Various issues may arise during the negotiation and conclusion of M&A transactions in the China. Most legal requirements pertaining to equity M&A transactions can be found in the Regulations on Mergers and Acquisitions of Domestic Companies by Foreign Investors (关于外国投资者并购境内企业的规定) (M&A Rules) promulgated on August 8 2006. The M&A Rules apply when an acquisition of a PRC domestic company, which is defined as “non foreign-invested enterprise(s) within the PRC territory”, by foreign investors, takes place. Other regulations may also be applicable when the target company is in certain industries or meets certain criteria, such as in possession of state-owned assets or having state-owned investors.

Methods of Acquisition and Forms of Consideration

The M&A Rules take two approaches for foreign investors acquiring equity in a PRC company. The Foreign Investor may either acquire equity directly from existing PRC shareholder(s) of the target company, or alternatively, subscribe for new shares by injecting funds to increase the registered capital of the target company. The latter approach is preferred in the event that the foreign investor intends for the target company to receive additional funds to facilitate its future growth or meet other specific funding requirements. The resulting entity after the acquisition will be a foreign-invested company (FIC).

The Foreign Investor is allowed to make payment of consideration in the form of cash, assets and/or shares of a company listed in an internationally-recognized exchange, or a special purpose vehicle. The payment by shares is also known as “share swap” in M&A terms, whereby a separate approval is required. Cash payment is most commonly seen in the practice and the cash consideration can be in either foreign currency or RMB. In the event that the case consideration is in RMB, special approval by the foreign exchange authority will be required.

Payment of Consideration

Under the M&A Rules, the consideration is required not to be markedly lower than the valuation of the equity determined by a qualified valuer in China. In the event that the transaction involves state-owned equity, such equity shall be valued by a valuer qualified to appraise state-owned assets, the result of which shall be filed with or approved by the SASAC.

Generally, the M&A Rules provide that the investor shall effect the payment of consideration: (i) in full within 3 months from the issuance of the business license of the resulting FIC; or (ii) otherwise approved by the relevant authorities, 60 per cent of the consideration within six months and the balance within one year from the issuance of the business license of the FIC. In the event that the target company is engaged in property development, the payment of consideration shall be made in full within three months from the issuance of the business license of the FIC.

Should the transaction involve state-owned assets, the consideration shall normally be settled in full in one lump sum payment. If the Foreign Investor intends to make the payment in installments, it shall apply to the SASAC, which originally approves the transfer of equity in the target company, for approval.

Overseas Payment?

Under the M&A Rules, a PRC vendor and the Foreign Investor are required to agree on the payment schedule and the venue where the payment is to be made. Also pursuant to the Circular on relevant Issues relating to the Administration on Approval, Registration, Foreign Currency and Taxation of Foreign Invested Companies (关于加强外商投资企业审批、登记、外汇及税收管理有关问题的通知), in the event that the payment of consideration has not been made in full, the Foreign Investor will only be entitled to the profit proportionate to the percentage of its payment. In addition, the Foreign Investor will not be allowed to exercise its decision making power in relation to the target company, if any, and cannot consolidate the assets of the target company into its own financial statement.

Under the M&A Rules, the payment of consideration is subject to confirmation by the State Administration of Foreign Exchange (SAFE) in the locality where the PRC vendor resides, who will in turn issue a registration certificate on foreign exchange testifying that the payment has been duly received. Though in practice the parties are seen to agree on partial or all of the payment to be made into the PRC vendor’s overseas account from time to time, such arrangements can be problematic since the local SAFE does not recognize overseas payment and therefore will not issue the certificate. As such, the Foreign Investor will be restricted from exercising its right as a shareholder for failing to provide the evidence of making the payment of consideration.

Lin Lei and Crystal Li

KhattarWong