This country-specific Q&A gives an overview of mergers and acquisition law, the transaction environment and process as well as any special situations that may occur in China.
It also covers market sectors, regulatory authorities, due diligence, deal protection, public disclosure, governing law, director duties and key influencing factors influencing M&A activity over the next two years.
This Q&A is part of the global guide to Mergers & Acquisitions. For a full list of jurisdictional Mergers & Acquisitions Q&As visit http://www.inhouselawyer.co.uk/index.php/practice-areas/mergers-acquisitions/
What are the key rules/laws relevant to M&A and who are the key regulatory authorities?
ZL: In China, the key rules/laws relevant to M&A are Company Law, Securities Law, Administrative Measures for the Material Assets Reorganization of Listed Companies (“Reorganization Rules”), Administrative Measures for the Takeover of Listed Companies, Measures for the Supervision and Administration over the Trading of State-owned Assets in Enterprises, Administrative Measures for Strategic Investment by Foreign Investors in Listed Companies, Provisions on the Merger and Acquisition of Domestic Enterprises by Foreign Investors, Several Provisions on the Alteration of Investors' Equities in Foreign Investment Enterprises, Administrative Measures for Outbound Investment, Administrative Measures for Approval and Record-filing on Overseas Investment Projects, Anti-monopoly Law, etc.
The competent regulation authorities vary for different types of the companies. In detail, the main regulation authority for M&A of the A-share listed companies is China Securities Regulatory Commission (“CSRC”) and/or Stock Exchange; the key regulation authority for M&A of the state owned companies is state owned assets supervision and administration department; the main regulation authorities for M&A of the foreign investment (foreign investor acquires the domestic companies or foreign investment companies’ acquisition, etc. ) are departments of business, foreign exchange, and others; National Development and Reform (“NDRC”), Ministry of the Commerce, and other related authorities regulate the outbound investment of the domestic companies; meanwhile, acquisitions referring to certain special industrial companies need the approvals of the industrial regulation departments. For example, the mergers and acquisitions among finance, insurance, securities companies may be involved the supervision of the China Banking Regulatory Commission, the China Insurance Regulatory Commission, CSRC.
What is the current state of the market?
ZL: As far as we know, in recent years, with the introduction of the positive national macro policies and the implementation of “Internet+”, “Going Out”, “the Belt and Road Initiative”, mixed ownership reform, deepening the reform of the financial system, industrial restructuring and upgrading, and other national strategies, the national economy achieves stable growth. And the Chinese enterprises to participate in the domestic and foreign mergers and acquisitions market also showed a sustained hot trend. With the continuous adjustment of the economic structure, the complete promotion of the reform of state owned enterprises, and capital market releasing the bonus constantly, we believe that, the market will lead to a new round of mergers and acquisitions tide.
Which market sectors have been particularly active recently?
ZL: According to our experience and observation of the M&A market, the active sectors of the domestic M&A market in recent years are mainly TMT, medical, education, etc. Compared to the traditional industry, TMT is a newly emerging industry, including technology, media, and telecom. We also noted that the service industries, including finance, medical and education, are also active.
What do you believe will be the three most significant factors influencing M&A activity over the next 2 years?
ZL: We think in the next two years, the most significant factors influencing enterprises’ M&A activities are as the followings:
Currently, alongside with national reform of Mixed Ownership Economy, capital market in diversified levels will be promoted to perfection. Moreover, the implementation of the strategy of “One Belt One Road” provides momentum for the M&A market. China is experiencing an upsurge period of M&A. The persistence of relative policies and whether there will be launching substantially favourable policy will have direct influence on enterprises’ M&A activities.
(2) Economic Environment
The complexity and the costs for M&A transactions would greatly depend on the persistence of economic growth and the prospection of the future, which are also closely linked with the acquired enterprises’ willingness to sell, evaluation and pricing. For M&A regarding listed companies, relative transaction will be more active in bull markets with relatively higher evaluation and the Buyer has better chances of financing, making it easier to get the deal sealed. Even the economic growth will shift from high speed to the gear of high-medium speed, the economic reform of China, the integration and reorganisation of industries and reform of State-Owned-Enterprises, as well as other long-term driving factors, such as extensive growth strategy, will promote the growth of M&A activities.
(3) Legal Environment
The alteration of regulations has a direct influence on the stand or fall and efficiency of M&A activities. For M&A regarding listed companies, China has primarily developed the legal framework for the reorganization and merger of listed companies. As a whole, the whole process can be regarded as a gradual perfection of stock market through continuous reorganization practices. The legislation will generally follow the steps of the practices in stock market. Although the M&A related legal framework is not perfect, it has great significance in regulating the M&A activities for listed companies. From the perspective of Chinese enterprises overseas M&A, relevant Chinese competent authorities have simplified the approval and filing procedure more than once to streamline administration and begin to delegate powers to the lower levels and have launched several regulations and policies supporting the Chinese enterprises to go global, which have tremendously boosted Chinese enterprises’ enthusiasm to invest overseas and have mitigated the pressure related to the approval and filing procedure before the enterprises.
What are the key means of effecting a merger?
ZL: M&A in its nature is a commercial activity. The key factor for concluding an M&A transaction is whether the parties’ interests in the transaction can be satisfied in this game. Under the situation where the parties’ interests in the transaction are fully satisfied, the key factors effecting a merger are reasonable transaction structure and unhindered regulatory approval.
What information relating to a target company will be publicly available and to what extent is a target company obliged to disclose diligence related information to a potential acquirer?
ZL: In an acquisition where the acquirer is a listed company, if such acquisition constitutes reorganization of material assets, generally, according to Measures of Material Assets Reorganization and Standards on the Contents and Formats of Information Disclosures by Companies Publicly Offering Securities No.26 - Material Asset Restructuring of Listed Companies (Revision in 2014), the listed company shall disclose in detail the information that may have material effect on the transaction, including but not limited to the target company’s general information, historical summary of shareholding, major assets, permits and licenses required for operation, major financing and assurance, material business contracts, financial subsidy, tax, administrative penalty, litigation and disputes, and major financial data.
In an acquisition where the acquirer is a non-listed company, generally, there is no mandatory requirement for disclosure. In terms of business custom, generally, whether to disclose related due diligence information to a potential acquirer is depended on the positions, bargaining power, and business demands of both parties. Where both parties of the transaction are of equal positions, the target company is at least obligated to disclose important information that may have material effect on the transaction and valuation of the target company, in order for the potential acquirer to decide on valuation of the acquisition. In an amicable transaction, the target company usually discloses relatively full fledged due diligence information to the potential acquirer.
To what level of detail is due diligence customarily undertaken?
ZL: Generally, in an ordinary case of acquisition, due diligence usually includes legal, financial, tax, business, and environmental aspects. In terms of legal due diligence, it usually includes general information, historical summary of shareholding, major assets, permits and licenses required for operation, major financing and assurance, material business contracts, financial subsidy, tax, administrative penalty, litigation and disputes.
In an acquisition that involves a listed company, if such acquisition constitutes material assets reorganization, the due diligence shall be conducted according to the requirements in Measures of Material Assets Reorganization and Standards on the Contents and Formats of Information Disclosures by Companies Publicly Offering Securities No.26 - Material Asset Restructuring of Listed Companies (Revision in 2014), and the due diligence information shall be disclosed publicly. In an acquisition that does not involve any listed company, as there are no mandatory requirements, the disclosure of due diligence is more depended on the acquirer’s commercial judgments and the negotiation of both parties. Therefore, the level of detail of due diligence undertaken on the target company is usually depended on the positions, bargaining power, and business demands of both parties. Generally, compared with acquisition that constitutes material assets reorganization of a listed company, in an acquisition that does not involve any listed company, the level of detail of due diligence is less stringent, with a focus on important items that may have effect on acquirer’s judgment of target company’s value and other important judgments.
What are the key decision-making organs of a target company and what approval rights do shareholders have?
ZL: According to Company Law, in a limited liability company, the shareholder meeting is the decision making organ; in an incorporated company, general meeting of shareholders is the decision making organ. Through the shareholder meeting or general meeting of shareholders, shareholders are entitled to make decisions on important items of the company, including guidelines of operation, investment plans, merger of companies, increasing or decreasing capital, separation, dissolution, liquidation, or company change.
According to Company Law, there is also a setup of board of directors (or an executive director) in a company, which is elected by and shall report to the shareholder meeting or general meeting of shareholders.
If the potential acquirer intends to acquire the target company by subscribing the increased capital or newly issued shares of the target company, the shareholder meeting or general meeting of shareholders of the target company will make resolutions on such capital increase; if the potential acquirer intends to acquire the target company by purchasing existing shares, the existing shareholders of the target company may have pre-emptive rights to purchase the shares to be transferred; additionally, in handling the formalities of change of shareholders as a result of the intended acquisition, cooperation of existing shareholders and their directors is indispensable.
What are the duties of the directors and controlling shareholders of a target company?
ZL: According to Company Law, the board of directors is responsible to the board of shareholders or general meeting of shareholders, and is in charge of executing resolutions of the board of shareholders or general meeting of the shareholders, determining the company's operational plans and investment plans, formulating the company's plans on the combination, division, dissolution, or transformation of the company. The board of directors participate in the target company's management and decision making mainly through resolutions of the meetings of the board of directors.
Company Law does not confer any special responsibilities to the controlling shareholders, who like the other shareholders, decide on the company's operational guidelines and investment plans, and important matters of the company such as combination, division, dissolution, liquidation and transformation also mainly through resolutions of the board of shareholders or general meeting. Because controlling shareholders has advantage in shareholding ratio, they can usually determine the result of the decision-making over concrete issues pending resolutions of the general meeting, determine the composition of the board of directors through its control of the general meeting, and through its control of the board of directors, further determine the composition of the senior officers of the target company, and thus exercise overall control of the target company.
Do employees/other stakeholders have any specific approval, consultation or other rights?
(1) Specific rights of the employees
According to Company Law, employees of a company shall, in accordance with the Labor Union Law of the People's Republic of China, organize a labor union, which shall carry out labor union activities and safeguard the legitimate rights and interests of the employees. When making a decision on company restructuring or any important issue relating to its business operations, or formulating any important rule or regulation, a company shall take into account the opinions of its labor union, and the opinions and proposals of its employees through the employee representatives' assembly or otherwise. Therefore, a target company's employees can exercise their right of consultation through employee representatives' assembly when the target company is facing an acquisition.
Additionally, according to the Measures for the Supervision and Administration over the Trading of State-owned Assets in Enterprises, if a target company is a state-owned enterprise and the transaction involves the resettlement of employees, a resolution on the plan of the resettlement should be discussed and adopted by the assembly of the employee representatives or of the employees.
(2) Specific rights of the other stakeholders
As far as the limited liability companies are concerned, according to Company Law, shareholders have the right of first refusal, under the same conditions, for the purchase of the shares held by the other shareholders. Therefore, if the transaction plan envisages its implementation through the acquisition of shared held by a major shareholder, prior waiver of the other shareholders' right of first refusal must be obtained.
What regulatory/third party approvals are required and what waiting periods do these impose, if any?
ZL: The required approvals are different in accordance with the different forms, parties of the transaction, and target company’s nature of the M&A.
For example, if the counterparty of M&A is a state owned company, then the transaction is likely to be required to go through the listing transfer process at Assets and Equity Exchange, asset appraisal process of the target shares and obtain approval/filing from the state owned assets supervision and administration department; the transaction of a listed company that involves Material Asset Restructuring, Back-door Listing or issuing shares etc. is required to obtain approval from CSRC or Stock Exchange; if the target company is an offshore company, then the transaction is also required to go through the examination, filing and registration process with NDRC, Ministry of the Commerce, and foreign exchange bank; the M&A of certain industry may also requires the approval from competent industrial administrations, e.g. the M&A of financing, insurance, securities company may requires approval from China Banking Regulatory Commission, the China Insurance Regulatory Commission and CSRC.
According to our experience, it’s different in every case to complete the approval from regulator/a third party. The time cost depends mainly on the department, level of approval, structure of transaction, industry of the target company etc. Generally, it takes more time to obtain approval from the state owned assets supervision and administration department, CSRC and NDRC；it takes less time to obtain approval from Industrial and Commercial Bureau and the State Administration of Foreign Exchange etc.
To what degree is conditionality an accepted market feature on acquisitions?
ZL: An M&A transaction usually contains the internal resolution of the buyer or the counterparty, or approval, filing or registration process from the domestic or overseas competent governmental department (e.g. Ministry of the Commerce, CSRC, NDRC, the state owned assets supervision and administration department in domestic China etc.). According to relevant laws, obtaining approval, filing or registration documents are always the effective conditions or closing conditions of a transaction. Therefore, usually in the transaction agreement, such approval, filing, or registration is usually taken as one of the effective conditions.
In addition, as to the M&A transaction itself, at the time both parties signing the agreement, according to requirements of both parties, there are always issues for the target company to be organized or regulated before closing. For example, if some material debt or asset of the target company should be split, which should be included in the SPA, and the transaction should closing according to the agreement only if the conditions are fulfilled. To our experience, it’s common for the M&A transaction to have the effective conditions.
What steps can an acquirer of a target company take to secure deal exclusivity?
ZL: To our experience, in order to secure deal exclusivity, both parties of the transaction will normally enter into a Termsheet, letter of intention, or framework agreement when they have reached an initial intention of M&A, which includes not only the main clauses that should be included in a formal transaction agreement after DD, but also the exclusivity clause in the Termsheet.
For example, in order to secure deal exclusivity, the target company makes a commitment that within certain time (usually is during DD period) of signing Termsheet, it should not directly or indirectly look for share/debt financing or accepting investment offer provided by a third party; should not provide information in relation to share/debt financing to a third party or take part in discussion and negotiation in relation to share/debt financing; and should not reach an agreement or arrangement with a third party on share/debt financing.
What other deal protection and costs coverage mechanisms are most frequently used by acquirers?
ZL: For the purpose of deal protection and costs coverage, Termination Fee and Non-Disclosure Agreement are most frequently used by acquirers besides the mechanisms detailed in Question 13.
i) Termination Fee (also referred to as Breakup Fee)
At early stage of acquisition, both parties of the acquisition will stipulate in the framework agreement or similar instrument that when the target company fails to obtain shareholder approval, agrees to a competing offer or the necessary government approval is denied or other stipulated event occurs, the target company will pay termination fees to the acquirers.
ii) Non-Disclosure Agreement (NDA)
Acquirers and target companies will execute Non-Disclosure Agreement before the implementation of substantive work and the target company will undertake to guarantee the confidentiality of all sensitive information disclosed by the acquirers.
Besides the above mechanisms, acquirers will take other mechanisms such as M&A insurance to cover the risks and costs pertaining to the transaction, but those mechanisms have not been used frequently.
Which forms of consideration are most commonly used?
ZL: Cash, shares and assets are all commonly used consideration in acquisitions and the form of consideration in each specific acquisition will be determined by the type of the transaction and the applicable laws. In acquisitions which involve material asset restructuring of listed companies, shares and assets are more frequently used as consideration to achieve the purpose of company restructuring. In terms of Provisions on the Merger and Acquisition of Domestic Enterprises by Foreign Investors, foreign investors are allowed to use shares issued by foreign companies as consideration to acquire domestic enterprises. And in accordance with the Measures for the Supervision and Administration over the Trading of State-owned Assets in Enterprises and relevant regulations, in acquisition involving transfer of state-owned shares, cash will be normally required as the consideration. In acquisitions of non-listed companies which don’t concern transfer of state-owned shares, acquirers have more flexible options as to the form of consideration.
At what stages of an acquisition is public disclosure required (whether acquiring a target company as a whole or a minority stake)?
ZL: Provided that the acquisition doesn’t concern listed companies, it’s not mandatorily required to make public disclosure except the documentation to competent authorities for governmental approvals and consents. In accordance with the Administrative Measures for the Takeover of Listed Companies，the acquirer is demanded to make public disclosure when the shares it holds in a listed company has reached five percent of shares issued by the company and every five percent increase afterwards. In terms of the Administrative Measures for the Material Assets Reorganization of Listed Companies, if the acquisition is in the form of material asset restructuring of a listed company and the listed company has reached a preliminary substantive intention with the counterparty and determined to enter into the process of material assets reorganization, it shall make public disclosure pertaining to the transaction and successive disclosure is required when the material assets reorganization gains advances such as the execution of reorganization framework or the approval opinions from competent authorities.
Are there any circumstances where a minimum price may be set for the shares in a target company?
ZL: The requirement for a minimum price usually exists in acquisitions involving state-owned shares or listed companies. According to Provisional Measures for the Management of Transfer of State-owned Equities in Enterprises, price of the shares shall not be less than 90% of the price determined by appraisal unless it’s consented by competent authority. When the acquirer is required to make tender offer to the shares of a listed company in pursuance of the Administrative Measures for the Takeover of Listed Companies, the offering price shall not be less than the highest price the acquirer paid to the shares of the same class within six months prior to the indicative announcement of the tender offer.
Is it possible for target companies to provide financial assistance?
ZL: In pursuance of the Administrative Measures for the Takeover of Listed Companies, listed companies are not allowed to provide financial assistance of any forms to its acquirers in order to protect the rights of the listed company and minority investors. Beyond that, non-listed target companies are not prohibited from providing financial assistance to acquirers conditioned that it’s not in violation of the constitutional documents of the target company. Nonetheless, it’s not common for target companies to provide financial assistance for acquirers in current acquisition practices.
Which governing law is customarily used on acquisitions?
ZL: Acquisitions in China shall be subject to mandatory provisions of Company Law, Securities Law and other applicable laws and the approval and consents from CSRC, Ministry of the Commerce and other related authorities are necessary to complete the transactions, therefore laws and regulations of mainland China are customarily used as governing law on acquisitions in China. Nonetheless, overseas transactions constituting a section of the acquisition is customarily governed by laws and regulations of the jurisdiction where the transaction is conducted.
What public-facing documentation is it necessary for a buyer to produce in connection with the acquisition of a listed company?
ZL: In terms of the Administrative Measures for the Takeover of Listed Companies, the buyer is obliged to produce: i) Report of Change in Equity when the equity it holds in a listed company has reached the statutory percentage, ii) Report of Takeover by Offer when it intends to increase its equity in the target company by tender offer, iii) Report of Takeover when it intends to increase its equity in the target company by agreement, indirect holding, etc. Meantime, the buyer shall submit to the Securities Exchange and the target company relevant documents in terms of the buyer identity, the funding source and other documents required by the CSRC for reference. When the acquisition of a listed company is conducted through material asset restructuring, the buyer is required to publicly commit to provide the information concerning the material asset restructuring and guarantee the authenticity, correctness and completeness of the above information.
What formalities are required in order to document a transfer of shares, including any local transfer taxes or duties?
ZL: Generally speaking, the target company should first go through the formalities for altering the registration in the administration of industry and commerce. And companies in certain industries, e.g. securities companies, should also seek approval from competent authorities before the registration in the administration of industry and commerce. Furthermore, the seller should submit an annual enterprise income tax return, which includes the declaration of share transfer income.
In case a foreign investor intends to acquire a listed company, according to Measures for the Administration of Strategic Investment in Listed Companies by Foreign Investors, it should submit application to the Ministry of Commerce for approval. Then, it should go through the formalities for confirmation of share transfer at the securities exchange and report to the CSRC for archival filing. Ultimately, the listed company should go through alteration registration at the administration of industry and commerce upon the issuance of certificate of approval for foreign-invested enterprises by Ministry of Commerce.
In case a state-owned shareholder transfers its shares of the listed company by agreement, according to Interim Measures for the Administration of State-owned Shareholders’ Transfer of Listed Company shares, it should submit the transfer to the state-owned assets supervision and administration institution at or above the provincial level for approval.
Are hostile acquisitions a common feature?
In China, hostile acquisitions have not become a common feature. However, with the dramatic change of economic and legal environment, hostile acquisitions tend to happen more frequently in the future M&A market. Reform of equity division has been successfully accomplished and the attitude of Chinese related laws and regulations towards hostile acquisition, such as Company Law (revision in 2014), Security law (revision in 2014), and Measures for the Administration of the Takeover of Listed Companies (revision in 2014), has been increasingly tolerant in recent years. It follows, therefore, that companies in China will face higher risk of hostile acquisition at the same time.
What protections do directors of a target company have against a hostile approach?
Measures for the Administration of the Takeover of Listed Companies (revision in 2014), in principle, restricts the power of the directors to take improper protecting measures against a hostile approach. In practice, however, the directors still have some protections against a hostile approach.
First, the directors can take the protecting measure of White Knight to invite a strategic partner to make a higher bidder to increase the value of shares, achieving the goal of deterring the hostile bidder.
Second, the measure of Staggered Board of Directors is also often used by the directors. It refers that groups of directors are elected at different times for multiyear terms according to Articles of Association of the company, which can challenge the prospective hostile bidder, since the hostile bidder will have to win multiple proxy fights over time and deal with successive shareholder meetings in order to successfully take over the company.
Third, on behalf of the target company, the directors can initiate court proceedings against the hostile bidder provided its takeover behaviours violate certain laws or regulations. The claims brought are mainly as followings: 1) violation of anti-trust laws; 2) insufficient information disclosure to the public; 3) criminal acts, such as fraud. Court proceedings, to some extent, can force the hostile bidder to increase the share price or slower the speed of the hostile acquisition.
Are there circumstances where a buyer may have to make a mandatory or compulsory offer for a target company?
According to Security Law (revision in 2014) and Measures for the Administration of the Takeover of Listed Companies (revision in 2014), a buyer is obliged to make a tender offer to all shareholders of the target company to buy all or part of shares they hold, when the buyer has possessed 30 percent of the stocks issued by the said company through trading at the stock exchange or by agreement, etc. and the purchase is intended to continue.
If an acquirer does not obtain full control of a target company, what rights do minority shareholders enjoy?
If an acquirer does not obtain full control of a target company, according to Company Law (revision in 2013), minority shareholders are still entitled to enjoy the capital proceeds, participate in making important decisions, and choose managers, etc. Furthermore, they still enjoy the right of reviewing the company’s bylaw, the minutes of the shareholders’ meeting, the financial reports and other company’s documents stipulated by laws.
Is a mechanism available to compulsorily acquire minority stakes?
As far as we know, there is no mechanism available to compulsorily acquire minority stakes provided by Chinese related laws and regulations due to the concern of possibly violating the right of minority shareholders. However, if the minority shareholders have reached an agreement which stipulates the right in the nature of drag along with the acquirer, then the latter will have the right rendered by the contract to compulsorily acquire the shares held by the former and such agreement is not prohibited by law.