Three experienced corporate counsel share their practical insights into topical outbound investment issues with Richard Li
What legal challenges may await when engaging in cross-border business? This question is popping up more frequently for the decision makers at Chinese companies as Chinese outbound investment continues to grow, and as past experiences have taught more investors the virtues of prudence and caution.
There can hardly be a one-size-fits-all answer, since investors who come from different industries or target different overseas markets often have their own unique problems to solve. But many of them still share some common challenges. Practical experiences of seasoned in-house counsel can therefore still serve as a good reference for their peers.
For this report, we asked three senior corporate counsel to share their experiences of the various issues they have grappled with involving outbound investment. We asked them how they handled specific legal problems, what solutions they used, and what experiences they accrued. Their discussion covers antitrust issues in overseas markets, multi-jurisdictional compliance management, and how to build contractual bulwarks against legal uncertainty in some foreign markets.
You may find their experiences useful, or may have your own opinions on the same issues. We welcome all corporate counsel engaging in China-related business to share your ideas with us.
Leslie Zhang Weihua
Zhang: Our major concern in overseas investments is risks linked to the change of laws and regulations in foreign countries, taxation disputes and the standards they tend to use in law enforcement. We usually cope with these risks by purchasing insurance products and actively communicating with the counterparties; we may also resort to the [central] government, or lawsuit, or arbitration for help. We may also require inclusion of “stabilization clause” and “waiver of sovereign immunity” in contracts with foreign governments.
In the front of M&A, foreign sellers are increasingly focused on change of the PRC law as well as risks associated with the [central] government’s regulatory approval, given the changed regulatory policy that the government has on outbound investments. Our countermeasures include reverse breakup fees, tiered reverse breakup fees, promises to secure governmental approval through best reasonable efforts, and agreements to deposit reverse breakup fees in escrow accounts upon execution of contract, depending on the bargaining power. We may also include in the contract the requirement that the Chinese buyer not be held responsible for risks relating to changes of PRC law and/or risks associated with government’s regulatory approval.
CBLJ: What kind of legal changes and regulatory risks from China are foreign sellers most concerned with?
Zhang: The central government has recently emphasized the guidance of outbound investments, with tightened control through an “encourage-limit-prohibit” system that treats different types of deals in different ways. Foreign sellers are paying attention to this. Since the end of 2016, they have been concerned about whether China’s offshore investment policy has changed, and how the country’s stance on renminbi outflow will affect their deals with Chinese buyers. They usually ask Chinese buyers to bear risks relating to China’s law change and the approval procedure with the central government, as represented by clauses on reverse breakup fees (deposited to escrow accounts), financing commitment and the time point of paying the transaction price.
CBLJ: How do you split risk burdens with the sellers by arrangement of “reverse breakup fee” or “tiered reverse breakup fee”?
Zhang: Major considerations of reverse breakup fees in negotiating a deal are as follows: First, higher reverse breakup fees. Chinese buyers are accepting higher reverse breakup fees recently, usually 3%-15%, compared with 3%-9% in the past.
Second, when to provide reverse breakup fees as guarantees. Reverse breakup fees have to be deposited in the escrow account, or a payment commitment has to be made by a financial institution as a guarantee upon execution of the contract. In the case of tiered reverse breakup fees, a fee at top-tier rate has to be deposited in the escrow account in a lump sum upon signing the contract. The fee also has to be deposited in full amount in a lump sum. Payment on installment basis is becoming history now.
Third, which currency and escrow to be used. Main currencies used include US dollars, euros and British pounds. In most cases, an escrow account is opened with a bank of Western countries or an overseas branch of a Chinese bank. There were cases that Chinese buyers successfully had their foreign counterparties agree to depositing reverse breakup fees in renminbi in a Chinese bank located in China. However, an arrangement like that is becoming much more difficult now as China tightens controls on foreign exchange.
Fourth, triggers for the payment of reverse breakup fees. Any one or combination of the following may trigger a reverse breakup fee, depending on negotiation results: (1) failure to get regulatory approval of the target country; (2) failure to get regulatory approval of China; (3) failure to get approval from the China Securities Regulatory Commission (CSRC) or a stock exchange of China; (4) failure to get approval from a shareholders’ meeting in the case of an A-share market-listed company; (5) failure to deliver the transaction on the Chinese side; (6) change of PRC laws and/or regulations; (7) transaction banned by Chinese regulator; and (8) other matters.
CBLJ: What kind of commercial clauses do you think a Chinese enterprise may use to circumvent risks in overseas markets relating to change of laws and regulations and law enforcement practices in foreign countries?
Zhang: A “stabilization” clause and “host state’s waiver of sovereign immunity” clause may be employed by Chinese dealmakers to secure economic return from the target assets. When new laws or regulations are passed in the host state, a “stabilization” clause gives an investor the right to ask the foreign government to alter the contract so that its interest in the project will remain the same as when the contract was signed. The host state’s waiver of sovereign immunity, on the other hand, means that it gives up its right to defend itself on the excuse of “sovereign immunity from suit” and will be subject to the jurisdiction of foreign national courts as well, under which circumstances the investor may make a claim against the host state on a commercial basis. The two clauses help prevent policy uncertainty risks in the target country. But for the risk-control purpose, they alone don’t work well; insurance coverage and protection under bilateral investment treaties are also a must.
For example, a contract commonly seen in international oil and gas extraction is a production sharing contract. It’s a common type of contract signed between a government and a resource extraction company in which a stabilization clause was first used during the First World War. According to the stabilization clause, the resource extraction company has the right to ask the host state to maintain the current level of its economic interest in the project, or bring any reduced level to a former condition, should the host state adopts new laws, regulations or policies that may affect the investment contract between the two.
There are two kinds of stabilization clause. One is a “freezing” clause, which specifies that the law that is in effect on the day that a contract is signed will apply to the project for the life of the project notwithstanding any subsequent changes in law. A freezing clause usually calls for parliamentary approval of the host state. The other is an “economic equilibrium” clause, which gives the oil and gas investor the right to renegotiate the economic clauses of the contract in the event that any change in the laws or regulations of the host state has harmed its possible return on investment, so that the investor can restore its original expected economic interest.
You: In recent years our legal team has been most concerned about antitrust reviews in overseas mergers and acquisitions (M&A). As the scale and the turnover of the company keep growing, our M&A, restructuring or outbound investment projects are all likely, to varying degrees, to fall into the scope of antitrust reviews in relevant jurisdictions. This is something we did not come across so frequently in the past.
Facing such issues, we will first be emphatic about the importance of antitrust filings, alerting the corporate leaders and business teams. Then we will hire experienced legal counsel, and work together with them on analysis and research, considering the actual conditions of the company, and what countries may require us to do antitrust filings. If necessary, we will communicate with the competent regulatory authorities prior to the filing, and proceed to carefully prepare filing documents, submit additional material in time when required, and provide clear explanations.
CBLJ: Why have you been confronting antitrust filings and reviews much more frequently in recent years?
You: The first reason for facing more antitrust reviews is that the growth of our company and our increasing turnover has made our investment activities easier to reach the threshold for antitrust review. The other reason is the increasing number of reorganizations of state-owned companies (SOEs) managed by the central government. The sizes of central SOEs are relatively huge even before reorganization, so after that they are more likely to trigger antitrust reviews.
CBLJ: What key points will you emphasize when alerting your company’s management to the importance of antitrust filing?
You: We mostly highlight this in front of the company’s leaders: We are an international mining company, and our future M&As on the global stage will all have the chance of facing antitrust examination. There will be very serious consequences if we attach little importance to this issue. In addition, we have already benefitted from antitrust filings.
CBLJ: What are the major benefits of prior-to-filing communication with relevant antitrust regulatory bodies?
You: It is very important to communicate with the antitrust authorities prior to the filings. First, we may gain the understanding and support of the regulators through such communication. More importantly, we can give the regulators more insights into this sector – after all, not all regulatory authorities are bound to have a relatively deep understanding of the international mining sector.
CBLJ: In which jurisdictions do you face the greatest pressure from antitrust compliance? What are the key issues you focus on?
You: We bear more antitrust compliance pressure when it comes to investment in Europe and Australia. In Europe, since we have many subsidiaries there, our activities are subject to regulation on both the national level and the EU level, so we face much pressure, from filing to multiple antitrust regulators. In Australia, we have a large business volume, so we are under more pressure to gain regulatory clearance by subdividing our markets and products in our antitrust analysis.
Hung: COSCO SHIPPING Ports Limited (the company) and its subsidiaries are principally engaged in the businesses of managing and operating container terminals and related businesses. As the global outlook for container terminals is expected to have sustainable volume growth in the coming years, the company is positioned to increase its investments in order to expand its global network and market share with a view to further strengthening its global competitiveness. As the company further implements its plan for globalization, the degree of complexity and the extent of risk exposure in relation to legal issues and restrictions on the multi-jurisdictional M&A transactions increase exponentially.
One of the major duties of an in-house legal team is to ensure strict compliance of the company with statutory legal requirements in different jurisdictions.
The company has undertaken many overseas investments in recent years. Such investments are often subject to various foreign legal and regulatory regimes, which involve different approvals and compliance. These business operations expose the company to different risks in different jurisdictions, including, but without limitation, financial risk, operational risk and compliance risk.
Besides, given that COSCO SHIPPING Ports Limited is a member of the COSCO SHIPPING group (China COSCO Shipping Corporation Limited and its subsidiaries), which is a conglomerate accounting for considerable worldwide turnover, and the contracting parties to M&A transactions conducted by COSCO SHIPPING Ports Limited are mostly sizable companies in the shipping industry, the company is required to observe stringent laws and regulations in several jurisdictions for M&A transactions, and obtain approvals from relevant authorities prior to completion of the transactions.
CBLJ: What kinds of legal issues and/or restrictions are you most concerned about in multi-jurisdictional overseas investments?
Hung: We are most concerned about merger control regulations and shareholding restrictions on foreign investment in multi-jurisdictional overseas investments.
Merger control regulations. Given the considerable turnover generated by the COSCO SHIPPING group and the contracting parties (usually global container terminal operators) in relation to M&A transactions, the legal department [of COSCO SHIPPING Ports Limited] is required to closely liaise with the relevant antitrust consultant in the entire process for compliance with multi-jurisdictional merger control regulations, including: (1) decisive influence analysis in classifying a sole control or joint control transaction; (2) extensive analyses on merger control filing requirements in several jurisdictions, including but not limited to the EU, several member states of the EU and the PRC; and (3) submission of requisite documents to merger control authorities to seek necessary approvals for completion of the transactions. COSCO SHIPPING Ports Limited could be subject to severe penalties should the company fail to comply with merger control regulations in jurisdictions requiring the merger control notification or formal filings.
Foreign investment restrictions. In certain jurisdictions, foreign investors are prohibited from holding a majority stake in local companies.
In consideration of the company’s expansion strategy in acquiring a controlling stake in existing container terminals or green field projects, the legal department is required to work closely with the respective local experts to overcome the local restrictions on shareholding structure and to come up with innovative solutions that could satisfy the company’s commercial interests on one hand, while complying with local regulations on the other.
CBLJ: What are some of the key aspects you focus on in your compliance practice with regard to the listing rules in Hong Kong?
Hung: With regard to the compliance of the listing rules in Hong Kong, the legal department faces challenges in executing agreements on continuing connected transactions with connected parties, and arranging with contracting parties in alternative disclosure in the announcement.
Continuing connected transactions. COSCO SHIPPING Ports Limited is continually expanding its business partnership network for the container terminal business, inevitably resulting in an increase in the number of connected transactions that might be subject to several requirements under the main board listing rules of the Stock Exchange of Hong Kong. Accordingly, the legal department is required to spend a lot of time repeatedly explaining to connected persons based in different jurisdictions regarding the requirements of the listing rules, in particular the pricing policy and the disclosure requirements for the purpose of executing and renewing master agreements governing continuing connected transactions.
Alternative disclosure in announcement. After several rounds of negotiations between our company and the contracting parties to the relevant M&A transactions, commercially sensitive terms might have been incorporated into the transaction documents to reflect the parties’ commercial interests.
If such transaction terms are subject to disclosure requirements under the main board listing rules, the legal department is required to work closely with legal teams of contracting parties to manage the contents and scope of disclosure to the optimal extent permissible under the listing rules, or otherwise to apply for waiver from strict compliance with the listing rules with provision of the alternative disclosure for consideration by the Listing Division.