A More Sophisticated Game: 2008 M&A Market in China

3. The new Labour Contract Law;

4. The new Bankruptcy Law;

5. The new Anti-Monopoly Law and recently developed transfer price rules; and

6. A series of new foreign exchange regulations concerning stock options, investing in real estate and individual foreign exchange rules.

The M&A Rules

Under the new M&A Rules, a foreign acquirer has to comply with the valuation rules of the target, under which the target cannot be sold at a price significantly lower than the evaluated one. The acquirer has to make and comply with the retention plan for the employees of the target, and go through possible anti-trust clearance and national security clearance. The acquirer also has to comply with a much more rigid payment schedule (normally up to three months) and may have to go to the Ministry of Commerce (MOFCOM), which is believed to be an inconvenient process, for final approval. Foreign acquirers therefore have to invest a lot of time and energy in designing the transactions so they fall outside of the jurisdiction of the M&A Rules. In an ideal design, even though the essence of a certain transaction is to buy out all or at least the material operation of the target, such a transaction is nonetheless crafted as procumbent of equipment plus the assignment of contracts.

Transfer Price Concerns

As in other jurisdictions, the tax implication in a non-equity deal is more important than in an equity deal. The acquirer would no longer benefit from the target's unused tax holidays (if any). Moreover, many acquirers use the variable interest equity (VIE) structure (i.e., with contracts, a newly set up foreign invested company virtually controls all the operations and revenues of an existing target in China) to bypass the regulatory approval/filing requirement under the M&A Rules as well as the market access restrictions. When a VIE structure is adopted, the transaction between the new company and target may well be subject to the transfer price rules recently developed under the PRC tax law. The parties are therefore not totally at liberty to set forth the price for transactions between affiliates. A miscalculation could make the VIE structure prohibitively expensive.

Forum Shopping for Rmb

Against the conventional regulatory philosophy that foreign exchange has to be taken back to China, the Chinese government is more concerned about the hot money travelling to and staying in China. The government has taken steps to slow the inflow of foreign exchange with, e.g., rules against settlement of foreign exchange in investing in real estate projects, and unregistered “round tripping” investee foreign-invested companies. Nevertheless, hot money still floods the China market. Some offices of the State Administration of Foreign Exchange (SAFE) have taken more arbitrary measures to disapprove settlement of foreign exchange in M&A transactions without legitimate reasons. These measures are not transparent and are not based on written rules. As a result, implementations vary from place to place. Acquirers are defending themselves by shopping around between different cities and provinces for the right venue in which to park their foreign exchange and sell it for Rmb.

Another interesting regulatory inconsistency is the implementation of Circular 75, which requires that the round-tripping PRC investors file their foreign equity position with the SAFE. Different offices have different policies on this filing, and investors are forced to find the most advantageous place in which to complete their Circular 75 filing.

A Regulatory Maze

One traditional battle in the China regulatory world is between the national government and local governments. In this case, the national government's position is to control the domestic economy by implementing rigid rules, and the local government's interest is to attract more investment by encouraging defence actions taken by acquirers to get around the current rules. The central government does not always have adequate capacity to enforce all the recent laws and regulations. The consequence is often a selective enforcement of law, and thus creates unequal opportunities for the M&A players. Acquirers need an expert with in-depth knowledge of this regulatory maze, who can lead them through these complicated, constantly changing dynamics to a successful closing.

Jun He Law Offices
Shanghai Kerry Centre, 32nd Floor
1515 Nanjing Road West
Shanghai 200040
T: 86-21-52985488
F: 86-21-52985492
Website: www.junhe.com