Cause for Complications: State-owned Assets In M&A Deals

Prior to the implementation of the Tentative Measures for Administration of the Assignment of Enterprise State-owned Assets and Equity (Measures – issued by the State-Owned Assets Supervision and Administration Commission (SASAC) and the Ministry of Finance (MOF) and effective from February 1 2004) SOA transfers were subject to mandatory appraisal requirements and other restrictions, in addition to standard consents, approvals and registrations. However, following the issuance of the Measures, transfers of SOAs must be conducted through a government-approved 'asset exchange' (Exchange). Exchanges implementing the highly ambiguous Measures are located, for example, in Beijing, Shanghai and Tianjin, and local practices vary widely from Exchange to Exchange. Only after all required procedures are completed at the Exchange (which may include a public bidding process) can transfers be submitted for 'traditional' approval via the Ministry of Commerce (or its local delegate) and registered with the relevant Administration of Industry and Commerce, as may be required depending on the nature of the transaction.

Practice Notes from Shanghai

In the context of a Sino-foreign joint venture, this bidding process before an Exchange and the resulting risk of a high bidder coming in as an uninvited shareholder arguably runs counter to the rights of first refusal that a shareholder has by virtue of joint venture laws and regulations. At least in Shanghai, however, practice provides some safeguards against such infiltrations in the context of buyouts and restructurings. Specifically, the Shanghai Municipality, Circular on Issues Relevant to Further Regulating the Transactions of State-owned Assets and Equity of Sino-foreign Equity and Cooperative Joint Ventures in the Municipality released on January 28 2005 (Shanghai Circular) provides for something akin to an exemption from the bidding process. Such exemption is subject to approval by the Shanghai United Assets and Equity Exchange (SUAEE) when state-owned equity of a joint venture is transferred to an existing shareholder (non-bidding process). The non-bidding process still requires certain filings with the SUAEE but the public bidding aspect is bypassed and the crux of the transfer in such circumstances is the basic share purchase agreement.

But, as is often the case in China, an interpretation of the Shanghai Circular is required to assess its applicability in practice. In this regard, the SUAEE has unofficially taken the view that the Shanghai Circular applies only to (i) joint ventures that are registered in Shanghai, and (ii) to transactions involving an SOE that is ultimately owned by the Shanghai Municipality, rather than the central level authorities, such as the SASAC. Questions abound as to the potential conflicts between SUAEE's application of the Measures and the strict requirements therein, and concerning how a transferee can ensure that it will ultimately receive clean and unencumbered title to an SOA.

An additional practical complication of the role of the Exchange is the documents that the Exchanges require and their relationship to those required by MOFCOM and the AIC. Indeed, some officials at the SUAEE insist that the parties use the government-supplied standard form of transfer contract for purposes of completing the relevant transaction in the Exchange (form contract). With just a mere 15 articles, the form contract is far less comprehensive than most western transferees would prefer, particularly in respect of key provisions such as closing conditions, reps/warranties and indemnities. Such a steadfast adherence to a standard contract harkens back to the early days of joint ventures in China when MOFCOM (then the Ministry of Foreign Trade and Economic Cooperation (MOFTEC)) strongly “encouraged” investors to use the standard MOFTEC-issued form of joint venture contract