As China continues with its economic reforms and the opening up of its markets,
foreign direct investment is playing an increasingly important role and holding
an ever-prominent position in the country's development.
Among the various approaches for foreign investors to enter China, M&A is widely
considered to be one of the most significant methods. Pursuant to Article 2 of
the Interim Provision on Acquisition of Domestic Enterprises by Foreign
Investors1, M&A can be defined as the acquisition of equity or assets.
Definition
Equity acquisition refers to:
(i) a foreign investor's acquisition of a local shareholder's equity in an
enterprise other than a foreign-funded enterprise (FFE), or
(ii) a foreign investor's subscription to a domestic company's capital increase,
resulting in the conversion of the domestic company into a newly established
FFE.
Asset acquisition refers to:
(i) a foreign investor's establishment of an FFE and the purchase through the
FFE of a domestic enterprise's assets and the operation of such assets, or
(ii) a foreign investor's acquisition of a domestic enterprise's assets and the
use of such assets to invest in and establish a FFE to operate such assets.
The definition above may not be the most accurate and standard one, since it is
not provided in legislation. We may expect to see the formal definition in the
Foreign Investment Law soon. From a definitive perspective, the two main M&A
vehicles of asset acquisition and equity acquisition can be seen as distinctly
different. However, the final goal of the two methods of acquisition is the
same, which is to establish an FFE.
Legal status of acquired companies
An equity acquisition will directly convert the acquired company into an FFE. By
contrast, an asset acquisition will not automatically change the legal status of
the acquired company.
In order to efficiently carry out an asset acquisition, a foreign investor may
use its existing FFE in China to acquire domestic assets; this has become common
practice. If there is no existing enterprise available, the establishment of a
new FFE and the acquisition of assets may be conducted simultaneously. Once the
new enterprise is established, the assets acquired can be put into operation
immediately.
Claims and debts
If a foreign investor carries out an equity acquisition, the FFE established
after the acquisition succeeds to the claims and debts of the acquired domestic
company. However, if assets are acquired, the domestic enterprise that sold the
assets will bear its existing claims and debts.
A key concern for foreign investors is whether they can conduct acquisitions
free of further claims or debts, other than what they have already considered.
Due to the absence of a credit-checking system, it is difficult for a foreign
investor to discover the real condition of a domestic company in an equity
acquisition.
Other than the claims and debts discovered by the foreign investor, there will
still be other financial burdens in some domestic companies, such as
considerable retirement pensions, which will have a negative impact on the
operation of the newly established FFE following an acquisition.
Valuation of equity and assets
All parties to an acquisition will determine a transaction price on the basis of
the value of the equity to be transferred or the value of the assets to be sold,
as appraised by a domestic asset appraisal institution in accordance with common
international methods.
Any acquisition by a foreign investor that may lead to a change in the equity of
a state investment asset or a transfer of title to state-owned assets may be
subject to a special valuation mechanism. The State-owned Asset Supervision &
Administration Commission of the State Council manages such matters, and any
proposed transfer of state-owned assets to a foreign investor must obtain the
pre-approval of the state body and its local counterparts before any further
steps are taken.
Endnote
1 Promulgated by the Ministry of Foreign Trade and Economic Cooperation, the
State Administration of Taxation, the State Administration for Industry and
Commerce and the State Administration of Foreign Exchange on March 7 2003 and
effective from April 12 2003.
Zhong Lun PRC Lawyers