Merger and Aquisition in China.docx

Merger and Aquisition in China.docx

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MergerandAquisitioninChina

GonearethedayswhenforeigncompanieswishingtoinvestinChinawerelimitedtogreenfieldinvestments.TheymaynowpurchaseoperatingChinesebusinessesandmayrestructuretheirexistinginvestmentsinChinathroughmergers,spin-offs,andholdingcompaniesthatwereimpossibleonlyafewyearsago.Thesedevelopmentsarenotconfinedtoforeigninvestors.DomesticChinesecompaniesarealsomergingandacquiringoneanother,andthemoresuccessfulamongthemhavebeguntobuyoutforeigninvestors.Theresultofallofthesedevelopmentsisarapidlyexpandingmergers-and-acquisitions（M&A）marketinChina.

China'sregulatoryregimehaslongbeenhostiletoM&Atransactions.Thatregimeischanging,however,bothtoaccommodatetheserecentdevelopmentsandtofurtherstimulateforeigninvestment.China'sWorldTradeOrganization（WTO）accessionwillnodoubtacceleratethesechanges.Nevertheless,theChinesegovernmentwillcontinuetohavecompellingpoliticalandeconomicreasonsformaintainingcontrolsinmanyeconomicsectors,andChina'sbusinessandlegalenvironmentswillcontinuetoposeobstaclestoM&Atransactions.

ThelegalframeworkforM&A

Awebofrestrictionsandgovernmentalapprovalrequirementsappliestoforeign-investedenterprises（FIEs）fromestablishmentthroughdissolution.ManyofthemoreonerousrestrictionsonFIEs,suchasminimumexportrequirementsandrequiredutilizationofadvancedtechnology,arebeingliftedinpreparationforChina'sWTOentry.

ThoughChineselawisbecomingmoreflexible,theformsofM&Atransactions,andaccompanyingprocedures,authorizedunderChineselawstilldifferinimportantrespectsfromthoseinotherjurisdictions.Theavailableoptionsgenerallydependontheresultintended（acquisition,divestiture,ormerger）;whetherthetransactioninvolvesotherFIEsordomesticChinesecompanies;andtheextenttowhichthetransactiontakesplacewithinChineseregulatoryjurisdiction.TransactionsinvolvingmergersoracquisitionswithwhollydomesticChinesecompaniespresenttheirownproblemsandmeritseparatediscussion

Offshoretransactions

ThemosteffectivewayforforeigninvestorstoavoidChina'sburdensomeregulatoryenvironmentwhentransferringoracquiringChinesebusinessassetsistokeeptheentiretransactionoffshore.IfaninvestmentinChinaisheldthroughanoffshorecompany,suchasaHongKongorCaymanIslandsholdingcompany,asecondoffshorecompanycansimplypurchasethesharesofthefirstcompanyunderthelawsoftheapplicableforeignjurisdiction.TheChinesegovernmentgenerallydoesnotpurporttoregulatesuchoffshoretransactionsandrequiresnoPRCgovernmentapprovals.IftheoffshorecompanyownsaninterestinanFIEinChina,theconsentoftheChinesejoint-venture（JV）partner（s）isnotgenerallyrequired,unlessthetransactionrequiresamendmentstotheFIE'sarticlesofassociationorjoint-ventureagreement.Figure1illustratesatypicaltransactionofthiskind.

ManyforeigninvestorsstructuretheirholdingsinChinathroughintermediateoffshoreholdingcompanies,oftenoneforeachFIE,preciselytopermitthisflexibilityforsubsequenttransfersoftheirinterests.ByusingmultipleintermediateoffshoreholdingcompaniesfordifferentFIEs,corporategroupscanalsoreadilyaccomplishmanyformsofintracorporaterestructuringwithoutbecomingenmeshedintheChineseregulatorysystem.

Onshore-offshoretransactions

Itissometimesimpossibletokeepthedealentirelyoffshore,evenwhenthepurchaserisanotherforeigncompany.WhenthetransactioninvolvesthetransferofanequityinterestorassetsinChina,orfromoffshoreinvestmentintoChina,ChinesegovernmentapprovalsandthevariousregulatoryrestrictionsonforeigninvestmentsinChinawillapply.

SaleofequityinanFIEtoanoffshoreinvestor

AforeigninvestormustsometimessellaninterestinanFIEdirectlytoanoffshorepurchaser.Thisoccurs,forexample,whenthesellerholdsitsinterestintheFIEwithoutthebenefitofaninterveningoffshoreholdingcompany.

EvenifanoffshoreholdingcompanyholdstheChinainvestment,thatcompanymayhaveotherassetsorliabilitiesthatthesellerseeks（oriscompelledbythepurchaser）toretain,makingitimpracticaltoselltheholdingcompanyoutright.Insuchcases,theonlyoptionmaybetoselltheonshoreownershipinterestintheFIEdirectlytoanoffshorebuyer（seeFigure2）.

Suchtransfers,inwhichtheforeignpurchasercansimplybuytheexistinginvestor'sequityinterest（expressedintermsofitsregisteredcapital）,mostofteninvolveequityjointventures（EJVs）orwhollyforeign-ownedenterprises（WFOEs）.Transferofaninterestinacontractualjointventure（CJV）ispossiblebut,becausetheparties'rightsandobligationsinaCJVneednotfollowtheproportionoftheircapitalcontributions,suchatransfergenerallyrequiresmorecomplexcontractualrestructuring.Becausethepurchaserinallofthesetransactionsisoffshore,thetransferissubjecttotheapprovalrequirementsoftheEJV,CJV,orWFOElaws,asthecasemaybe,and,foraJV,totheChineseparty'sconsentaswell.

Anothercommononshore-offshoretransactionariseswhenaChinesepartnerinajointventuresellsitsinterest.ThismayoccureitherwhentheChinesepartnersimplywishestoexitthebusinessorastheresultofafallingoutbetweentheparties.TheforeigninvestormaythenhavenochoicebuttopurchasetheChineseparty'sequity.Iftheforeigninvestortherebyacquires100percentcontrol,theJVbecomesaWFOE.If,asissometimesthecase,thebusinesssectorinquestionisregulatedmorestrictlyforWFOEsthanforJVs,problemsinobtainingthenecessaryregulatoryapprovalmayarise.

Foreigninvestmentsindomesticcompanieslimitedbyshares

The1994CompanyLawauthorizedSOEstoorganizethemselvesasjoint-stockcompaniesandauthorizeddirectforeigninvestmentinthosecompanies.TheProvisionalRegulationsonUtilizationofForeignInvestmenttoReorganizeState-OwnedEnterprises,promulgatedbytheStateEconomicandTradeCommission（SETC）inSeptember1998,setoutapprovalproceduresforsuchinvestments.TheregulationsaddSETCapproval（localornationaldependingonthesizeoftheinvestment）totheapprovalsalreadyrequiredforestablishmentofFIEsgenerally.Theinvestmentisalsosubjecttogeneralrestrictionsonforeigninvestmentinspecificeconomicsectors.Ifthetransactionisapprovedandtheforeigninvestoracquires25percentormoreofthejoint-stockcompany'sequity,thecompanymaybeconvertedtoanFIE.Anacquisitionoflessthan25percentwillleavetheforeigninvestorwithaminoritystakeinadomesticChinesecompany.

Foreigncompanieshavemadeseveralhighlypublicizedinvestmentsofthischaracter,ofwhichtheEastmanKodakCo.dealisthemostwellknown.SOEs,however,typicallyhaveproblemsthatmakethemunattractiveinvestmenttargets--agingplantandequipment,heavydebtburdens,andredundantworkforces.Thereare,moreover,onlylimitedprotectionsforminorityinvestorsinChinesecorporations.Asaresult,foreigninvestorshavebeenreluctanttopursuethisformofinvestment.

Nevertheless,China'sdesperateneedtorestructureandrejuvenateitsSOEscontinuestodrivethegovernmenttoexperimentwithnewapproachestoattractdirectforeigninvestmentinSOEs.Local"equityexchangecenters"havebeenestablishedinBeijing,Shanghai,andinShenzhen,GuangdongProvince,insomecasesforspecialized,high-technologydeals.Thesecentersaretoservebothassourcesofinformationonavailabledealsandas,ineffect,expeditersforthegovernmentapprovalprocesses.Somelocalitieshavealsobegunexperimentingwithdifferentapprovalprocessesforforeigninvestmentintheirjurisdictions.Shanghai,forexample,doesnotapplythe1998SETCProvisionalRegulationsbutapprovesabroadrangeoftransactionsthroughtheShanghaiStateAssetsManagementOfficeandthelocalofficeoftheministryinchargeoftheindustryinquestion.TowhatextenttheseprocedureswillovercomeforeignantipathytoinvestinginSOEsremainstobeseen.

Listedcompanies

Foreigninvestorsarecurrentlyauthorizedtobuyonlyonecategoryofshares,knownasBshares,inChinesecompanieslistedonChina'stwostockexchanges（inShanghaiandShenzhen）.ChinahassuggestedthatitmayeventuallyopentheA-sharemarkettoforeigninvestorsaswell.Chinadoesnot,inanyevent,permithostiletakeoversofpubliccompaniesthroughopen-marketpurchasesortenderofferswithouttheconsentoftheChinaSecuritiesRegulatoryCommission.Privateplacementsofunlistedstate-ownedsharesinlistedcompaniescangenerallyonlybemadetootherSOEs.

TransactionswithinChina

FIEsinChinacaneitherbuyassetsfromexistingcompanies,or,byundergoingstructuralreorganization,investdirectlyinthem.

Assetsalestoforeigninvestors

AssetsalesareusedinChina,aselsewhere,whenabuyerwishestoacquireabusinessbutwantstoavoidthatbusiness'sexistingliabilities.AssetsalesareparticularlyattractiveinChinabecauseoftheunusualdifficultiesinidentifyingalloftheliabilitiesofatargetcompany.Theforeigninvestorwillgenerallybeunabletoholdtheacquiredassetsdirectly.Itwill,therefore,eitherhavetouseanexistingFIEorestablishanewone.TheestablishmentofanewFIE（withaChinesepartnerifitistobeaJV）willbeanonshore-offshoretransaction,asdiscussedabove.Itwillalsobesubjecttoapplicableforeign-investmentapprovalandqualificationrequirements.Theactualassetpurchase,however,willbeanentirelyonshoretransactionbetweent