Payment Schedules in Acquisitions: Contractual or Statutory?

It is generally understood that a payment schedule is a commercial issue, which should be determined solely by the purchasers and sellers in M&A transactions. However, as we can see in China, a payment schedule is also a matter that is regulated by law. Even without a contractual agreement on the payment schedule, the purchaser cannot be relieved from a legal time limit on the transaction. Article 7 of the Circular provides that the parties to an equity transfer shall specify the time limit for the payment of the equity takeover price by the foreign investor in the equity transfer agreement and the approval authority shall not approve an agreement without such a specific provision. As such, the absence of a payment schedule provision in the relevant agreement could make governmental approval of the M&A transaction impossible to obtain.

The relevant regulations and rules mentioned above not only raise the schedule requirements but also specify how such requirements should be implemented. It is provided that the investor with the controlling interest may neither obtain decision-making power in the enterprise nor consolidate its interest and assets in the enterprise into its financial statement until it has paid the takeover price in full. A mandatory provision appears to impose an unnecessary burden on the parties, especially when "decision-making power" is not clearly defined. Will a relevant board resolution be determined null and void just because the controlling shareholder has not paid the takeover price in full? As to the restriction upon the consolidation of financial statements, a serious conflict of law may arise if the foreign investor is a listed company and its domestic laws mandate consolidation of financials for pubic disclosure.

FIEs: Domestic or Foreign Entities?

According to Article 24 of the Tentative Provisions, equity acquisitions of foreign-invested enterprises (FIEs) in China by foreign investors shall be governed by current FIE laws and regulations and the Changes in the Equity Interests of Shareholders of Foreign-invested Enterprises Several Provisions; any matters not provided for in such laws and regulations shall be handled "with reference to" the Tentative Provisions. As such, the Tentative Provisions and its payment schedule requirement shall also apply to acquisitions involving FIEs as target companies. But it is still uncertain whether the payment schedule provisions apply in a case where the purchaser and the seller are both foreign entities. From the perspective of foreign exchange control it may be impossible to supervise the payment progress regarding a share transfer between two offshore entities.

SOEs & Listed Companies

As we can see from Article 11 of the Using Foreign Investment to Reorganize State-owned Enterprises Tentative Provisions (issued on November 8 2002), the authorities in charge of state-owned enterprise administration also make payment schedule provisions. Besides meeting the requirements provided by the Tentative Provisions and the Circular, in a case of acquiring an SOE, the purchaser shall provide security for its remaining unpaid amount. It is unclear what sort of security under the PRC Security Law should be provided.

With respect to listed companies, the strictest standard has been adopted. Article 5 of the Issues Relevant to the Transfer of State-owned Shares and Legal Person Shares in Listed Companies to Foreign Investors Circular, provides that the securities registration and clearing institution and the administration for industry and commerce may not process change in ownership or shareholder registration until the transfer price has been paid in full by foreign investors. In this regard, when choosing a listed company as a target company, the purchaser would be well advised to pay the consideration in a lump sum, as it cannot be registered as the shareholder of the listed company before full payment.

By Christophe Han & Sidney Qin, Llinks Law Office