Wu Dong of Hui Ye Law Firm discusses the key points necessary for understanding the foreign acquisition of Chinese state-owned enterprises
Major business areas and significant transactions
Hui Ye Law Firm was founded in 1999. M&A Law Firm is the English name of the firm, reflecting its commitment to mergers and acquisitions since its beginning. In 2000, I and Gordon Yang, the founder of Hui Ye Law Firm, were involved in a M&A project between the Chinese White Cat Group and Henkel, a famous German company, restructuring six Henkel companies in China and ten White Cat Group’s companies, but due to land allocation issues, the two sides could not reach an agreement, so the White Cat Group switched to a joint venture with Hutchison Whampoa, a famous Hong Kong-based company found by Li Ka-shing. We were involved in the design and negotiation of the joint venture and capital increase plan, as well as the drafting of legal documents in both English and Chinese. The final joint venture and capital increase project of RMB 1bn between White Cat and Hutchison Whampoa was approved by the Ministry of Commerce of the People’s Republic of China and became a model of joint venture between state-owned enterprises and foreign investors in Shanghai. In recent years, I have handled large-scale M&A projects including the establishment of a joint venture company (The Paper Audio & Video Technology Jinan) between The Paper and ByteDance (parent company of TikTok), the project of Bright Food Group sells shares of Sino-American joint venture Gillette (Shanghai) Limited to P&G for RMB 1.8bn, the acquisition of Japanese equity interests in Shanghai International Airport Hotel by China Eastern Airlines, the public issuance of RMB 10.3bn corporate bonds and RMB 480bn overseas Korean Won bonds, 500m Singapore Dollar bonds and 50bn Japanese Yen bonds by China Eastern Airlines and its Fly at Will project, the transfer of equity interests in two holding subsidiaries of Commercial Aircraft Corporation of China (COMAC), the project of China Tennis Association, Beijing China Open Tennis Sports Development Center and Chengdu Sports Industry Investment Group jointly establishing a joint venture cooperation project of Beijing China Open Tour Sports Management (China Tennis Tour Project) and the acquisition of Suparna Airlines under Hai Nan Airline Group by State-owned Assets Supervision and Administration Commission, Department of Transportation and Aviation Industry Investment Company of Jiangsu Province.
Hui Ye Law Firm has received many awards from The Legal 500, Chambers, LEGALBAND and ALB in the area of M&A. I have also been listed in The Legal 500 as a recommended lawyer for ‘Corporate and M&A’ in 2023 and 2022, Chambers Global and Greater China as a recommended lawyer for ‘Corporate and M&A’ in 2023 and 2022. I was awarded ‘Top Lawyer in China for Corporate M&A’ and ‘Top 15 Transaction Lawyers in China’ by LEGALBAND in 2022 and 2021. Also, the issuance of 300bn Korean won bonds by Eastern Airlines has been listed in ‘Deals of the Year 2020’ by China Business Law Journal.
Considerations and key points related to the acquisition of Chinese state-owned enterprises by foreign investors
There are a large number of state-owned enterprises (SOEs) in China. Based on my experience in dealing with many cases of the acquisition of Chinese SOEs by foreign investors, the following are special matters that need to be noted as opposed to ordinary acquisitions:
Distinguishing between different types of state-owned enterprises
Chinese SOEs are divided into two categories, central SOEs and local SOEs, which are supervised by the central government and local government respectively. In addition, there are some special types of SOEs in China. Financial SOEs, such as state-owned banks and asset management companies, are supervised by the Ministry of Finance, while cultural media SOEs, such as television and newspapers, are supervised by the Publicity Department. Besides, if the subject company of an acquisition has multiple state-owned shareholders, the largest shareholder will fulfil the relevant approval procedures for the foreign acquisition.
Public transfers on the property market
In the process of acquisition of SOEs by foreign investors, in principle, the acquisition should be done publicly through the property rights market, such as China Beijing Equity Exchange, Shanghai United Assets and Equity Exchange, etc, which are different trading venues from Shanghai Stock Exchange and Shenzhen Stock Exchange. According to the principle of fair competition, the qualifications of the transferees shall not include the contents that have definite direction. For example, in the project of selling shares of Shanghai Gillette to P&G, if a condition is set out as the transferee must be one of the top three companies in the world in the field of cleaning products, then it clearly points to P&G, Unilever and Henkel, therefore this condition is illegal. However, other qualification conditions can be set. For example, in this project, we require the transferee to be established for more than five years and have a registered capital of at least RMB 3bn and a good financial position and ability to pay, make continuous profits in the last three years, have a net asset value of not less than RMB 4bn, and at the same time, not be engaged in a business that competes with the subject company. It is legal to set the conditions in this way.
Information disclosure and pre-disclosure system
To ensure fairness and openness in equity transfers, China has strict requirements for the information disclosure system in public transfers, including both pre-disclosure and formal disclosure. First, in the course of a public transfer in the equity market, if it involves a transfer of actual control of the enterprise, such as a foreign investment acquiring 51% of the shares of the subject company, the transferor is required to make a pre-disclosure for not less than 20 working days through the website of the equity trading institution within ten working days of the approval of the act of transfer. The content of the pre-disclosure shall include but not be limited to the following, the basic information of the subject of the transfer, the shareholder structure of the subject enterprise, the decision-making and approval of the act of transfer of property rights, the main financial index data in the latest annual audit report and the latest financial statements of the subject enterprise. Secondly, a formal disclosure is required, whether a transfer of control is involved in the acquisition or not. That means, even if a foreign investment only intends to acquire 30% of the shares of the subject company, the transferor shall make a formal disclosure not less than 20 working days. In addition to the above-mentioned pre-disclosure information, the formal disclosure should also include the terms of the transaction and the reserve price of the transfer, whether the management of the enterprise will participate in the transfer, the bidding method and the relevant evaluation criteria for the selection of the transferee, and whether the original shareholders of the limited liability company will waive their right of first refusal, etc.
Other shareholders’ right of first refusal of the acquired company
Pursuant to the relevant provisions of the PRC Company Law, in the event of an acquisition of part of the shares of the subject company, other shareholders of the company may exercise their right of first refusal. Although, as stated in the previous paragraph, foreign investors acquiring state-owned equity interests must through Assets and Equity Exchange in China, other shareholders of the subject company exercising their rights of first refusal may choose either to deal through Assets and Equity Exchange in China or reach an agreement without Exchange. Therefore, in the transaction, it is necessary to confirm whether the other shareholders of the subject company opted to exercise their rights through Exchanges.
Audit, asset valuation and determination of listing price
Due to the special nature of SOEs, China has strict requirements for audits and asset appraisals in acquisitions. First, an asset appraisal must be commissioned from a qualified institution for an equity transfer project and the equity transfer price must be determined on the basis of the appraisal results and must not be lower than the appraised price. For example, in the P&G acquisition of Gillette, the appraised price of the SOE’s equity is RMB 1.8bn, so the listing price on the Exchange cannot be lower than RMB 1.8bn. However, if no transferee is solicited, the price can be reduced to RMB 1.7bn and then listed again. If the transaction cannot be completed for RMB 1.7bn, it is planned to be listed for RMB 1.6bn, as the price is lower than 90% of the evaluation result, written consent from the State-owned Assets Supervision and Administration Commission (SASAC) is required. Secondly, in accordance with relevant laws, if no qualified transferee has been solicited within 12 months after the first official disclosure of information, the procedures for the transfer of property rights, such as auditing, asset evaluation and information disclosure, should be performed again. Therefore, it is advisable to control the entire acquisition time within one year to ensure the timeliness of audit, asset evaluation and other reports.
Anti-monopoly and national security review of foreign mergers and acquisitions
China has strict restrictions on the acquisition of SOEs by foreign investors, including anti-monopoly review and national security review. First, if the M&A transaction constitutes concentration of undertakings, it requires an anti-monopoly review by the State Administration for Market Regulation (SAAMR). Whether an M&A transaction constitutes a concentration of undertakings depends on whether there is a transfer of control, which is generally considered to occur when more than 50% of the equity is acquired. In addition, the establishment of a joint venture between foreign and Chinese parties to exercise joint control will also require prior notification of concentrations of undertakings.Secondly, foreign M&A are also subject to national security review by the National Development and Reform Commission (NDRC), not the Ministry of Commerce. Unlike the CFIUS review, China includes ‘greenfield’ investments and establishment of joint ventures by foreign enterprises in NDRC review. If foreign investors gain effective control in areas which are vital to national security such as important agriculture, energy, infrastructure, culture and finance are subject to security review. Since this sentence appears twice, they need to be modified accordingly. The military industry, which is related to national defence security, and investments in the vicinity of military facilities are subject to security review regardless of whether control is obtained.
Currency of payment, instalment payment and guarantee system
China requires foreign acquisitions of SOEs to be settled in RMB. Payment in principle needs to be made through the Assets and Equity Exchange unless the transferor provides a written opinion from the SASAC.
The payment for the transaction shall, in principle, be made in one lump sum within five working days from the effective date of the contract, but in special circumstances such as larger amounts, China also allows for an instalment payment clause. However, in order to ensure the security of the transaction, restrictions are imposed on the down payment, time of payment, security status and interest for the instalment payment. First, the down payment shall not be less than 30% of the total price. Secondly, the time of payment shall be five working days from the effective date of the contract, which is in line with the time limit requirement for full payment. Thirdly, the rest of the payment shall be provided with legal and effective security. Fourthly, interest shall be paid during the period of deferred payment at the same bank loan rate and the payment period shall not exceed one year.
In the project that I handled, P&G acquired 30% of the shares of Shanghai Gillette held by Bright Food Group for RMB 1.8bn. P&G already held 70% of the shares of Gillette, and after the acquisition Gillette was converted from a Sino-foreign joint venture to a wholly foreign-owned company. This project then took the form of an instalment payment. P&G pledged its 21% shares of Gillette to Bright Food Group (SOE) as security for the instalment payments. It is noteworthy that P&G in the US pledged its equity in the subject company to secure the instalment payments, which is a relatively rare form of security in foreign acquisition practice. Normally, a bank guarantee, for example, is required as security.
Negative list of foreign mergers and acquisitions and other matters
When foreign investors acquire SOEs, they have to comply with the requirements of the Catalogue for the Guidance of Foreign Investment Industries and the Negative List for foreign investment. Not all industries can be invested in by foreign investors, and the Negative List lists the areas where investment is prohibited or restricted. Areas where foreign investment is absolutely prohibited, such as private schools for military, police and other special nature education, for-profit private schools for compulsory education, civil aircraft design, manufacturing and maintenance, etc. Areas where foreign investment is restricted, such as securities companies, which require a Chinese holding, and life insurance companies, which require no more than 50% foreign investment. It is also important to note that when foreign investors acquire a SOE, matters involving the resettlement of employees must be approved by the assembly of the representatives of the employees or employees’ assembly, but not by the trade unions, and in this respect, China differs from foreign countries. At the same time, acquisitions of SOEs require not only a decision by the SOE’s board of directors or shareholders’ meeting, but also a decision by the SOE’s party committee and approval by the SOE’s higher authority (usually the SASAC).
Planning for the future of the profession and the social responsibility of lawyers
In recent years, legal services in industries such as big data, AI, biomedicine, pensions, media, aviation, education and sports have been on the rise. These emerging fields have diverse transaction models, complex types of mergers and acquisitions, and transactions involving corporate business not only across borders but also across industries. I am an adjunct professor at East China University of Political Science and Law and hope to summarise more practical experience, write more relevant articles and give more lectures to the students of the law school and young lawyers in this field.
Having been practicing law for many years, I realise that as a lawyer I must not only protect every transaction, but also contribute to the development of the social legal system to the best of my ability. I have also served as a director of the Shanghai Shareholding and Securities Research Association, an arbitrator of the Shanghai, Nanjing and Guangzhou Arbitration Commissions, and an expert in legislative consultation with the Shanghai Municipal government. I have participated in the drafting and revising of many Chinese national and local legislations, such as the Company Law of the People’s Republic of China, the Shanghai Regulations on Optimizing the Business Environment, and the Shanghai Regulations on the Protection of Consumer Rights and Interests. I hope to use my professional expertise as a lawyer to contribute to the progress of law in China and to make Shanghai a metropolitan city like New York and London.
