I OVERVIEW OF M&A ACTIVITY
i M&A activities in 2015
Following a robust 2014, M&A activities in China continued to prosper in 2015. The total completed deal volume rose to 4,156, while the deal value reached a record high of US$316.08 billion,2 representing an increase of 33 and 56 per cent, respectively, compared to the 2014 deal level.3
The high valuation level of A-share listed companies (one of the highest price-earnings ratio in the major exchanges) in general, dynamic ‘new’ economy sectors (e.g., telecommunication, media and technology (TMT) and service), ample liquidity in the market as a result of loose fiscal and monetary policy, the liberalisation of merger financing regulations and other creative financing practices through investment products, and limited partnership interests of partnership funds or other structured products offered to high-net-worth (HNW) individual investors, all contributed to such substantial increase.
ii Statistics and observations
Domestic deals account for the majority of M&A activities in China. A highlight domestic deal was the Greenland Group’s back-door listing through Jinfeng Investment with a valuation of 65.5 billion renminbi.4 It is not only the largest domestic deal of 2015, but also sets a record for restructuring and mergers in the A-share market.
For cross-border deals, while inbound cross-border investment deals experienced a slight decrease in deal volume, the deal volume (382 transactions in total) and deal value (US$67.4 billion in total) of outbound cross-border investment deals reached new heights, increasing by 40 and 21 per cent, respectively, compared to the preceding year.5 The outbound deals initiated by private enterprises (versus state-owned enterprises (SOEs)6) in particular grew substantially. European enterprises were popular acquisition targets in 2015 for Chinese outbound investment due to the attractive valuation level in Europe after the 2008 financial crisis and a relatively weak euro. Key transactions carried out by SOEs include ChemChina’s acquisition of Pirelli, a multinational company based in Italy specialised in the production of tyres and cables for €7.1 billion,7 and Jin Jiang Hotel Development Co, Ltd’s acquisition of Groupe du Louvre, which is the third-largest hotel group in Europe, for €1.3 billion.8 For private companies, China Minsheng Investment Corporation acquired Sirius International Group for US$2.59 billion,9 and Fosun International Limited’s strategic investment and subsequent buyout of the US insurance company Ironshore at more than US$2 billion.10 The prosperity of outbound investment activities is arguably closely related to loose monetary policy (e.g., through interest rate cuts), the bull market for A-shares in the first half of 2015 and the high valuation level of A-share listed companies even after the market ‘crash’ in the second half of 2015.
iii Features and insights
Chinese companies listed in the overseas capital market seeking relisting in the Chinese market (through going-private, restructuring and domestic public offerings) was another key driver of M&A activities in 2015. Through back-door listings or initial public offerings, these companies wanted to access the much higher valuation level at the A-share market. Milestone transactions include Focus Media’s back-door listing in the A-share market with a relisting initial valuation of 45.7 billion renminbi,11 Qihoo 360’s going-private transaction with a delisting valuation of approximately US$9.3 billion12 and WuXi Pharma Tech’s going-private transaction with a delisting consideration of around US$3.3 billion.13 While Focus Media completed its back-door listing in 2015, most of the other going-private transactions are still in the delisting phase, while their relisting in the China market could face regulatory uncertainties. Even going-private transactions are facing unexpected foreign exchange conversion hurdles as the State Administration of Foreign Exchange (SAFE) tightens up its foreign exchange conversion practice due to capital outflow concerns.
Another noteworthy trend in 2015 was the consolidation of market leaders in the TMT sector. Many key players in their respective markets are seeking to merge with each other to consolidate and create synergy. These include the mergers of DiDi/Kuaidi in the taxi hailing service business, 58 Tongcheng/Ganji in the internet information categorisation business and Meituan/Dianping in the group-buying and online shopping business.
II GENERAL INTRODUCTION TO THE LEGAL FRAMEWORK FOR M&A
While the PRC Company Law is generally applicable to M&A transactions in China (subject to various exceptions), inbound cross-border M&A, outbound cross-border M&A and purely domestic M&A are governed by different regulatory regimes.
i Inbound cross-border M&A
From a practical perspective, China’s inbound cross-border M&A laws and regulations may be classified into three categories: laws and regulations governing foreign investment industry policies (Foreign Investment Industry Regulations); laws and regulations governing foreign investors’ acquisitions activities in China (the Provisional Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (M&A Regulations)); and laws and regulations governing the organisation of various foreign investment vehicles and enterprises (collectively, FIEs) to be established after the M&A transactions (Investment Vehicle Regulations).
Foreign Investment Industry Regulations
China’s inbound foreign investment industry policies are primarily governed by the Regulations Guiding the Directions of Foreign Investments (Guiding Regulations) promulgated by the State Council. The Guiding Regulations classify all foreign investment projects into four categories: ‘encouraged industries’, ‘permitted industries’, ‘restricted industries’ and ‘prohibited industries’. The Foreign Investment Industry Guideline Catalogue, which is promulgated and updated by the State Development and Reform Commission (NDRC) and the Ministry of Commerce (MOFCOM) from time to time, lists all industries under the encouraged, restricted and prohibited categories. The rest fall under the ‘permitted industries’ category. The Guiding Regulations and the Guideline Catalogue apply to every foreign investment project in China, irrespective of the percentages of foreign ownership in an FIE. Except for banning foreign investments in prohibited industries, the primary legal implication of classifying foreign investment industries into four categories is the level of government approval an investment is subject to. In addition to the generally applicable Guiding Regulations and Guideline Catalogue, foreign investments in certain industries are subject to industry-specific regulations that specify the permitted scope of the business and corporate forms of FIEs; impose minimum capitalisation requirements, investor qualification requirements and limitations of the terms of an FIE; and provide for specific industry approval requirements.
In recent years, the State Council has initiated several free trade zones in China, including the Shanghai Pilot Free Trade Zone, Fujian Pilot Free Trade Zone, Tianjin Pilot Free Trade Zone and Guangdong Pilot Free Trade Zone (collectively, FTZs). Instead of the Guiding Regulations and the Guideline Catalogue, inbound foreign investment industry policies in such FTZs are primarily governed by a published Negative List. For inbound cross-border M&A in these FTZs, only those in the industries expressly listed in the Negative List would be subject to restrictions and thus subject to the prior MOFCOM approval, effectively eliminating the MOFCOM approval requirement for most transactions in the FTZs.
The M&A Regulations issued by MOFCOM on 22 June 2009 are the primary regulations governing foreign investors’ acquisitions of equity interests in, or the assets of, any purely domestically owned company or enterprise in the PRC. Pursuant to the M&A Regulations, such transactions are subject to MOFCOM approval. The purchase price must be determined by reference to the appraised value of the assets or equity interests to be acquired and must be paid, with certain exceptions, within three months after the issuance of the amended business license of the target company to reflect the transaction.
Acquisitions of equity interests in FIEs are subject to the foreign investment approval authority authorising the initial establishment pursuant to the Several Regulations on Changes in Equity Interests in FIEs jointly issued by MOFCOM and the State Administration for Industry and Commerce (AIC) on 28 May 1997.
In addition, according to the Notice on Launching the Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors issued by the General Office of the State Council on 3 February 2011, if the target of a particular foreign investment is in an industry that may affect the national security (such industries mainly include key agricultural products, energy and resources, infrastructure, transportation services, key technology, major equipment manufacturing14), such investment may trigger a national security review and approval process conducted by a ministerial committee jointly headed up by NDRC, MOFCOM along with the relevant industry-specific regulator or regulators.
Investment Vehicle Regulations
After being invested in or acquired by a foreign investor, the target company will become or remain an FIE in the PRC, and its establishment, management and operations, termination and dissolution will be then governed by the relevant Investment Vehicle Regulations. Currently, there are five principal foreign investment vehicles:
- a Sino-foreign equity joint ventures;
- b Sino-foreign cooperative joint ventures;
- c wholly foreign-owned enterprises;
- d foreign-invested joint-stock companies; and
- e foreign-invested investment companies.
Each of these investment vehicles is regulated by a set of specific laws and regulations in addition to the PRC Company Law.
ii Outbound cross-border investments
PRC companies and offshore companies that will use funds from within China to make acquisitions overseas are currently subject to the approval of and registration with NDRC, MOFCOM and SAFE (and their respective local counterparts, as the case may be).
According to the Administrative Measures for the Verification and Approval and Record-Filing of Outbound Investment Projects (promulgated on 8 April 2014 and effective on 8 May 2014) and its subsequent amendment, a Chinese investor participating in an overseas bidding process in which the amount of the Chinese investor’s investment reaches or exceeds US$300 million should, before engaging in substantive work with foreign parties, submit a project information report to NDRC to obtain a confirmation letter issued by NDRC. Such confirmation letter is commonly known as NDRC’s pre-clearance. Furthermore, the Chinese investor must obtain a notice of registration from NDRC prior to the execution of the final legally bidding documents; otherwise, the procurement of the notice of registration should be expressly provided in the signed transaction agreement as a condition precedent to closing. The amount of the Chinese investor’s investment, and the home jurisdiction and industry of the target asset, will dictate the level of government authority required for the approval and registration of an outbound cross-border investment by Chinese investors.
According to the Administrative Measures for Outbound Investment (as promulgated on 6 September 2014 and became effective on 6 October 2014), an overseas investment by an SOE owned by the central government would generally need to be approved and registered (depending on the home jurisdiction and industry where such investment is made) with the central MOFCOM, and an overseas investment by a ‘local’ enterprise (not just an SOE) would need to be approved and registered with the local MOFCOM at the provincial level where the local enterprise locates. The application for registration with MOFCOM can be filed simultaneously with the application to NDRC.
Upon completion of the MOFCOM registration, under the current SAFE regulations the Chinese investor needs to register the transaction, through a local bank, with the local branch of SAFE where the investor incorporates in order to be able to remit out of the PRC the consideration payable by it in the transaction. After such registration, the investment amount can then be legally remitted overseas to complete the transaction.
Simplified procedure in FTZs
In certain FTZs (such as the Shanghai FTZ), the outbound investment procedure described above has been simplified for those outbound investment transactions conducted by enterprises established in, and within the approval authority of, such FTZs. For those transactions, the Chinese investor is only required to file to the management council of such FTZs instead of being required to separately complete the MOFCOM and NDRC procedures.
iii Domestic investment
Purely domestic investment
For purely domestic investment with no involvement of a foreign investor, an FIE in China or issues specified in subsection iv, infra, the investment could be carried out simply by following the PRC Company Law and the articles of association of the target company (to the extent that they are not in conflict with the PRC Company Law). After reaching a contractual agreement, the closing of the investment and title transfer should be registered at AIC or its local counterpart, which is mainly a formality matter.
Domestic investment involving FIEs
For an investment in or an acquisition of purely PRC domestic companies by FIEs, the Foreign Investment Industry Regulations are still applicable in the sense that FIEs are banned from investing in or acquiring purely domestic companies engaging in industries prohibited from foreign investment; and FIEs’ investments in ‘restricted industries’ must be reviewed and approved by MOFCOM before they can be completed and registered with the AIC, while FIEs’ investments in ‘permitted industries’ and ‘encouraged industries’ are no longer subject to the MOFCOM approval requirement.
iv Certain other legal issues regarding M&A in China
Certain other common legal issues may emerge from M&A transactions in China, regardless of whether they are inbound, outbound or purely domestic M&A transactions.
Issues related to state-owned assets
Acquisitions of the assets or equity of SOEs are subject to the state-owned asset appraisal requirement and the approval of the relevant state-owned asset authorities, as well as various applicable procedural requirements (e.g., bidding). Acquisitions of assets or equity by SOEs may also be subject to the state-owned asset approval requirement. The State-owned Asset Supervision and Administration Commission (or its local counterpart) is the approval authority, and it has issued various rules and regulations governing transactions involving state-owned assets or SOEs.
M&A involving an A-share listed company
For investments in or acquisitions of A-share listed companies, according to the PRC Securities Law (as amended on 31 August 2014) and the Measures for the Administration of Takeover of Listed Company (as amended on 23 October 2014), reporting obligations, together with a standstill period for any further acquisition, would be triggered if the investor acquires more than 5 per cent of the equity interests in an A-share listed company or, after holding more than 5 per cent of equity interests in an A-share listed company, changes the interest by 5 per cent or more. If an investor intends to acquire 30 per cent of equity interests or more, or, after holding more than 30 per cent of equity interests, intends to acquire more shares, subject to limited exceptions, a mandatory tender offer obligation would be triggered, and the investor could only carry out its investment by issuing a general or partial tender offer. Furthermore, after purchasing more than 75 per cent of equity interests in an A-share listed company, the company will be deemed to no longer meet the requirement of the listing rules and will need to delist from the exchange.
For an investment or acquisition by A-share listed companies, according to the Measures for the Administration of Major Asset Reorganiation of Listed Companies (as amended on 23 October 2014), if an M&A transaction by an A-share listed company meets any of the following standards, it will be deemed to be a major asset reorganisation of such A-share listed company and thus subject to its shareholders’ approval: the total amount of the purchased assets accounts for 50 per cent or more of the total amount of end-of-period assets of the listco; the business income generated from the purchased assets in the latest accounting year accounts for 50 per cent or more of the business income of the listco; or the net asset value of the purchased assets accounts for 50 per cent or more of the end-of-period net assets of the listco, and exceeds 50 million renminbi.
In addition, a major asset reorganisation will be subject to the approval of the China Securities Regulatory Commission (CSRC) if the relevant A-share listed company will issue new shares in connection with the major asset reorganisation or the major asset reorganisation will constitute a back-door listing.
Investment in a specific industry with industry requirements or approval
The relevant governmental authority regulating a specific industry may issue standalone regulations requiring that a potential investor in an industry be subject to investor qualification requirements, or subject transactions to special prior approvals.
III DEVELOPMENTS IN CORPORATE AND TAKEOVER LAW AND THEIR IMPACT
i 2015 Foreign Investment Catalogue
NDRC and MOFCOM updated the Guideline Catalogue in March 2015, largely to further deregulate foreign inbound investment. Compared to the previous 2011 Guideline Catalogue, the number of restricted industries has been reduced from 79 to 38, and prohibited industries from 38 to 36.
ii 2015 State Council opinions on implementing the Negative List
As discussed above, currently only foreign investments in FTZs follow the ‘negative list’ approach, while investments outside the FTZs follow deal-by-deal approval pursuant to the Guideline Catalogue. According to the Opinions of the State Council on Implementing the Negative List as Market Access (Negative List Opinions, effective on 2 October 2015); however, the State Council and relevant authorities would make joint efforts to enact both a general market access negative list and a foreign investment negative list. This means that in future, any investment (regardless of foreign investment or investment by domestic companies) not falling into the above two negative lists would no longer be subject to any prior PRC governmental investment approval requirement before it can be completed and registered with the AIC. The negative list-based approach will largely deregulate China’s inbound foreign investment practice and hopefully encourage foreign investments.
According to the Negative List Opinions, the implementation of the negative lists would be divided into two phases. In the first phase (from 1 December 2015 to 31 December 2017), the State Council would set up more pilot zones that follow the negative list system to accumulate more experience. In the second phase (from 1 January 2018), the State Council would officially start to promote the negative list system nationwide.
iii Draft Foreign Investment Law
Another notable development on regulatory regime is the draft Foreign Investment Law, which is being published for public comments. Although it is not expected to become legally effective before considerable further legislative efforts and possibly extensive revisions, many new provisions contained therein have already attracted a lot of attention and discussion due to the fundamental changes these provisions will bring to the China foreign investment regulatory practice to date.
General application of PRC Company Law
After a transition period of three years, the PRC Company Law will uniformly apply to domestic companies and FIEs, and the previous parallel standalone regulations (such as the joint venture laws and foreign investment enterprise law) applicable to FIEs will be phased out.
Market access – negative list approach
The Foreign Investment Law introduces the negative list system applicable to foreign investments, which is consistent with the idea of in the Negative List Opinions mentioned above.
After the implementation of the negative list system, FIEs not falling into the negative list, instead of the more heavy-handed governmental approval procedures, will only be required to fulfil an information notification obligation in certain situations, resulting in less compliance costs and administrative burdens.
To balance the elimination of the deal-specific investment approval system, the Foreign Investment Law elaborates and formalises the national security review system and potentially subjects ‘any foreign investment that endanger or may endanger the national security’ to a national security review.
The Foreign Investment Law also introduces a broad definition of ‘control’ and focus on the control concept to distinguish ‘foreign’ or Chinese control in a substance over form analysis. Thus, a domestic variable interest entity (VIE) under the VIE structure15 would still be treated as an FIE if it is deemed as being ‘controlled’ by a foreign investor. As a result, any attempt to use a VIE structure to evade foreign investment restrictions will likely no longer be effective.
IV FOREIGN INVOLVEMENT IN M&A TRANSACTIONS
Cross-border M&A transactions involving Chinese acquirers substantially increased in 2015. This trend is also continuing in 2016. Foreign acquirers, on the other hand, have grown more cautious in conducting inbound M&A transactions in the traditional manufacturing sectors, especially after the first quarter of 2015, despite various government measures to encourage inbound investment.
i Outbound cross-border M&A
For years, Chinese overseas acquisitions tended to involve technologies, brands and know-how, with the intention being to bring these back into the Chinese market. With the slowing of the economy, PRC companies (especially private companies) are also increasingly trying to achieve growth and diversify risks by directly acquiring companies in developed countries. The key destinations of the 382 outbound M&A transactions in 2015 were developed countries, mostly Europe and the US. These countries are attractive to Chinese companies due to their matured businesses environments and low legal risks. Hand in hand with this trend is the shift from the energy and resources sector to the TMT, financial services and real estate sectors. Private enterprises are becoming the main driver of this trend, although it is still SOEs that dominate mega-deals.
ii Inbound cross-border M&A
In 2015, 202 inbound deals were announced, down from 248 deals announced in 2014. The total value of the 2015 deals was US$25.2 billion, compared to US$14.4 billion for the 248 deals in 2014.16 The key players in inbound M&A were Singapore, the US and Japan.17 While the aggregate value of the 2015 inbound M&A deals increased, setting aside the two mega-deals completed in early 2015,18 the deal volume showed only a moderate increase compared to the rather low 2014 level.
iii Future prospects
The first quarter of 2016 saw the announcement of the largest acquisition by a Chinese company to date: China National Chemical Equipment Corporation’s (ChemChina) US$43 billion acquisition of Swiss agrichemical company Syngenta.19 Together with other deals announced in the first few months of 2016, including Haier’s US$5.6 billion acquisition of GE Appliance, Anbang’s US$14.3 billion failed acquisition of Starwood Hotels and Chinese home appliance maker Midea Group’s unsolicited US$5.07 billion proposed acquisition of German factory robot manufacturer Kuka AG,20 China’s outbound M&A activities seemed to have entered a new era. Unless the liquidity environment and general high valuation environment in China changes and the government effectively further tightens its control of foreign exchange conversion in outbound M&A deals, we expect China outbound M&A transactions to continue to grow.
Foreign investment into China through inbound M&A transactions, especially in the traditional manufacturing sectors, will probably abate in 2016 given the relatively high valuation level of good Chinese targets, relatively weak economic fundamentals of the Chinese economy, lingering restrictions on foreign investment in sensitive industries and growing renminbi depreciation risks. In the long run, the increasing integration of the Chinese economy and market with the rest of the world, the liberalisation of the investment regulatory approval framework (e.g., the Foreign Investment Law and the Negative List Opinions; see Section III, supra) and the increased use of the renminbi as a global currency, as promoted by the government, will hopefully balance out some of the factors that are curbing the further growth of inbound investments.
V SIGNIFICANT TRANSACTIONS, KEY TRENDS AND HOT INDUSTRIES
In 2015, with 1,022 deals (38 per cent of market by deal counts) and 345.86 billion renminbi in deal volume (33 per cent of market by deal volume), the TMT sector dominated the China market.21 The TMT sector was followed by healthcare and financial services in terms of deal counts (239 and 220 deals transacted respectively) and by real estate sector (130.27 billion renminbi for 12.5 per cent of the market) and the financial service sector (107.93 billion renminbi for 10.3 per cent of the market) in terms of deal volume.22
i Outbound investments
Chinese buyers have become more and more sophisticated in structuring their outbound initiatives, and leveraged acquisitions are becoming the norm. For example, in the fourth-largest outbound deal in 2015 measured by deal value, HNA Group reached out to a consortium led by ICBC for acquisition financing for its US$2.8 billion acquisition of Swissport, the world’s largest aviation ground handling and cargo service provider.23 It is reported that the consortium provided HNA Group with a five-year term acquisition loan of US$0.95 billion for the transaction.24
ii Consolidation of market leaders in the TMT sector
The cashless share merger between DiDi and Kuaidi in the taxi-hailing service industry is noteworthy due to the dominant market positions of the parties and also their strategically designed co-development structure after the merger. DiDi and Kuaidi both provide taxi-hailing services to users through an APP on smartphones. Since 2014, in order to seize the market, both DiDi and Kuaidi provided substantial amounts of subsidies to taxi drivers and users, which gradually evolved into a cash-burning war between them two companies.25 After several rounds of financing, the competitors, realising that the war was too costly and unsustainable, decided to become ‘allies’ and turn the old arena into a new platform for both to grow. After the merger, a dual-CEO system was adopted, and both the brands and business of DiDi and Kuaidi remain independent and are supposed to develop in parallel. The transaction survived potential antitrust concerns.
iii Going-private and back-door listings
Back-door listings remained an attractive path for ‘returnees’ (i.e., offshore companies effectively re-domiciled to China through complicated restructuring) to embrace the Chinese stock markets in 2015. Focus Media’s back-door listing in the A-share market with a valuation of 45.7 billion renminbi was a milestone transaction due to its massive size and steep valuation appreciation compared to the delisting valuation. After its restructuring, Focus Media selected an A-share listed shell company. The shell company suspended trading in the A-share market for a major asset reorganisation, and it entered into a transaction agreement with the shareholders of Focus Media. The transaction agreement set out a de facto share swap arrangement between Focus Media and the shell company allowing Focus Media to be acquired by the shell company and the shareholders of Focus Media to become the owner of the shell company. The back-door listing arrangement was subsequently approved by the general meeting of shareholders of the shell company and the CSRC. The back-door listing approach has the advantage of being less time-consuming and having more deal certainty compared to a domestic IPO.
VI FINANCING OF M&A: MAIN SOURCES AND DEVELOPMENTS
Chinese companies increasingly started using large pools of capital and leverage to optimise their acquisition financing structures in 2015 as transactions became larger and acquirers wanted to maximise their returns for the capital deployed.
While, historically, foreign banks have played a central role in China cross-border acquisition financing, a major development in 2015 was the increasingly important role played by the Chinese banks. The Chinese banks have developed more flexibility in financing terms and a higher risk appetite. The 2015 revision of the Guidelines on Risk Management of Merger and Acquisition Loans granted by Commercial Banks (Revised Guidelines) by the China Banking Regulatory Commission has generally relaxed the qualification requirements on lenders. A bank may now provide M&A loans if:
- a it has a sound risk management system and an efficient control mechanism;
- b its capital adequacy ratio is not less than 10 per cent;
- c all its other regulatory indices meet the applicable regulatory requirements; and
- d it has a professional team responsible for M&A loan due diligence and risk assessment.
The amount of an M&A loan should not exceed 60 per cent of the total acquisition price under the Revised Guidelines, an increase from the previous 50 per cent cap, and the maximum term of the loan has increased from five to seven years. Security requirements have also been relaxed, and are now no more stringent than other loans in the acquisition financing context as long as the security taken is proportionate to the risks associated with the acquisition financing loan.
Another major trend for financing of M&A is the quasi-public syndication for big-ticket investments,26 in which a growing number of sponsors try to tap the funds of HNW individuals through fund structures or structured products. Such syndication can take the form of financial products or other structured products issued by investment companies, asset management companies, trust companies and insurance companies to their individual customers. With this new ‘syndication’ trend in its various forms, the capital threshold for investors to participate in risky equity investments has dramatically reduced (only 50,000 renminbi in some cases). Such new trend not only introduces new players to the arena, but also profoundly changes the funding source and structure in the M&A market.
VII EMPLOYMENT LAW
PRC employment law offers rather robust protection to employees in general. The need to comply with statutory procedures can have effects on M&A transactions involving asset acquisitions, business reorganisations, or other substantial transfers or downsizings of the labour force, both in terms of financial costs and transaction timing. Labour disputes have introduced extra hurdles to a number of major M&A transactions in China over the past few years, such as Lenovo’s acquisition of IBM in 2014, where hundreds of employees went on strike, and Walmart’s streamlining of its PRC business, which led to the involvement of the police and eventually a collective labour arbitration.
An asset acquisition or business reorganisation does not generally constitute a ‘material change of the objective circumstances’ under PRC employment law; thus, it does not grant the seller a unilateral right to terminate labour contracts. Even if an acquisition or reorganisation qualifies as a ‘material change of the objective circumstances’, the seller shall negotiate with each employee about relocation and offer a comparable position. Only after failing to reach an agreement with employee through bona fide negotiation may the seller then terminate the employment contract, with severance paid based on service years. In the case of mutual agreement, the current employment contract shall be terminated and substituted with a new employment contract with the new employer. Service years could either be bought off by the seller upon termination, or carried over to the new employer. In transactions involving substantial downsizing of the labour force, statutory ‘economic downsizing’ procedures apply that require an advance notice to the labour union or all employees, and the filing of a downsizing plan with the labour authority. In contrast, the employment relationship usually remains unchanged in equity transactions; therefore, employment issues are of less concern in such transactions.
VIII TAX LAW
The PRC Corporate Income Tax Law introduced in 2008 and its various implementing rules (CIT Law) are the cornerstones of China’s M&A tax law system. Under the CIT Law, foreign companies, FIEs and purely domestic companies undertaking M&A transactions are subject to unified corporate income tax (CIT) rules. The standard CIT rate is a flat 25 per cent, which can be reduced under limited circumstances. The prevailing withholding tax (WHT) rate is 10 per cent on PRC-sourced income generated by a non-resident enterprise without an establishment or place of business in the PRC (subject to tax treaty relief), or whose PRC-sourced income is not effectively connected with its establishment or place of business in the PRC.27
If an M&A transaction meets certain criteria set forth in the Circular on Corporate Income Tax Treatment of Corporate Restructuring Transaction (Cai Shui  No. 59) (Circular 59), it will be deemed to be a qualified corporate reorganisation for the purpose of Circular 59, and a deferral of the recognition of taxable gains on such a transaction will be allowed.
After adopting the CIT Law, the State Administration of Taxation (SAT) has been increasing its efforts to tackle perceived tax-avoidance transactions. On 3 February 2015, the SAT issued the long-awaited Announcement 7 setting forth the PRC’s indirect offshore equity disposal reporting and taxation rules. In general, Announcement 7 requires that indirect transfers of assets (including shares of Chinese-resident enterprises) by non-resident enterprises through arrangements without reasonable business purposes that aim to avoid CIT should be re-characterised and treated as direct transfers of Chinese taxable property in accordance with Article 47 of the CIT Law, and thus subject to tax filing or WHT obligations, as the case may be. In addition, Announcement 7 further specifies that if a seller fails to make a tax filing or pay the WHT, or both, the buyer will be required to fulfil such obligations.
IX COMPETITION LAW
PRC anti-monopoly law requires merger clearance by MOFCOM for M&A transactions that constitute a ‘concentration of undertakings’ and meet the following turnover thresholds: the combined global turnover of the undertakings to the concentration in the previous financial year exceeded 10 billion renminbi, and the PRC turnover of each of at least two undertakings to the concentration in the previous financial year exceeded 400 million renminbi; or the combined PRC turnover of the undertakings to the concentration in the previous financial year exceeded 2 billion renminbi, and the PRC turnover of each of at least two undertakings to the concentration in the previous financial year exceeded 400 million renminbi.
Only after MOFCOM’s issuance of approval or conditional approval can the transaction be implemented. The merger clearance can be a very time-consuming process, which primarily consists of:
- a a preparation stage (usually three to five weeks): preparing merger clearance filing documents containing competition analyses;
- b a pre-case acceptance stage (usually six to eight weeks or longer): MOFCOM issues a few supplementary information requests in the four to five weeks before officially accepting the filing for merger clearance review;
- c a Phase I review stage: lasting for 30 calendar days after official acceptance. If MOFCOM decides not to conduct Phase II review, it will issue its clearance approval; and
- d a Phase II review stage: the statutory review period for this stage is 90 calendar days, plus possibly an additional 60-calendar day extension. In 2015, most cases (except for those eligible for a simple case review) were cleared by MOFCOM during Phase II. As such, the fact that a review process is extended to Phase II does not necessarily signal that MOFCOM has identified competitive concerns; it may simply be because MOFCOM is understaffed and has a huge backlog of filings, or because MOFCOM is waiting for other stakeholders’ opinions before reaching a final decision.
After its review, MOFCOM may opt to unconditionally approve a transaction, approve it with conditions attached or block it under limited circumstances. In MOFCOM’s eight-year record of merger control, only two transactions have been blocked, while there have been around two dozen cases that were subject to conditional approvals.28 In those transactions approved with conditions attached, MOFCOM determined that they were likely to adversely affect competition, but that the remedies proposed would address the competition concerns, and thus decided to approve them with conditions (which may include structural remedies and behavioural remedies).
Save for the above, on 11 February 2014, MOFCOM issued the long-awaited Interim Provisions for Criteria Applicable to Simple Cases of Concentration of Undertakings, and granted fast-track and simplified review procedures for certain cases qualifying as ‘simple cases’ that are unlikely to raise competition concerns. For these simple cases, MOFCOM usually grants unconditional approval within a Phase I review period. One point worth mentioning is that MOFCOM will also publish a summary of a transaction on its official website and solicit public comments for a period of 10 days during the Phase I review period, which may potentially increase public exposure and invites potential complaints or whistle-blowing.
The merger clearance process in China, given the average amount of time it takes, can sometimes create significant deal management issues for M&A transactions. This is particularly true for those private equity transactions in which parties do not anticipate an antitrust angle to a deal, and such parties can be very surprised at the time it takes to clear the PRC merger clearance process.
As previously mentioned, unless the liquidity environment and general high valuation environment in China changes, and the government further tightens its control of foreign exchange conversion in outbound M&A deals, China’s outbound M&A transactions will continue to flourish. Foreign investment into China through inbound M&A transactions, especially in traditional manufacturing ‘old’ economy sectors, is being affected by the relatively high valuation level of good Chinese targets, relatively weak economic fundamentals of the Chinese economy and growing renminbi depreciation risks. That said, there are still plenty of good investment opportunities in the ‘new’ economy sectors (e.g., TMT, high-end manufacturing, healthcare and other service sectors). In the long term, if the government lets the market play a more decisive role in setting the renminbi exchange rate and proceeds with the market-driven listing reform for Chinese companies, we might start to see a more balanced inbound and outbound M&A growth trend. On the purely domestic M&A deal front, given the need to further consolidate the market to reduce excess capacity in the ‘old’ economy sectors and the strong deal appetite of ‘new’ economy companies, we suspect the deal activity level will remain robust.
1 Norman Zhong and Helen Fan are corporate partners at Fangda Partners. The authors would like to thank Chuck Sun, Eric Yan, Samuel Xie and Lorraine Lin for their assistance with the preparation of this chapter.
2 ‘China Mergers & Acquisitions Scale Set A Record High in 2015, Returns Reach 5.92 Multiples’ (only in Chinese), ChinaVenture Investment Consulting Group, 8 January 2016: www.chinaventure.com.cn/cmsmodel/report/detail/1072.shtml.
4 ‘China’s Biggest Developer Greenland Group to Make Back-Door Listing’, SCMP, 25 April 2015: www.scmp.com/business/markets/article/1775194/chinas-biggest-market-cap-
5 David Brown and Christopher Chan, ‘M&A 2015 Review and 2016 Outlook’, PwC, 26 January 2016, www.pwccn.com/home/eng/ma_press_briefing_jan2016.html.
6 SOEs are any enterprise owned or controlled by the PRC central or local government or in which a government investment vehicle is a major shareholder.
7 Press release, ChemChina, ‘ChemChina and Camfin Signed Share Purchase Agreement
with respect to Pirelli’, 23 March 23 2015: www.chemchina.com.cn/en/sj/webinfo/
2015/03/1427071078820022.htm; and ‘State-Owned Firm Announces Deal for Italian Tire Maker Pirelli’, Caixin Online, 25 March 2015: english.caixin.com/2015-03-25/100794663.html.
8 Press release, Louvre Group, ‘A new shareholder for Louvre Hotels Group’, 28 February 2015: www.louvrehotels.com/en/our-news/new-shareholder-louvre-hotels-group.
9 Press release, China Minsheng Investment Group, ‘Sirius Group acquisition by CMIH finalized’, 19 April 2016: www.cm-inv.com/en/companyNews/757.htm.
10 China Outlook 2016, KPMG.
11 Press release (only in Chinese), Focus Media Group, 28 December2015, www.focusmedia.cn/detail/91/#jump.
12 Press release, Qihoo 360 Technology Company Limited, ‘Qihoo 360 Enters into Definitive Agreement for Going Private Transaction’, 18 December 2015, ir.360.cn/phoenix.zhtml?c=243376&p=irol-newsArticle&ID=2123936.
13 Press release, WuXi AppTec, ‘WuXi PharmaTech (Cayman) Inc. Announces Completion of Going Private Transaction’, 10 December 2015, www.wuxiapptec.com/press/detail/302/18.html.
14 The national security review applicable to a foreign investment in the finance industry is subject to a separate future legislation.
15 The VIE structure is commonly used to evade the restriction or even prohibition of foreign investment in certain industries. In a typical VIE structure, a domestic company (usually referred to as a VIE entity) would hold a foreign-restricted or prohibited licence and operate a business, while the actual equity interests of a foreign investor would be reflected in a wholly foreign-owned entity (usually owned by a Hong Kong company for tax consideration: WFOE), and then the VIE entity would enter into a series of control agreements with the WFOE to contractually render the VIE entity to be actually controlled by the WFOE.
16 Focus Media Group press release, see footnote 11.
18 The US$10.4 billion investment by ITOCHU Corporation and Charoen Pokhand Group in CITIC, and the US$5 billion investment by Qatar for Investment and Development and Hamad Bin Suhain Enterprises in ShangDong Dongming Petrochemical Group.
19 Press release, ChemChina, ‘ChemChina and Syngenta Reach Acquisition Agreement’, 3 February 3, 2016, www.chemchinapetro.com.cn/youqien/xwymt/gsxw/webinfo/2016/
20 ‘China’s Midea Makes $5-billion Bid for German Robot Maker Kuka’, CNS, 20 May 2016, www.ecns.cn/video/2016/05-20/211363.shtml.
21 Zero2IPO Research Center.
23 Focus Media Group press release, see footnote 11.
24 Press release, HNA, ‘HNA Group Acquires 100% Equity Interest in the World’s Largest Ground and Cargo Handling Services Provider Swissport’, 31 July 2015, www.hnagroup.com/en/news/corporate/index.html.
25 ‘Battle between taxi app Didi and Kuaidi’, China Daily, 11 February 2015, www.chinadaily.com.cn/business/tech/2014-02/11/content_17277262.htm.
26 Fan Bao, ‘Beware of the Quasi-Public Syndication for Venture Capital Investments’ (only in Chinese), 29 February 2016, stock.qq.com/a/20160229/058597.htm.
27 ‘Taxation of Cross-Border Mergers and Acquisitions-China’, KPMG, 2010 Edition, www.kpmg.com/LU/en/IssuesAndInsights/Articlespublications/Documents/MA-Cross-Border-2010-China.pdf.
28 The calculation here does not include any transaction filings that MOFCOM refused to accept, and which refusal can sometimes effectively block the transaction.