Call Option Issues in Cross-border M&A Transactions

Sources of Option Shares

A call option is always granted as a right not an obligation, which may be exercised upon satisfaction of certain conditions and/or within a certain period agreed by the grantor and grantee. Both parties may negotiate and agree on the sources and price of option shares, the expiration of the option, and the manners, times and conditions for exercising the option. The option shares can be the existing shares to be transferred from the shareholder and/or the new shares to be issued by the target company.

Lock-up of Existing Shares

To ensure the future transfer of existing shares, the foreign buyers may hope to have them locked-up for a certain period, but PRC law does not provide a comprehensive mechanism to achieve the lock-up of option shares. For numerous limited or unlisted companies, the administration for industry and commerce, as the company registration authority, may be deemed as the only government body qualified to carry out the lock-up. In practice, however, the local company registration authorities may refuse to register the lock-up for various reasons. Although there is also no specific provision to follow for a listed company, in a previous case, the stock depository and clearing institution accepted a lock-up application submitted together by the grantor and the grantee of a call option contract.

New Share Issuance by Listed Companies

Under PRC law, B shares can be issued to foreign buyers by private placement but A shares so far cannot. There are also precedents in the market for B shares issuance to foreign buyers by private placement. PRC law or policy is not clear about whether non-traded legal person shares can be issued by private placement to foreign buyers. So far there are no such precedents in the market. It is still subject to CSRC approval at the time of placement.

Approval by a Shareholders' Meeting

Under PRC law, even if a subscription option contract is approved by a shareholders' meeting, a separate approval for the share issuance resulting from exercising the option is still required. For a listed company, if the foreign buyer is regarded as a connected person due to its shareholding in the target company, it will have to abstain from voting at the relevant shareholders' meeting. This adds uncertainty to exercising the option.

Time Gaps and Price

Pursuant to the PRC Company Law, the time elapsed between two consecutive new share issues by a company limited by shares shall not be less than one year. This time gap for new share issuance imposed by the Company Law might influence the exercise of an option. To avoid such uncertainty, it can be arranged in an option contract that in case there is any planned new share issuance within the specified period, the foreign buyer may choose: (i) to combine any new share issuance and the issuance of the option shares into a single issuance; or (ii) to extend the term for exercising the option.

To combine the two share issuances, however, the principle of the same price for the same issue established by the Company Law may be contravened if the agreed price of the option shares is higher or lower than that of the new shares to be issued. Besides, for a listed company, whether there can be a public offer and private placement in the same issue is subject to CSRC approval.

Regulatory Approval

As any increase of the share capital of a target company in such regulated industries is subject to government approval, a formal application for approval of the share transfer or share issuance has to be made by the target company to the relevant government body. It deserves to be noted that such approval shall be obtained when the option is exercised, no matter whether government approval is granted at the time that the option is created Moreover, in practice, the Chinese government authority would prefer not to grant its approval to an option or to give a prior approval for the share transfer or share issuance.

Even if the law permits it, the government authority might at its discretion say no to a share transfer or share issuance. This also brings more uncertainty to the exercising of an option. Notwithstanding this, the vendor would like to have the option expire after a certain period. But the foreign buyer may require an extension of the exercising term if the share transfer or issuance has not been approved by the regulatory authority.