Breaking New Ground in State-owned Assets Transfers

The Tentative Procedures go one step further than the Opinions and establish a compulsory regime by which any transfer of state-owned assets in enterprises should be conducted through qualified equity exchanges. Admittedly, this move to further regulate the market has been discussed for some time and is already reflected in some notable local regulations.⁶ A number of local regulations have recently been enacted that govern the establishment and management of equity exchanges. Local regulations have been promulgated in Shanghai, Beijing, Tianjin, Shenzhen, Chongqing, Guangzhou and in Shandong province. With the enactment of the Tentative Procedures, however, equity exchanges are promoted as a new platform for general and mandatory state-owned asset transactions.⁷

Scope of Application

The Tentative Procedures govern the transfer for consideration of state-owned assets from enterprises or from the SASAC and its local branches (the Assignors) to domestic or foreign legal persons, individuals or other entities (the Assignees) (Article 2).⁸

"State-owned assets in enterprises" refers to the rights and interests arising from various forms of investment in enterprises by the state, or by state-owned or state-controlled enterprises, and other rights and interests that shall be determined as state-owned in accordance with the law (Article 2).⁹

The Tentative Procedures exclude transfers of state-owned assets by financial enterprises and listed companies from its scope of application. These are subject to separate sets of rules (Article 2). Also excluded is the transfer of state-owned assets from Chinese enterprises located abroad, for which separate regulations will be promulgated (Article 36).

In transactions involving foreign investment and investment from Hong Kong, Macao and Taiwan, the stipulations of the Foreign Investment Industrial Guidance Catalogue(外商投资产业指导目录) should be complied with (the Catalogue was last revised on March 11 2002, and became effective as of April 1 2002).

Methods of Transfer

The Tentative Procedures state that transfer of state-owned assets must be conducted either through auction, competitive bidding or agreement (Article 5).

At the same time, the Tentative Procedures impose stricter rules as to the determination of the transfer method to be adopted. For instance, where two or more potential Assignees are identified following a public offer, the proposed Assignor must, after consultation with the equity exchange, choose between auction or competitive bidding in accordance with the particulars of the assets to be transferred (Articles 17 and 18). Previous regulations, such as the SOE Restructuring Provisions and the Shanghai Regulations are obviously less prescriptive.¹⁰ Furthermore, within the range of services provided by the "Comprehensive Service Window" in Shanghai, no mention is made of assistance services in the context of an auction or bidding process.¹¹

Transfer by agreement is only allowed upon the SASAC's approval and when only one potential Assignee is identified following a public offer (Article 18), or when transferring state-owned assets to specially qualified Assignees in key designated industries (Article 30).

No transaction will be allowed if ownership over the targeted assets is unclear or subject to disputes (Article 6).

Roles of Equity Exchanges

A detailed description of the status and role of the equity exchanges goes beyond the scope of this article. For our purposes, it is sufficient to say that equity exchanges are established and sponsored by local governments to act as equity and asset transaction platforms and to provide a wide range of services to facilitate transactions. Under the current regulations (including the Tentative Procedures, see Article 32(1)), transactions involving SOEs must be conducted at an authorized equity exchange for the transaction to be legal. In short, equity exchanges play a central function in the process of SOE restructurings and asset sales.

Under the Tentative Procedures, the SASAC has the power to select and authorize equity exchanges throughout the country to engage in state-owned asset transfers. The criteria for selection and authorization include that the equity exchanges shall (Article 10):

(1) comply with relevant laws, regulations and state policies concerning transfer of state-owned assets;

(2) perform duties of the equity exchange and closely examine the qualifications and conditions of the parties to state-owned assets transactions;

(3) disclose public information relating to asset transfers and regularly report to the SASAC;

(4) have adequate facilities to accommodate transfer activities (including premises, information disclosure channels and professional personnel); and

(5) operate properly and have a clean compliance record for three consecutive years.

Once selected and authorized, equity exchanges have almost quasi-regulatory powers and the SASAC effectively makes them an integrated part of its supervision and control framework.

Qualification of Potential Assignees

The Tentative Procedures set out criteria for selecting potential Assignees. These include possession of a solid financial position and ability to pay, a sound commercial reputation and "other qualifications stipulated by state laws and regulations" (Article 15). In the case of transactions involving foreign investment, the SOE Restructuring Provisions provide further guidance in respect of the meaning of "relevant business qualifications" and an ability to provide "advanced technology", business management expertise, the need for a track record in the business of the targeted SOE and medium or long-term investment plans.¹²

Transfer Procedures

The Tentative Procedures set out complex and manifold procedures that a state-owned asset transfer transaction should follow:

Step 1 - The Assignor must compile a feasibility study report (FSR) on the proposed transfer and submit the FSR to its highest decision-making body for internal review and approval. Approval of the FSR must be given in writing. If the Assignor is a wholly state-owned enterprise the approval body is its general manager working meeting, and if it is a wholly state-owned company it is its board of directors (Article 11).

Step 2 - If the transfer implies matters relevant to the employees of the Assignor, the employees' representative congress shall express its views and an employees' resettlement plan must be discussed and approved by the employees' representative congress (Article 11).

Step 4 - After approval of the proposed transfer, the Assignor must check the subject assets and compile a balance sheet and an assets list. A qualified accounting firm must be instructed to conduct a comprehensive audit, including auditing the financial affairs handled by the legal representative of the Assignor who will eventually vacate his position following the transfer (Article 12).

Step 5 - The Assignor must invite a qualified state assets appraiser to appraise the assets. The results of the evaluation should be confirmed by or filed with the competent government authority and used as the reference basis for setting the transfer price of the assets (Article 13).

Step 6 - Detailed information of the proposed assets sale must be announced in selected newspapers and on the website of the equity exchange for the purpose of soliciting interested potential Assignees (Article 14).

Step 7 - According to the result of the public offer, the Assignor (having consulted with the equity exchange) must proceed by way of auction, competitive bidding or private agreement (if only one Assignee expressed interest or upon SASAC approval) (Articles 17 and 18).

Step 8 - The Assignor and the Assignee must enter into negotiations and then draft the contract. The Tentative Procedures set out the main contents of the assets transfer contract. In the case of the transfer resulting in the state losing its controlling position in the Assignor, both parties should also agree on a restructuring plan (including the employees' resettlement programme) before signing the assets transfer contract (Article 19).

Step 9 - When the transaction is completed, the equity exchange will issue an assets transfer certificate that both parties to the transfer shall submit to the relevant government departments for registration (Article 24).

The Tentative Procedures do not provide guidance as to how they dovetail with the procedures applicable to transactions involving foreign investors,¹³ for which the existing regulations naturally also apply. This means that along with the pre-existing piecemeal environment of overlapping or even conflicting regulations, the area will remain unclear.

In the Shanghai Regulations, transactions must unfold in four main steps:¹⁴

Step 1 - Submission of an application form to the "Comprehensive Service Window". After acceptance of the application, it shall be filed with the Shanghai Foreign Investment Commission (FIC).

Step 2 - Entrustment of an asset valuation institution to conduct valuation, the results of which shall be submitted to the Shanghai Assets Valuation Centre for confirmation.

Step 3 - Entrustment of a qualified equity brokerage agency to carry out the transaction including drafting the equity transfer contract for the parties to sign.

Step 4 - Completion of the transfer shall take place at the equity exchange that examines and approves the transfer documentation and issues a transaction certificate. Thereafter, the Assignor shall cancel the registration of the state assets or register the changes of the state assets following the transfer.¹⁵

The main distinct feature of the Shanghai Regulations is that they create an integrated procedural system through a "Comprehensive Service Window". The window aims at streamlining the procedures, from the inception to the approval and registration of transactions.¹⁶ However, most of the procedures under the Tentative Procedures are to be conducted before the Shanghai Regulations even enter into play. This means a transaction will generally have to go through the combined procedures under the two sets of regulations.

Approval Procedures

The Tentative Procedures give the SASAC overall control and supervision powers on the transfer of state-owned assets (Article 7) with wide responsibilities such as formulating the supervision framework and rules, selecting equity exchanges and inspecting transactions of state-owned asset transfers (Article 8).

However, unlike regulations of a similar nature, the Tentative Procedures do not spell out time sequences and procedural steps for obtaining government approval, but merely specify a number of guidance points for the transaction parties to follow. These include:

• the SASAC shall decide upon state-owned asset transfers conducted by those enterprises directly under its administration. Where the transfer results in the state losing its controlling position, this must be reported to the same level of government for its approval (Article 25);
• the SASAC shall also, jointly with the financial department, decide upon significant state-owned asset transfers conducted by important subsidiaries of those enterprises that are directly under its administration. Where such a transfer relates to public administration (Article 26) or allocated land or mining rights (Article 21), prior approval from the relevant departments is required;
• where the transaction alters the nature of state shares or transfers the effective control in a listed company, additional approval procedures shall be completed with the security regulatory authorities (Article 27); and
• after the transfer has been approved or decided, if the parties make adjustments to the transfer proportion, or if there is any important change to the transfer plan, it shall be submitted for new approval according to the prescribed procedures (Article 31).

For approval purposes, the following main documents shall be examined by the authorities (Article 28):

• the Assignor's resolution documents on the transfer;
• the transfer plan (Article 29);¹⁷
• the Assignor's registration documents and assets ownership certificates;
• a legal opinion delivered by a law firm; and
• relevant information relating to the Assignee.

Creditor Protection

The Tentative Procedures contain a few provisions relevant to creditor protection. Creditors must be notified before any transfer of the main assets, and their consent on the SOE restructuring shall be obtained in advance. The use of SOE restructuring for evading debt repayment obligations must be strictly prevented.¹⁸

Loss of State Control

The Tentative Procedures contain a number of provisions dealing with the consequences of the state or the Assignor losing its position of control in the enterprises following the transfer. For example:

• the SASAC should be directly involved in the assets verification process and be responsible for appointing auditors of the Assignor (Article 12);
• when signing an assets transfer contract, there is a requirement for both parties to simultaneously produce a restructuring plan. This must include the priority resettlement programme for the employees of the Assignor that is to be approved by the employees' representative meeting (Article 19);
• employment matters shall be handled properly in accordance with relevant state policies. The salaries of the employees, all kinds of social insurance premiums and other relevant expenses shall be settled, and the continuity of all kinds of social insurances of the employees of the Assignor shall be ensured (Article 22);
• the transfer of the state-owned assets shall be decided by the SASAC and be reported to the government of the same level for approval (Article 25); and
• documents submitted by the Assignor for approval shall also include the debt settlement agreement with financial institution creditors (Article 29).

Price and Payment

Significantly, the Tentative Procedures emphasize that there must not be any substantial deviation from the appraisal value. Where, in the course of a transaction, the value of the subject assets falls below 90% of the appraisal value, the transaction should be suspended and only after obtaining consent from the relevant authority shall the procedure be continued (Article 13).

The Tentative Procedures also emphasize the principle of a one lump sum acquisition payment. However, where the amount of the transaction is "relatively high", instalment payments are permitted. In such a case, the first payment must not be less than 30% of the total transfer price and shall be paid within five working days of the date of the effectiveness of the assets transfer contract. In addition, the Assignee must provide a guarantee. For the first time in Chinese legislation, the Tentative Procedures introduce the principle that an interest payment should be paid on the portion deferred at the rate applicable to the banks, and that the maximum deferred period is one year (Article 20).

Compared to the SOE Restructuring Provisions¹⁹ and the Beijing Regulations²⁰, foreign buyers are subject to even more stringent payment conditions, with a mandatory down payment of at least 60% of the total consideration.

Under the Shanghai Regulations, foreign investors have three months to pay the acquisition price calculated from the issuance date of the business licence of the foreign investment corporate vehicle used for buying the assets or to be set up following the share acquisition or the increase of registered capital. Where an extension is necessary, a maximum six months extension period may be granted subject to approval.²¹

Under the Opinions,²² the departments in charge of the SOE must determine the price of the state-owned assets. The appraisal price is an essential reference, but the price might also be affected by elements such as market supply and demand for the assets, the price of other comparable assets on the market, the terms of the employees' settlement plan and the introduction of advanced technologies. For listed companies, the price of state-owned shares should be set according to the company's performance and profits, and above the net asset value of each share.

Employee Protection

Investors would be well advised to consider the employment implications of the transfer of state-owned assets and to appreciate the Chinese authorities' concerns about social stability.²³ The issue has already been substantially regulated by various national and local regulations under the principle that employees' legitimate rights and lawful interests shall not be prejudiced under an SOE restructuring or state-owned assets transfer.

For example, in the Opinions²⁴ it is requested that a restructuring plan, and in particular any plan concerning the resettlement of employees, be also subject to the approval of the SOE's employees' congress or employee representatives' meeting before the plan can be implemented. The SOE shall use its existing assets to settle in full all unpaid wages, employees' medical bills, inappropriately used employee housing funds and unpaid social security contributions.

The Tentative Procedures also state that the employees' resettlement programme relating to the transfer shall be examined and agreed by local labour administrative authorities (Article 29(3)). Failure to properly resolve employment issues may result in the transfer being stopped by the SASAC or held invalid by the courts (Article 32(5)).

Under the Shanghai Regulations, where the controlling position in the enterprise is to be assigned or where all the main operational assets of a SOE are to be sold, the parties must formulate a restructuring plan and an employee settlement plan must be submitted to the employees' representative organs for review and consent. The employee resettlement plan of the SOE is one of the approval documents submitted to the Shanghai Municipal Foreign Investment Commission.²⁵

Legal Liabilities

Various civil and even criminal liabilities with stiff consequences may be imposed on parties (including professionals) involved in transactions that are made in violation of laws and the Tentative Procedures. As far as the Assignor and Assignee are concerned, if a transaction is concluded in the following circumstances, the SASAC or other relevant approval authorities may stop the transaction or apply to the court to render the transfer null and void (Article 32):

(1) a failure to conduct the transfer in accordance with the Tentative Procedures and non-observance of corporate decision procedures or ultra vires corporate decisions;

(2) a deliberate concealment of the assets from the valuation process or the providing of false accounting information, thus causing untrue auditing or valuation results and leading to a loss of state-owned assets;

(3) collusion between the Assignee and the Assignor to transfer the state-owned assets at a lesser value, thus causing loss to the state-owned assets;

(4) a failure to properly resettle the employees, to maintain the continuity of social insurance premiums, to pay debts owing to employees, to settle payable insurance premiums and the infringement of legitimate rights and interests of employees;

(5) a failure to settle creditor's rights and debts, illegally removing assets or evading debts, or transferring the state-owned assets that are subject to security without the consent of the security beneficiary;

(6) fraudulent behaviour by the Assignee to influence the Assignor's decision or terms of the assets transfer; or

(7) in the price competition or auction of the transaction, suppression by the Assignor of the price in collusion with others leading to the loss of state-owned assets.

Conclusion

The Tentative Procedures introduce a new level of control on transactions involving state-owned assets that will inevitably produce downsides, notably in rendering transactions more cumbersome, despite assurances to the contrary. If experience is any guide, the additional effects of the Tentative Procedures may well be that state-owned asset transfer transactions will require more protracted efforts and at the end become more difficult and onerous to complete. These side effects may act as a deterrent in certain circumstances, so that the final contextual objective of the Tentative Procedures may prove oddly served.

Endnotes

1 Recently issued national and local regulations include: Supervision and Administration of Enterprise State-owned Assets Tentative Regulations (promulgated and effective May 27 2003); Using Foreign Investment to Reorganize State-owned Enterprises Tentative Provisions (promulgated November 8 2002 and effective January 1 2003); Acquisition of Domestic Enterprises by Foreign Investors Tentative Provisions (promulgated March 7 2003 and effective as of April 1 2003); and Rationalization of Reorganization of State-owned Enterprises Several Opinions (promulgated on November 30 2003); Acquisition of State-owned Enterprises in the Municipality of Shanghai by Foreign Investors Several Opinions (Hu Guo Zi Chan (2002) No.77); Beijing Municipal Government, Merger and Acquisition of State-owned Industrial Enterprises by International Investors and Domestic Non-publicly Owned Economic Organization Provisional Regulations (the Beijing Regulations, promulgated on September 30 2003). Other new regulations will be introduced concerning salary standards for executives, adoption of share options and guidelines on authorized management of state-owned assets.

2 Issued under a Notice of the State Council General Office, Guobanfa [2003] No. 96.

3 Regarding the acquisition of state assets and SOEs by foreign investors, readers are referred to the Using Foreign Investment to Reorganize State-owned Enterprises Tentative Provisions (SOE Restructuring Provisions).

4 Addressed in both Point 3(2) of the Opinions and Article 1 of the SOE Restructuring Provisions. According to official statistics, the average price reached by state-owned assets in non-listed companies transferred through equity exchanges is 10% above their appraisal value, whereas the average price of state-owned assets negotiated privately is about 30% below their appraisal value (see Zhonguo Zhengjuanbao, "Guoziwei fuzeren jiu guanyu guifan guoyou qiye gaizhi gongzuo yijian" da jizhe wen," December 18 2003).

5 As was, for instance, the sale of state-owned Yutong Group to a group of former managers in 2001.

6 See, for example, Article 5 of Shanghai Municipality, Acquisition of SOEs in the Municipality by Foreign Investors Several Opinions Implementing Rules (the Shanghai Regulations), issued and effective as of August 4 2003.

7 About 20 equity exchanges have been set up or approved by the SASAC. Also see Articles 4 and 32(1) of the Tentative Procedures.

8 The Opinions, however, also cover publicly listed companies, see Points 1 and 6.

9 See also Article 4(2) of the SOE Restructuring Provisions, which defines "state-owned assets" in enterprises as "the state-owned assets of state-owned enterprises and the state-owned equity of company system enterprises". Article 3 of the Supervision and Administration of Enterprise State-owned Assets Tentative Regulations (promulgated by the State Council and effective as of May 27 2003) defines "state-owned assets" in enterprises as "the various forms of investment in enterprises by the state, the rights and interests arising from such investments and other rights and interests that, in accordance with the law, are determined to be state-owned".

10 Article 8, Shanghai Regulations, Article 8 of the SOE Restructuring Provisions.

11 Article 6, Shanghai Regulations.

12 Article 5, SOE Restructuring Provisions.

13 For example, Article 10 of the Shanghai Regulations provides a list of application documents to be submitted for transactions involving foreign investors.

14 Article 7, Shanghai Regulations.

15 In fact this is not the case as the approval is not yet granted. Under the Shanghai Regulations, it is clear that a full approval procedure must then take place before the relevant registration changes are carried out. In principle, approval is granted within 10 days.

16 Comparing with the procedure described in the SOE Restructuring Provisions: (1) submission of a full set of documents; (2) examination of set of documents and eventually, hearings, preliminary consent or rejection; (3) submission of transfer contract along with a full set of documents (in the Shanghai Regulations, apparently 2 and 3 are combined); (4) approval of the transfer contract; (5) examination and approval of the foreign investment enterprise, and; (6) registration.

17 The transfer plan shall contain the following main contents for approval: basic information about the state-owned assets to be transferred; information about the argumentation of the transfer; the employee resettlement programme approved by labour security departments; the debt settlement programme (including debts to employees); the plan for application of the proceeds from the transfer; and the main contents of the public announcement of the transfer.

18 Article 7, SOE Restructuring Provisions.

19 Article 11, SOE Restructuring Provisions.

20 Article 6, Beijing Regulations.

21 Article 14, Shanghai Regulations.

22 Point 1(6) and (7), the Opinions.

23 Article 1, Article 9(2), SOE Restructuring Provisions.

24 Point 1(9), the Opinions.

25 Article 9, Shanghai Regulations.