Advisories & Insights

China Reveals Rules on Foreign Acquisition

China's entry into the WTO paved the way for many foreign investors eyeing opportunities to acquire Chinese companies during China's privatization of state-owned enterprises. However, the confused state of the Chinese law on this subject has prevented most investors from making substantial deals. Recently, the Chinese Ministry of Commerce (MOC) issued provisional rules governing foreign investors' acquisition of domestic companies, effective April 12, 2003 (The Regulation).

Scope of Application

The Regulation applies to two types of transactions: (1) equity-based acquisition, and (2) asset-based acquisition. Asset-based acquisition also includes a foreign investor acquiring the asset of a Chinese company and using that asset to form a Foreign Invested Enterprise (FIE).

The Regulation applies to all foreign investors. It compliments existing laws governing foreign investment in China and is effective only if the existing laws have no clear provisions. The Regulation's applicability is subject to China's Industrial Guidelines Catalogue for Foreign Investment, which prevents 100% foreign ownership in certain industries and majority ownership in others.

Approval

All acquisitions that come under this Regulation must be approved by the MOC or its local agencies, depending on the size of the acquisition. To prevent delay, it is important that the application is professionally prepared and contains all required documentation to prevent delay.

If MOC issues a certificate of approval, the applicant must then apply to the State Administration of Industry and Commerce (SAIC) for registration. The application to SAIC must be based on MOC's certificate. The applicant is required to submit detailed documents in support of the application.

Appraisal and Purchase Price

All assets and equity to be acquired must be appraised to ensure that purchase price does not fall substantially below their worth. The appraisal must be conducted in accordance with "internationally accepted procedures." However, no specific international appraising procedure is provided, leaving room for dispute as to the acceptable procedure. It is unclear whether a Chinese valuation firm can perform such an appraisal without first showing its expertise in international business appraisal standards.

Purchase Price

In addition to cash payment, the Regulation permits the parties to structure acquisition as asset-for-equity swaps. Foreign investors may use their lawfully owned equity or assets in another company as consideration in the acquisition.

Foreign investors must pay the agreed purchase price within three months from the issuance of business license. Under special circumstances, MOC may allow foreign investors to pay 60% of the purchase price within six months and 100% within a year.

Anti-Competition/Anti-Monopoly Issues

MOC is sensitive about a foreign-owned company dominating the domestic market in a particular industry. Therefore, certain anti-competition/anti-monopoly bars are set to prevent this from happening. Foreign acquisition of Chinese companies will face rejection if the combined size or market share of the resulting entity reaches or exceeds certain limitations. MOC retains considerable discretion on finding a FIE monopolistic.

The Regulation contains an escape provision from MOC's anti-competition/ anti-monopoly review. If the proposed acquisition satisfies certain conditions, such as bringing in advanced technology, the parties may apply for an exemption from the anti-competition/anti-monopoly review.

Miscellaneous

Unless agreed differently, the emerging entity from an equity-based acquisition must assume the liabilities of the former entity. But, in an asset-based acquisition, the domestic enterprise selling the asset retains its own liability.

A selling Chinese entity must serve notice on its creditors and publish a print announcement about the proposed sale within 10 days from approval of the sale. Creditors shall demand the debtor to pay off, or provide security for, its debt within 10 days of such notice and announcement.

Some off-shore acquisitions may also come under the Regulation if they meet certain criteria set forth in the Regulation. Review and approval by MOC or SAIC may be required for off-shore transactions involving acquisition of a Chinese-owned asset.

Conclusion

The Regulation represents China's attempt to legitimize and manage the sale of Chinese-owned assets and equity to foreign investors. Due to the complexity of this process, it is advisable to ask experienced professionals for advice about the legal aspects of an acquisition and assistance in pushing the deal through.

In conjunction with MOC, other governmental agencies are releasing regulations of their own to implement the changing state of China's foreign investment laws. In the next article, we will discuss the latest rules from the State Foreign Exchange Administration regarding foreign currency registration in foreign direct investment projects. If you would like more information about the new rules and how they might affect your Chinese operations, please feel free to contact me at the phone number or email listed below.