With the opening of the Chinese market, acquisitions of domestic businesses by foreign investors have become a primary means of foreign direct investment. The following is an overview of key compliance issues encountered in the course of acquisitions by foreign investors. In practice, a more detailed analysis should be conducted, taking into account the specific circumstances of each transaction.
An acquisition by a foreign investor must first satisfy market access requirements. The investor should make sure that the enterprise, post-acquisition, complies with the requirements on business scope set out by state policy with respect to foreign investments. If any industry-specific qualification requirements on foreign shareholders have been imposed – for example, with the advertising and telecommunications industries – the investor should also meet these requirements.
In practice, there are instances where an area is permitted under industrial policy, but the industry’s regulatory authority has not formulated implementation rules for the entry of foreign investment. In such circumstances, the concerned industry remains a grey area for foreign investors. Take the third-party payment business for example. Although a few foreign-invested enterprises (FIEs) have been granted operation permits, the People’s Bank of China is yet to issue detailed provisions regulating foreign-invested payment institutions, thus leaving a relatively large degree of uncertainty for business backed by foreign investments in this area.
If the acquisition takes place in China, the transaction should be approved by the Ministry of Commerce (MOFCOM). In certain restricted industries where pre-approval by an industry regulatory authority is required, such an approval should be secured before an application is submitted to MOFCOM. Additionally, national security review or anti-trust clearance may be required if the target business involves the military, sensitive or key industries, or if business turnover of the parties reaches the filing threshold.
These formalities, if applicable, must be addressed before MOFCOM will review and approve an acquisition application. If the deal involves state-owned assets, special requirements should also be complied with, such as asset verifications, appraisals and approvals by the competent authority administrating the management of state-owned assets.
If the acquisition concerns a publicly listed company in China, other than being a QFII (qualified foreign institutional investor), the investment must be approved by MOFCOM and the China Securities Regulatory Commission (CSRC) and should follow the statutory processes of assignment by agreement or private placement. After obtaining the above approvals, the enterprise being acquired, or the investor, should register amendments to the existing corporate profile or formation of a new enterprise with the State Administration for Industry and Commerce (SAIC).
If the target is an existing FIE in China, and its ultimate shareholder holds its interest through an intermediate holding company, the transaction may be completed via acquisition of the intermediary. In this scenario, the transaction is generally not subject to PRC laws and regulations. If the deal, however, involves factors that may lead to a national security review or antitrust clearance under applicable PRC rules, filings with Chinese authorities will still be required.
It is noteworthy that if the transfer takes place in an offshore tax haven – corporate tax rate of less than 12.5% – the selling party should file with the tax bureau where the FIE is domiciled. If the Chinese tax bureau concludes the arrangement is to evade tax and the offshore intermediary has no economic substance, the transaction will be deemed as a direct transfer of equity interests in a PRC resident enterprise, and the seller will pay PRC corporate income tax on its capital gains.
Given that an acquisition usually results in a change of control, or constitutes a material transaction, the target company should obtain consent from third parties in accordance with the agreements it has entered, such as securing consent from the bank and other right holders under the provisions of loan and security agreements. The company selling assets should also publicly notify its creditors. Creditors, in addition to protection rights under the agreements they have with the target company, may also exercise their avoidance right pursuant to the Contract Law on the grounds that, for example, their debtor has transferred assets at an unreasonably low price. In this respect, the parties to an acquisition can ensure the amount of consideration is reasonable. There are no other statuary grounds whereby the transaction may be nullified.
If the acquisition takes place in China, documentation including equity transfer agreements (or capital increase subscription agreements) and asset purchase agreements are governed by PRC law and only become effective upon the necessary approvals. The amount of consideration is determined based on – and should not be considerably lower than – the appraisal results of the equity or assets by a third party appraiser. In the case of equity transfer, the consideration should be paid in full within three months of the completion of registration with SAIC. In special circumstances and upon approval, this may be extended to one year. If only foreign parties are involved – for example, the foreign shareholder of an existing FIE transfers equity to another foreign investor – the consideration may be determined between the parties without being subject to appraisal or a compulsory payment timeframe.
If the acquisition is conducted via subscription of newly increased capital or asset purchase, foreign investors are subject to timing requirements for capital contributions under applicable rules. For example, in an acquisition effected by way of capital increase, 20% of the capital contribution must be paid in before registering the change with SAIC. Given the recent amendments to the Company Law with respect to registered capital, such mandatory arrangements are expected to be removed soon. If an acquisition occurs indirectly offshore, save for the restrictions imposed by applicable laws of foreign jurisdictions, parties may freely agree on the terms of the transaction at their own discretion, with less attention to the implications of PRC rules. However, post-acquisition changes of corporate names, trademarks and management still entail formalities with MOFCOM and SAIC. These procedures, however, are comparably simpler than those involved in direct acquisitions by foreign investors.
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