What is meant by “acquisition of a domestic company by a foreign purchaser?”

The China M&A transactions of foreign investors are subject to a specific legal regime known as the “Acquisitions of Domestic Enterprises by Foreign Investors Provisions” or M&A Rules. The M&A Rules came into force in April 2003 and was since amended twice, in September 2006 and June 2009.

The scope of the M&A Rules covers the following transactions (“M&A Transactions“):

 

    • Equity Deals: The acquisition by a foreign investor (i.e. any company established outside Mainland China) of equity in domestic company (i.e. 100% domestically-owned, without any foreign investor); and
    • Assets Deals: The acquisition by a foreign investor of the assets of a domestic company.

What types of Equity Deals are subject to the M&A Rules?

The following Equity Deals are subject to the M&A Rules:

 

  • The acquisition by a foreign investor of all or part of the registered capital of a domestic company; and
  • The subscription by a foreign investor to the capital increase of a domestic company.

What types of Assets Deals are subject to the M&A Rules?

The following Asset Deals are subject to the M&A Rules:

  • The registration by a foreign investor of a new subsidiary in China for the purpose of using it as a dedicated vehicle for the acquisition of the assets of a domestic company; or
  • The acquisition of the assets of a domestic company by a foreign investor for the purpose of contributing them to the registered capital of a new subsidiary specially created to operate the said assets.

However, the M&A Rules do not clearly specify whether their application is conditional on the acquisition of all or part of the assets of a domestic company. In most cases, the policy of local authorities is to favor a broad interpretation of the M&A Rules.

What are the conditions applicable to any M&A Transaction?

Any foreign investor engaged in the M&A Transaction must ensure that its investment complies with the following conditions:
      • The M&A Transaction must comply with China’s foreign investment regulations. Other constraints apply only to foreign investments in a given industry (capital distribution between foreign and Chinese partners, minimum amount of registered capital, qualification of the foreign investor, etc.)
      • The target company and its shareholders shall give their consent to the M&A Transaction in accordance with its Articles of Association and China’s Company Law.
      • In the event of an Asset Deal, the seller shall inform its creditors by means of a press announcement.
      • The parties to the M&A Transaction must draw up a plan detailing the measures taken to safeguard employment after completion of the transaction.
      • In the event that the M&A Transactions involves a state-owned enterprise or state-owned assets, the purchase price for the transferred equity or assets must be determined in accordance with a specific procedure.

      • The Acquisition Transaction must be approved by the Ministry of Industry and Commerce (“MOFCOM”) and then registered by the State Market Regulatory Administration (“SMRA”).

      • The Acquisition Transaction shall comply with China’s merger control regulations shall not go against the interest of the country’s economic interest.

Are there limits to the contractual freedom of the parties? Are there mandatory provisions?

The M&A Transaction must be formalized by a purchase agreement. In this respect, the M&A Rules limits contractual freedom of the parties regarding certain provisions:
    • Applicable law: the acquisition contract shall be subject to Chinese law.
    • Determination of Purchase price: the purchase price must be determined on the basis of an independent valuation of the participation or assets transferred by an appraisal institution appointed by the parties. In practice, the parties have a certain margin to agree on a price that differs from the valuation made by the appraisal institution, but this margin is limited.

    • Payment of the purchase price: the purchase price must be fully paid by the foreign buyer within 3 months after the completion of the M&A Transaction.
In some circumstances, the Foreign Investor may request a payment in installments (maximum 60% within 6 months of closing and the balance within 12 months).

Are the M&A Rules still relevant? (June 2020 update)

There have been uncertainties as to whether the M&A Rules shall still apply following the coming into force of the New Foreign Investment Law on 1 January 2020.

One of the key features of the Foreign Investment Law is to repeal the distinction and difference of treatment between domestic and foreign-invested companies in China. However, the M&A Rules – which have not been repealed – continue to target and govern the acquisition of domestic companies.

When questioned about whether the M&A Rules and its restrictions/limitations remain applicable, local authorities in different provinces and districts have different opinions.

We will continue monitoring the latest developments in this respect and advice that you enquire with the local representations of MOFCOM and SMRA if you are currently engaged in an M&A Transaction.