Anti-dilution Issues in Cross-border M&A Transactions

As an alternative, foreign buyers may request the issue and subscription of non-traded legal person shares to maintain their shareholding percentage. However, although the restriction has been lifted that prevented foreign buyers from purchasing existing non-traded legal person shares, the CSRC has no clear policy regarding whether foreign buyers may subscribe to non-traded legal person shares of listed companies newly issued by private placement. So far there are no such precedents in the market.

Shareholders' Approval and Exercising Rights

In general, M&A transactions require the approval of a shareholders' meeting. Anti-dilution arrangements as part of the transactions will also be subject to shareholders' approval as one package. Even so, under PRC law the exercise of anti-dilution rights will be subject to another approval by a shareholders' meeting. The rationale is that the exercise of anti-dilution rights will trigger the target company's capital increase, which, under PRC law, requires separate shareholder approval. Such a requirement is completely different from the law and practice in most common law jurisdictions. In most jurisdictions, in the event a transaction is structured with sufficient certainty upfront and authorized by necessary corporate action, even if such transaction will take place in the future, the consummation of the same shall not be subject to another corporate action at that time. Therefore, the practice of PRC law in this regard definitely adds uncertainty to anti-dilution arrangements.

Time Gaps between Two Share Issues

According to the PRC Company Law(中华人民共和国公司法), the time elapsed between two consecutive new share issues by a company limited by shares shall not be less than one year. Such a statutory provision obviously hinders the exercise of the anti-dilution right within a one-year period from a new share issue of a target company, and foreign buyers will face dilution during this one-year period. Therefore, it is essential to combine a new share issue and the issue of the corresponding anti-dilution shares to foreign buyers into a single issuance.

Connected Transactions and Independent Shareholders' Approval

When the target company is a listed company, independent shareholders' approval is required for a connected transaction. Under the Listing Rules of Shanghai Stock Exchange (Listing Rules), where a person is deemed as a connected person of a listed company, independent shareholders' approval is required for the transaction between such connected person and the listed company if the size of the transaction reaches a certain threshold. Given that foreign buyers may be regarded as connected persons due to their shareholding in target companies, they would have to abstain from voting at the relevant shareholders meetings. They would therefore have no control over whether their proposed exercising of anti-dilution rights would be approved. If such approvals were not forthcoming, they would face dilution if target companies proceed with any issue of shares.

There is no clear and consistent definition of connected persons under the Listing Rules. A connected person is defined variously as a connected legal person, connected individual and potential connected person. Connected legal person means a legal person having a direct or indirect control of the concerned listed company or under the common control of another company with such concerned listed company, or an entity controlled by a connected individual (as defined in the Listing Rules) directly or indirectly. According to relevant PRC laws and practice, "control" means that a company may direct the management and operation of another company, including, among others, having a stake of more than 30% in the concerned company. If a non-connected person will, upon the completion of a concerned transaction, be regarded as a connected person, such non-connected person shall be deemed as a potential connected person for the relevant transaction under the Listing Rules.

Shareholders' Pre-emptive Rights

Under the Company Law, in the event that a limited liability company increases its capital, the existing shareholders have pre-emptive rights to subscribe to such increased capital, which means each existing shareholder has a statutory anti-dilution right. However, the Company Law does not provide the terms and conditions on which the existing shareholders may exercise their pre-emptive rights. As such, it is still necessary to develop a specific mechanism to exercise anti-dilution rights for foreign buyers and to consider the whole anti-dilution arrangement in the scenario that other shareholders may also choose to exercise their statutory anti-dilution rights.

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