Notable issues in the M&A of military and defence industry

By Zhang Xuan、Wang Haonan and Jiang Yizhen, East & Concord Partners
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At a meeting with the People’s Liberation Army delegation during the third session of the 12th National People’s Congress in March 2015, President Xi Jinping said for the first time that the integration of military and civilian development should be upheld as a national strategy.

With the joint efforts by the Central Committee of the Communist Party of China, the State Council and the Central Military Commission, the military-civilian integration policy has become an important strategy to push for market-oriented development of China’s defence industry. More and more listed companies have explored opportunities of business transformation by merging and acquiring defence assets.

Zhang Xuan Partner East & Concord Partners
Zhang Xuan
Partner
East & Concord Partners

According to incomplete statistics, there were 225 merger and acquisition (M&A) deals in the defence industry as of the third quarter of 2016, with 83 done by defence corporations and 142 by military related companies. State-owned enterprises and privately owned enterprises separately accounted for roughly 40% and 60% of these M&A activities, respectively.

The defence industry requires different legal services due to its particularity. When performing due diligence on defence M&As, especially military related civilian-run companies, lawyers should pay attention to some extra issues in addition to the ordinary checklist.

Confirm the special requirements on the qualification of intermediaries for defence M&As. As military enterprises generally hold defence and military secrets, intermediaries, such as law firms and accounting firms, must meet different qualification requirements.

For a holder of the scientific research and production licence of arms and equipment, an intermediary should first obtain the registration certificate of confidential requirements for military-secret-related consulting services from the State Administration for Science, Technology and Industry for National Defence (SASTIND) and sign a confidentiality agreement before they can offer intermediary services.

If a company only has a confidentiality qualification certificate and does not have the scientific research and production licence of arms and equipment, the intermediary should consult local defence authorities to confirm whether the deal involves military secrets. If not, the intermediary and its staff need not obtain confidentiality qualifications as long as they would not be able to get access to confidential information.

Confirm whether an M&A deal should obtain a prior approval. If a listed company is engaged in a defence deal, it is necessary to confirm whether the takeover target has obtained the scientific research and production licence of arms and equipment. If the takeover target or its subsidiary has the certificate, it is a military related enterprise as defined in the Temporary Provisions on the Reorganization and Listing of Military Related Enterprises and the Examination of Capital Operation in Military Projects After Listing (Hereafter referred to as Temporary Provisions). If the M&A deal proposed by the military related enterprise is subject to the Temporary Provisions, the acquirer and the takeover target shall seek the SASTIND’s approval and instructions to complete the deal.

Therefore, the SASTIND’s approval is in principle a prerequisite to such deals. The acquirer should first obtain the SASTIND’s approval after working out the M&A proposal, and then proceed with internal approval procedures and information disclosures.

Confirm whether the takeover target has one or more of the four certificates for defence enterprises. During their due diligence on the M&As of defence enterprises, lawyers should learn about whether the to-be-acquired company has one or more of the four certificates, namely the registration certificate of equipment manufacturer, the confidentiality qualification certificate, the arms and equipment quality system certificate, and the scientific research and production licence of arms and equipment.

If the company is a manufacturer of complete arms and equipment, key or important subsystems and core auxiliary products, which are on the catalogue for scientific research and production licence of arms and equipment issued by the SASTIND and the General Equipment Headquarters, it should have all four certificates.

If the company is a manufacturer of special equipment and ordinary auxiliary products out of the catalogue, it should pass the qualification examination of equipment manufacturers to obtain the registration certificate of equipment manufacturer, the confidentiality qualification certificate, and the national quality management system certificate, and establish a quality management system of arms and equipment. It is no longer required to pass the examination for the scientific research and production licence of arms and equipment and the compulsory arms and equipment quality system certification.

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If the company is a manufacturer of civilian products for military purposes, it should pass the equipment manufacturer certification (mainly through paper review) to obtain the registration certificate of equipment manufacturer and the national quality management system certificate, without the need for the confidentiality qualification certificate, the scientific research and production licence of arms and equipment, and the compulsory arms and equipment quality system certification.

M&As of quality defence enterprises are gaining momentum. Intermediaries should take notice of the particularity of the defence sector to match their business development.

Zhang Xuan is a partner at East & Concord Partners. Wang Haonan and Jiang Yizhen are associates at the law firm

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