company (including foreign-invested enterprises) and the acquisition causes the buyer to have more than 200 shareholders.
The buyer may avoid the prospectus requirement by choosing to implement the stock-for-stock takeover as a major asset reorganisation of the target listed company. After obtaining CSRC approval, the buyer may directly apply to list its publicly issued shares on a stock exchange. In this way, the buyer is not required to prepare a prospectus, although it remains subject to the relevant IPO rules and requirements.
Exchange Listing Requirements
The buyer in a stock-for-stock takeover transaction of a listed target company must itself be exchange-listed or otherwise apply to list its shares. For example, if the buyer is a foreign investor, then it is required to be listed on an offshore exchange. Where the buyer is a domestic unlisted company, the buyer is required to apply to list all its shares on a domestic stock exchange in China.
Bidders are required to prepare and submit audited financial statements if their post-acquisition shareholding in a listed target company will reach or exceed 20% (whether the acquisition was in cash or stock-for-stock). In addition, if a buyer acquires shares in the target company in a private placement as part of a stock-for-stock acquisition, the buyer is required to submit relevant audited financial statements or a valuation report for the shares paid as consideration. These financial statements and reports must be prepared in accordance with either Chinese accounting standards or international accounting standards.
Transaction documents the parties have executed to complete a listed company acquisition, need to be filed with the stock exchange and/or the CSRC.
All the directors, as well as the supervisors and management, of a company must have the obligations of loyalty and diligence to the company under the PRC Company Law. This is similar to the concept of fiduciary duty under common law and is owed to the company.
It is not common for the board of directors of a private company to establish any committee in business combination.
The board of directors of a company tends to play a limited role in Chinese M&A deals. The founders or controlling shareholders are usually more actively involved in negotiations rather than the board. Minority shareholders may be involved in the negotiations in a limited way, to the extent that the deal affects their own rights and interests, such as in terms of consideration, escrow or tax withholding. It is not common to have shareholder litigation challenging the board’s decision to recommend an M&A deal.
Financial advisers are commonly engaged to provide financial services and advice to the company (typically to the controlling shareholders or the founders) in connection with an M&A deal, especially in terms of valuation and deal structure. There have been limited cases involving engaging a financial adviser to provide a formal fairness opinion, but this is not very common in domestic deals.
The most notable trend in China’s M&A area is simply the robustness of the domestic market. The first half of 2021 witnessed 6,177 M&A transactions, the highest level since early 2018. This was driven by the country's focus on improving the domestic economy to facilitate a rapid rebound from the COVID-19 pandemic, according to a report from global accounting and advisory giant PwC. China’s outbound M&A also rebounded, reaching an announced value of USD25.3 billion, an increase of 51% compared to the first half of 2020, according to an EY report. Another trend covered by the EY report was the volume and growth of TMT M&A, particularly outbound, which accounted for USD9 billion, almost twice the amount of the second-favourite sector, and it grew by 110% over the same period last year. When the statistics of the second half of 2021 are released, it is expected that domestic M&A will continue taking the lead due to industrial upgrading and transformation. Yet the impact of the pandemic and other related uncertainties may continue to affect mainland and cross-border M&A activity in the second half of the year.
Under the PRC legal and regulatory regime, parts of the PRC economy remain subject to foreign investment restrictions, generally limiting or prohibiting foreign participation in various industry sectors that the PRC government deems sensitive or a matter of national/public security. The Special Administrative Measures for Access of Foreign Investment (Negative List) (the “Negative List”) specifies the maximum foreign shareholding limits applicable to restricted industry sectors. The Negative List is generally updated once a year; most recently on 24 June 2021, it was reported that the National Development and Reform Commission (NDRC) is working with the Ministry of Commerce (MOFCOM) to update the Negative List. In general, for activities and businesses that are subject to such restrictions, sophisticated transaction and corporate structuring may be called for to comply with the foreign investment regime.
National Security Review
On 19 December 2020, the Measures on Foreign Investment Security Review (the “Security Review Measures”) were released by the NDRC and MOFCOM, and they took effect on 18 January 2021. The Security Review Measures reinforce the PRC government’s legal tool, ie, a “security review” process, to prohibit or limit any foreign investments that may be deemed to have a significant impact on China’s national security.
Parties to M&A transactions are putting more focus on assessing whether proposed transactions trigger national security reviews. However, the scope of foreign investment that may be deemed to fall within the security review requirement is quite broad and vague, resulting in many foreign investors as well as target companies in China facing difficulties in making effective assessments. A “pre-consultation” with the NDRC may be carried out to obtain its non-binding view on whether a transaction is suspected or has certain characteristics that may cause the transaction to be subject to a national security review.
Import and Export Technology Control
On 28 August 2020, MOFCOM and the Ministry of Science and Technology jointly issued an amendment to the Catalogue of Technologies Prohibited or Restricted from Export (the “Catalogue”), last amended in 2008. The Catalogue lists technologies that are prohibited or require pre-approval for export. This amendment to the Catalogue added 23 items to the list of restricted exports, modified the descriptions of 21 restricted or prohibited items, and removed four previously prohibited and five previously restricted items. The changes mostly relate to information technology, software and computer service businesses.
On 17 October 2020, the Standing Committee of the National People’s Congress (SCNPC) issued the Export Control Law of the People’s Republic of China (the “Export Control Law”), which came into effect on 1 December 2020. The Export Control Law makes a number of substantial changes to China’s current export control regulatory regime, indicating that regulators may take a more active and pragmatic approach to broadly safeguard China’s national security and interests (especially in the area of technology) going forward.
Any cross-border M&A involving technology needs to consider whether the Catalogue or provisions of the Export Control Law apply. In particular, under the Export Control Law, export control does not only apply to the transfer of controlled items from the territory of Mainland China to overseas but also to the “provision of controlled items by citizens, legal persons or non-legal-person organisations of Mainland China to foreign organisations or individuals”. Such “deemed export” may be broadly interpreted to include the sale of a company by a Chinese seller as long as the company has any technology that is listed as a controlled item.
Blocking Rules and Anti-sanction Law
On 9 January 2021, MOFCOM issued the Rules on Blocking Unjustified Extraterritorial Applications of Foreign Legislation and Other Measures (the “Blocking Rules”), effective as of the same day. Under the context of ongoing US sanctions on Chinese companies, pursuant to the Blocking Rules, the State Council is tasked with establishing an inter-departmental working mechanism, headed by MOFCOM, to take charge of blocking unjustified extraterritorial applications of foreign legislation and other measures.
If the working mechanism confirms an unjustified extraterritorial application of foreign legislation or another measure, MOFCOM may issue a “Prohibition Order” against the relevant foreign legislation or other measure. A Chinese citizen or entity that has suffered losses from foreign legislation or measures falling within the scope of a Prohibition Order (an “Aggrieved Party”) may initiate litigation in China to claim compensation from a third party who benefited from said foreign legislation or measure (a “Benefiting Party”), unless the Benefiting Party has applied for and obtained from MOFCOM an exemption from compliance with a Prohibition Order. The Blocking Rules seem to be another tool in the vein of the Security Review Measures.
On 10 June 2021, the SCNPC promulgated the Law of the People's Republic of China on Countering Foreign Sanctions (the “Anti-sanction Law”), effective as of the same day. The Anti-sanction Law follows, and on the surface may suggest a step up from similar but lower-level legislation, such as the Blocking Rules. Under the Anti-sanction Law, if the (unspecified) relevant State Council departments decide that a foreign nation has violated international law (or even basic norms of international relations) to “contain or suppress” the PRC, or has simply employed “discriminatory restrictive measures” (even based only on the foreign country’s own laws) against PRC citizens or to “interfere with PRC internal affairs”, the departments may add any of the following to a so-called “countermeasures list”: any person or organisation who directly or indirectly participated in the drafting, decision-making or implementation of the discriminatory restrictive measures, as well as any person or organisation affiliated therewith and any manager, director or officers of any organisation on the list. Once an individual or organisation is on the list, relevant State Council departments may employ one or more of the following “countermeasures”: refusing to issue or cancelling visas, banning entry into the PRC, and deportation; sealing up, seizing and freezing movable, immovable and other types of property in the PRC; prohibiting or restricting relevant transactions, co-operation or other activities with domestic organisations or individuals.
As a simple (albeit probably extreme) example, if a company participated in or is even closely tied to any “discriminatory restrictive measures” (even vicariously, through its senior management or actual controllers) against the PRC or any PRC party, the Anti-sanction Law provides for the State Council to effectively stop the company’s transactions (including M&A) with PRC companies.
Data and Personal Information Protection
The year 2021 has been witness to a rapid development of data security regulation in China.
On 20 August 2021, the PRC promulgated the long-awaited Personal Information Protection Law (the “PI Protection Law”), which came into effect on 1 November 2021. Its 74 articles comprise both high-level and specific rules for a broad range of issues related to the processing of personal information of individuals. On the one hand, its coverage overlaps with several laws, regulations, recommended national standards, etc, released in the last few years; thus it may serve as a synthesis of rules while superseding existing conflicting rules. On the other hand, while it contains new or extended rules, it also leaves some aspects of protecting personal information to future implementation rules.
The PI Protection Law includes many provisions apparently imposing concrete responsibilities on parties processing PI, and heightened requirements for those that control large volumes of PI or operate important online platforms. It addresses many concerns that have recently come to be key in China, including automated decision-making and PI cross-border transfers, and may bring some innovations (although still subject to how certain clauses would be implemented, interpreted and applied), eg, the extraterritoriality standards and the heightened (ie, “specific”) consent standard. Parties who process PI should pay attention to obligations and requirements imposed by the PI Protection Law, and promptly set up or reinforce PI compliance policies and engage professionals to address PI issues when necessary, as the PI Protection Law heralds a stricter and more complex PI legal compliance regime in China.
On 10 June 2021, the PRC promulgated the Data Security Law of the People's Republic of China (the “Data Security Law”), effective as of 1 September 2021. The Data Security Law calls for central and local government authorities to give meaning to the term by issuing catalogues of important data and also adds to the requirements regarding important data, particularly:
In addition, both the PI Protection Law and Data Security Law:
The year 2021 marks the beginning of the 14th Five-Year Plan and also a "new era" of PRC antitrust enforcement. The National Economic Conference and central government have repeatedly emphasised the strengthening of antitrust enforcement power and preventing disorderly expansion of capital.
Starting in December 2020, parties that had made transactions in the past but had not completed the requisite filings for them were identified and retroactively punished. Most were internet companies with variable interest entity (VIE) structures: from January to August 2021, 49 historical fail-to-file transactions were investigated and those responsible were punished by China's antitrust agency, which contrasts with the mere dozen such cases in the four years before that enforcement push.
China is also accelerating the revision process of its Anti-monopoly Law (AML) and placing special focus on monopolies in the internet field. On 23 October 2021, draft amendments to the AML were released for public comment. On 7 February 2021, the Anti-monopoly Guide of the Anti-monopoly Commission of the State Council for the Platform Economy Sector (the “Guidelines”) were issued and indicate that antitrust law enforcement agencies can, if they deem it necessary, investigate on their own initiative M&A transactions that do not meet the merger control filing threshold, especially mergers and acquisitions of start-ups and new platforms (also known as "killer acquisitions"). This rule is also reflected in the draft amendments to the AML, which, for the first time, list the key areas in which merger control review will be a focus for regulators, including in the finance, technology and media sectors. In addition, the amendments would significantly increase the penalties for unlawful concentrations, eg, a fine of up to 10% of the operator's turnover in the previous year, compared to a maximum RMB500,000 under the current AML.
From the perspective of merger control review enforcement, it appears that China antitrust authorities will continue to focus on M&A in areas such as internet platforms, technological innovation, data security and social impact, especially in businesses involving internet innovation and “choke-hold” technologies, such as the semiconductor industry.
Intellectual Property Law
A further addition to the punitive damages for intellectual property infringement, ie, the Interpretation on the Application of Punitive Damages Responsibility in Civil Cases relating to Infringement of Intellectual Property Rights (the “Interpretation on Punitive Damages”), came into effect on 3 March 2021. Although punitive damages are provided for by current PRC legislation concerning intellectual property, the Interpretation of Punitive Damages seeks to provide the framework for courts to determine whether and what amount of punitive damages to award. In principle, punitive damages are awardable only for “severe violations” to intellectual property rights. As the Interpretation of Punitive Damages is geared towards augmenting protections for intellectual property right-holders, where an intellectual property portfolio is a target company’s most valuable asset, it is crucial to evaluate and manage the potential benefits and risks associated with intellectual property rights in M&A transactions.
Cross-Border Enforcement of Arbitral Awards
Mainland China and Hong Kong have long had an arrangement regarding their enforcement of arbitral awards rendered in each other’s geographic territory, but on 19 May 2021, the arrangement was strengthened by the Supplementary Agreement of the Supreme People’s Court on the Reciprocal Enforcement of Arbitral Awards between the Chinese Mainland and the Hong Kong Special Administrative Region (the “Supplementary Arrangement”).
The Supplementary Arrangement augments the rights and avenues open to parties with favourable awards to pursue enforceable assets. Specifically, where an award debtor has a place of domicile or property for enforcement in both Mainland China and Hong Kong, the award creditor may apply to the courts in both places for enforcement simultaneously. The two courts will confer with each other in pursuit of enforceable assets up to but not exceeding the total amount under the arbitral award. In addition, the Supplementary Arrangement also broadens the time period in which a party in a PRC-HK-related arbitration can apply for property preservation. When negotiating arbitral resolution clauses in cross-border M&A transactions, parties may consider whether designating Hong Kong for dispute resolution could be additionally advantageous in light of the particular circumstances of the parties and the assets in the transactions.