The promotion and implementation of the reform of the mixed ownership economy of state-owned enterprises (SOEs), supply-side structural adjustment and private enterprise market integration cannot be dissociated from acquisitions and restructurings.
The main legal issues that enterprises need to pay attention to in the course of an acquisition or restructuring include: first, procedural legal issues associated with acquisitions and restructurings, e.g. whether the internal decision-making procedure and level are legally compliant, whether the decision-making entity is an authorized entity, whether the contractual parties are qualified, whether the necessary announcement procedure has been carried out, and whether the approvals, recordals or registrations involved in the acquisition or restructuring have been completed. Second, substantive legal issues associated with acquisitions and restructurings, e.g. whether title to the target company’s assets is free and clear, and whether there is any major legal obstacle to the transfer of title to the target company’s equity or assets.
These legal issues are common and frequently encountered in the course of an acquisition or restructuring. If these issues are not solved properly, they may result in the failure of acquisition transactions. In practice, these issues can be resolved through technical means such as legal due diligence, adjustment of the transaction structure and revision of transaction documents.
On 1 July 2016, the State Council’s State-Owned Assets Supervision and Administration Commission (SASAC) and the Ministry of Finance jointly issued the Measures for the Oversight of Transactions Involving the State-Owned Assets of Enterprises (order No. 32), which requires mandatory floor trading for the capital increases and material asset transfers of enterprises, and which specifies the conditions for where a transaction can be conducted through private negotiations and the authority for approving the same. Additionally, the order extends the listing announcement period and adds property right transfer advance information disclosure, and transaction completion announcement periods.
The Interim Administrative Measures for the Recordal of the Establishment and Change of Foreign-Invested Enterprises (Draft for comment), effective from 1 October 2016, specifies that the establishment and change of foreign-invested enterprises and Taiwan-invested enterprises that are not subject to special administrative measures (the Negative List) for access will cease to be subject to administration by way of approval, and will be subject to administration by way of recordal.
The above two sets of regulations will have a relatively big impact on acquisitions and restructurings involving SOEs and foreign-invested enterprises. In addition to the instances expressly specified in order No. 32, property right transfers, capital increases and asset transfers all require floor trading, and the types of announcements and increases in their periods increase transaction costs and transaction difficulty. However, order No. 32 effectively strengthens oversight over transactions that involve the state-owned assets of enterprises. The draft simplifies the administration of foreign-invested enterprises by competent authorities, shortens the time required for acquisitions, and reduces the difficulty involved in acquisitions.
Backdoor listings. Another important recent trend has been the more stringent regulation of backdoor listings. In June 2016, the China Securities Regulatory Commission (CSRC) issued a draft seeking comment on revisions to the Administrative Measures for Material Asset Restructurings of Listed Companies, which is mainly aimed at regulating backdoor listings.
In the current regulations, where the two criteria of “where the total assets purchased from the acquirer and its connected persons account for more than 100%” and “change in control” are both met, a backdoor listing is constituted and CSRC approval is required.
The draft revises the single criterion of total assets to five metrics, i.e. total assets, operating revenue, net profit, net assets and shares issued to purchase assets. If any one of the metrics reaches or exceeds 100% within five years after the change in control, a backdoor listing is constituted. It further specifies that even if none of the five metrics reaches or exceeds 100%, if a fundamental change in the listed company’s main business occurs after the change in control, the same will be deemed a backdoor listing.
Revisions made by the draft also include: specifying that whether a change in control has occurred will be determined based on article 84 of the Administrative Measures for the Acquisition of Listed Companies; abolishing the realization of ancillary financing for backdoor listings through restructurings; specifying the implementation of review requirements for backdoor listings that are more stringent than those for IPOs; and increasing the legal liabilities for circumventing backdoor listings.
Additionally, at the sponsor representative training meeting in May, relevant CSRC officials clarified for the first time the five major directions in acquisition and restructuring regulatory policy, including: (1) more stringent regulation of backdoor listings; (2) strengthening of information disclosure and relaxation of substantive reviews; (3) upcoming implementation of “one stop” examination and approval; (4) innovation in payment methods for acquisitions and restructurings, bringing in such payment methods as preferred shares and private placements of convertible bonds, further improvement of the market-based pricing mechanism, support for the provision of acquisition financing by financial advisers, and support for the development of acquisition funds; and (5) enhancement of the transparency of acquisition and restructuring reviews.
Acquisitions of NEEQ listing enterprises. According to relevant statistics, the rate of failure of acquisitions and restructurings initiated by National Equities Exchange and Quotations (NEEQ) listing enterprises is about 90%. The reasons are, in the author’s opinion: (1) because the fundamentals of many NEEQ listing enterprises are not bad, they frequently become the active or passive acquisition targets of listed companies; however, many projects have run aground or been suspended because of a more stringent regulatory stance toward listed company acquisitions and restructurings recently; and (2) due to the fact that the transacting parties are not able to reasonably manage their expectations with respect to future development, acquisition price, post-acquisition integration and other such arrangements, the transactions fall through because the parties are unable to reach a consensus.
Furthermore, the insufficient familiarity of transaction participants with the acquisition and restructuring rules for the NEEQ listing enterprises, and the overly low intermediary fees resulting in insufficient professional support and preparatory work, have caused frequent problems at the acquisition and restructuring legal and technical levels, e.g. the failure of acquisition transactions caused by the acquisition procedure, equity of the target company or scale of the target assets not satisfying legal requirements.
Transaction participants need to treat professional firms with greater importance, thoroughly familiarize themselves with and flexibly apply the rules, and avoid professional technical-level errors to enhance the success rate of acquisitions.
Li Yanli is a partner at Zhong Lun Law Firm. She can be contacted on +86 10 5957 2059 or by email at email@example.com