Wu Dong and Sun Xiaoning from Hui Ye Law Firm highlight a number of considerations that warrant particular attention from foreign investors seeking to acquire state-owned enterprises in China.
Foreign investors usually acquire Chinese state-owned enterprises (SOEs) via an acquisition agreement, capital increase, absorption and merger, purchase of shares in SOEs on the Shanghai Stock Exchange (SSE) or Shenzhen Stock Exchange (SZSE), etc. The acquisition can be broadly classified as one of two types – ie, either an equity acquisition or an asset acquisition. The most important type is equity acquisition.
Foreign Takeover Process for Chinese State-Owned Enterprises
Foreign acquisition of SOE equity can also be understood as SOEs transferring equity to foreign investors. The standard procedure for the transfer of state-owned shares involves:
- the subject company’s shareholders reporting to the relevant state-owned assets regulatory authority for approval of the equity transfer;
- internal decision-making procedures;
- a resolution of the subject company’s employee representative assembly;
- audit and asset valuation of the subject company;
- qualification conditions for foreign investors;
- disclosure of information on chosen stock exchange;
- public solicitation of the transferee;
- arrangement of bidding to determine the transferee;
- announcement of the transaction results; and
- issuance of the equity transaction certificate and certificate of delivery.
Foreign investors should take the following key issues into account when acquiring Chinese SOEs.
Is due diligence necessary before acquisition?
Foreign investors need to conduct due diligence on the subject company prior to mergers and acquisitions. First of all, foreign investors must ensure that the companies they invest in or acquire are not part of industries that fall within the sphere of state prohibition or limitation of foreign investment. Second, foreign investors should focus on aspects of the subject company such as tax refunds, incentives, subsidies and preferential policies, as well as its record on environmental protection and pollution. Also, in order to prevent significant legal risks arising from mergers and acquisitions, foreign investors should consider:
- whether the subject company’s accounts receivable exceed the statute of limitations; and
- whether the subject company has undisclosed external guarantees, significant lawsuits and administrative penalties.
For these purposes, foreign investors would be well advised to entrust lawyers and accountants with the task of performing due diligence on the subject company prior to acquisition.
Does the transfer of equity require internal and external approval?
When SOEs transfer their equity, the transfer plan not only needs to be approved within the SOE internally – namely, by the resolution of the shareholders’ meeting, the board meeting and the Communist Party committee within the SOE – but also requires external approval (ie, it must be approved by the relevant state-owned assets regulatory authority and the relevant higher-level authorities). The acquisition of some leading SOEs is also subject to approval by the government at the same level.
Can foreign investors use state-owned land?
The property of Chinese SOEs often includes land. Land use is divided into different types, such as land for commercial use, land for industrial and mining warehousing purposes, and land for transport use. When acquiring an SOE, foreign investors must use land in strict accordance with the purposes specified in the overall land utilisation plan. If their land use is inconsistent with the specific purpose, foreign investors must apply to adjust the use of the land.
The right to use state-owned land can be obtained in two different ways – either through government allocation (划拨土地) or through transfer (出让土地). If foreign investors want to acquire an SOE that obtained its land use right through government allocation, foreign investors must go through a formal approval process to convert government-allocated land use rights into “transferred” land use rights after acquisition. They must also pay a land transaction fee – therefore, the equity valuation should be adjusted accordingly.
Do any special rules apply to the foreign takeover of famous Chinese brands?
If the subject company owns a famous trade mark or “China Time-honored Brand”, the Ministry of Commerce of the People’s Republic of China (MOFCOM) stipulates that it must submit a report to MOFCOM. SASAC stipulates that if a foreign investor acquires control of an SOE, it must not use the original intangible assets (eg, shop names and franchises). In this respect, foreign investors should pay great attention to the difference between MOFCOM and SASAC, as both are central government departments.
How is the transaction price determined?
The transaction price should be determined on the basis of the result of an asset valuation organisation’s assessment of the equities to be transferred or the assets to be sold. The parties to the takeover may agree on an asset assessment institution lawfully established within China. It is forbidden to divert any capital abroad in any disguised form by transferring any equities or selling assets at a price that is obviously lower than the assessment result.
Who ensures the proper placement of employees?
During the acquisition of SOEs by foreign investors, a plan for the proper placement of employees should be formulated and submitted for review and approval by the employee representative assembly rather than by the trade union. The enterprise must alter or renew the labour contracts of the retained employees and pay economic compensation to the dismissed employees in accordance with the law. Additionally, the enterprise is required to make up the social insurance charges owed by the original SOE.
