Break it up: Mofcom's new rules on divestment

Mofcom's power to order divestitures as a condition of approving reviewed deals stems from Articles 28 and 29 of the AML. Article 28 empowers Mofcom to prohibit reviewed deals that have, or are likely to have, the effect of eliminating or restricting competition in a market in China. Article 29 provides that Mofcom can, as an alternative to outright prohibition of a reviewed deal, apply restrictive measures to the deal or deal parties to remove or reduce the reviewed deal's “negative impact” on competition.

    In late 2009, Mofcom published the Measures for the Review for Concentrations of Business Operators (经营者集中审查办法) (Review Measures), which broadly sketches the type of restrictive measures Mofcom may impose on business operators participating in reviewed deals under Article 29 of the AML, and outline how such measures will be implemented and enforced in practice. Among other
things, the Review Measures (which commenced on January 1 2010) provide that:

- Restrictive measures imposed by Mofcom may be either behavioural or structural in nature – with behavioural measures including requirements such as the opening up of networks or licensing of key technology, and structural measures including requirements such as divestment by a business operator of certain operations or assets (the Divestment Business); and

- Mofcom will supervise and examine the performance by any business operators of fulfilling any restrictive measures imposed upon them.

    Although the Review Measures only briefly touch on Mofcom's power to impose structural remedies, the measures do make it clear that a business operator who is required to undertake a divestment (the divestiture obligor) will need to report on the implementation of that divestiture to Mofcom within specified timeframes. Additionally, the Review Measures provide that Mofcom may set a time limit for corrective action if a divestiture obligor fails to comply with divestiture conditions imposed on a reviewed deal, and may penalise the divestiture obligor if it then fails to proceed with the corrective action in the required timeframe.

Content of the Divestiture Rules

The Divestiture Rules expand on the aforementioned content of the Review Measures, and explain more precisely the divestment method and process that will need to be followed by divestiture obligors.

    Key elements of the Divestiture Rules can be summarised under five headings, as below:

A two-phase process for completion of mandated divestments

The Divestiture Rules contemplate two main phases that may occur during the process of implementing mandated divestitures.

Phase one: Divestment under the supervision of a trustee

During the first phase, the divestiture obligor may carry out the divestiture under the supervision of a trustee (Monitoring Trustee).

    The divestiture obligor will be responsible for appointing the Monitoring Trustee and notifying Mofcom of this appointment within 15 days of the Mofcom decision that includes the relevant divestiture condition (Merger Decision). If Mofcom considers that the choice of Monitoring Trustee is not appropriate or in conformity with the Merger Decision, the divestiture obligor may be required to appoint a replacement.

    Under the supervision of the Monitoring Trustee, the divestiture obligor must complete the following steps within a timeframe that will be stated in the Merger Decision:

(a) Find an appropriate purchaser and enter into the purchase agreement and other related agreements (Purchase Agreement) with the purchaser; and

(b) Transfer the Divestment Business to the purchaser and finish all the related legal procedures within three months after it has entered into the Purchase Agreement (however the Divestiture Rules also contemplate that Mofcom may extend this period if the divestiture obligor applies for an extension and provides sound reasons for it).

    The divestiture obligor is also required to provide such assistance to the Monitoring Trustee as is necessary for it to fulfil its responsibilities, including supplying it with relevant “information on parties to the business divestment, business divestment related books and records, information communicated to potential buyer, information of potential buyer, and information on the progress of the business divestment”.

Phase two (if required): Divestment conducted by a trustee

If divestiture does not occur as required in this first phase, a second phase will be implemented during which the task of finding an appropriate purchaser and entering into the Purchase Agreement will also be passed to a trustee (the Divestment Trustee).

    The divestiture obligor is again responsible for appointing the Divestment Trustee and notifying this appointment to Mofcom for approval. This must occur at least 30 days before the period in which Mofcom stipulates that divestment through the Divestment Trustee must take place.

    To enable the Divestment Trustee to fulfil its mandate, the divestiture obligor is required to provide the Divestment Trustee with written authorisation for its independent disposal of the Divestment Business, as well as provide such assistance to the Divestment Trustee as is necessary for fulfilment of their duties.

    The Divestment Trustee will then be required to complete the divestiture with a period specified in the Merger Decision.

Qualifications and responsibilities of the Monitoring Trustee and Divestment Trustee

The Divestiture Rules require that Monitoring Trustees and Divestment Trustees be persons or organisations with the necessary resources and capacity to undertake their requisite tasks. They must also be independent from all of the parties to the relevant reviewed deal and any purchaser of the Divestment Business.

    Based on international practice, the types of business operators that Mofcom may be most likely to approve as Monitoring Trustees and Divestment Trustees are law firms, accounting firms, investment banks, and consulting companies.

    According to the Divestiture Rules, Monitoring Trustees and Divestment Trustees are accountable to, and report to Mofcom. Although it is the divestiture obligor that is required to contract with (and pay) these trustees, the divestiture obligor cannot amend or terminate the relevant contract – or even give supplemental instructions to the Trustees under the contract – without Mofcom's prior consent.

    The Divestiture Rules require Monitoring Trustees and Divestment Trustees to diligently and duteously fulfil their responsibilities, which include:

- In the case of Monitoring Trustees, monitoring the divestiture obligor's fulfilment of its obligations, as well as enforcement of the Purchase Agreements and mediating disputes between the divestiture obligor and any potential purchaser; and

- In the case of Divestment Trustees, finding an appropriate purchaser, and entering into the Purchase Agreements, within the timeframe and according to the methods specified in the relevant Merger Decision.

    Monitoring Trustees and Divestment Trustees are also required to submit reports to Mofcom in relation to the above matters.

    Monitoring Trustees and Divestment Trustees must also preserve the confidentiality of trade secrets and other confidential information learned during the performance of their duties.

Requirements applicable to the purchaser of Divestment Business

The Divestiture Rules provide that a purchaser of the Divestment Business must satisfy several conditions, which include the following:

(a) The purchaser must be independent from the parties to the reviewed deal;

(b) The purchaser must have the necessary resources and capacity and intent to maintain and develop the Divestment Business; and

(c) The purchaser's acquisition of the Divestment Business must not arouse competitive concerns (presumably, this will be assessed by Mofcom according to the same standard that applies to a reviewed deal).

Responsibilities of relevant parties prior to divestiture

According to Article 12 of the Divestiture Rules, parties to a reviewed deal that has been the subject of a divestment order must also take steps to safeguard the value of a Divestment Business before it is sold by the divestiture obligor. In particular, the parties must:

(a) Manage the Divestment Business independently from the other business activities of the parties, and in a way that safeguards the best interests of the Divestment Business. In particular, the parties must not poach staff or transfer business secrets from the Divestment Business.

(b) Appoint special management to ensure the responsibilities referenced in (a) are met (the Monitoring Trustee will then supervise the performance of, and any changes to, this special management); and

(c) Ensure that prospective purchasers can obtain sufficient information about the Divestment Business so as to evaluate the value, scope and future development of the Divestment Business.

Mofcom's role in the divestment process

As mentioned above, Mofcom is responsible for evaluating candidates for the roles of Monitoring Trustee and Divestment Trustee, and will also review the agreements that divestiture obligors seek to enter into with such trustees. Mofcom also supervises and evaluates the trustees' performance.

    In relation to purchasers of the Divestment Business, Mofcom will review and approve any such potential purchaser, as well as the Purchase Agreements.

Do the Divestiture Rules reflect Mofcom's orders in previous divestment cases?

Since the AML commenced on August 1 2008, Mofcom has made three merger review decisions that include divestment remedies.

    In all three cases, it appears that the conditions were negotiated at length with the relevant business operators participating in the reviewed deals. This reflects the intent of the Review Measures, which provides that business operators participating in reviewed deals will be notified if Mofcom identifies competition concerns arising from the deal and will give those business operators an opportunity to propose remedies to, and discuss those remedies with, Mofcom.

    The first relevant decision related to the proposed acquisition of Lucite International Group by Mitsubishi Rayon. Mofcom announced its decision in relation to this reviewed deal on April 24 2009, and the decision statement indicates that Mofcom's concerns about the deal stemmed from an assessment that the parties would have a post-merger share of the relevant market in China exceeding 60% (far greater than that of the second and third largest market participants in China) and Mitsubishi Rayon was a significant participant in several downstream markets (which, according to Mofcom's reasoning, would provide it with the capability of employing enhanced upstream power to implement 'blocking effects' on its competitors in the downstream markets). Mofcom's approval of the deal was thus subject to a requirement that a subsidiary of Lucite in China undertake upfront divestment of 50% of its annual methylmethacrylate production capacity for five years.

    In two subsequent cases, Mofcom required business operators to divest specific business assets or operations. Specifically, Mofcom cleared Pfizer's acquisition of fellow pharmaceutical company Wyeth on September 28 2009, subject to the requirement that Pfizer divest its PRC swine mycoplasmal pneumonia vaccine. This divestment remedy was imposed to address Mofcom's concern that (amongst other things) Pfizer and Wyeth would have a combined market share of 49.4% in the post-merger market involving this vaccine, which was significantly higher than the next largest competitor.

    Just over one month later, on October 31 2009, Mofcom approved the merger of Sanyo and Panasonic on condition that Panasonic and/or Sanyo divest a significant portion of their existing businesses (including assets outside of China) relating to three particular battery segment markets. Again, this divestment remedy was imposed in part as a result of Mofcom's concern about high market shares that the merged entity would have in the relevant markets. Specifically, Mofcom was concerned that the strength and market share of the merged entity would provide it with a degree of market power that existing levels of buyer-side power and general competition dynamics in the industry would be unlikely to countervail.

    Each of these decisions preceded publication of the Divestiture Rules, but the terms of Mofcom's divestment conditions broadly reflects key elements of the processes and requirements that will now apply to future divestment orders as a matter of conformity with the Divestiture Rules.

    For example, in each case, the divestiture obligor(s) were given a specific (and publicly stated) period within which to complete their divestments – subject to the possibility of this period being extended if good cause could be shown. Additionally, in each case the purchaser of the Divestment Business was required to be an independent business operator approved by Mofcom, and Mofcom reserved the right to appoint an independent trustee to take control of the divestment process if the divestiture obligor failed to adhere to requirements Mofcom imposed on the divestment process.

    In this context, introduction of the Divestiture Rules should not be seen as dramatically altering any aspect of the pre-existing AML merger control enforcement regime. However, the Divestiture Rules will provide some additional certainty regarding mandated divestment processes, which will be welcomed by business operators who are currently, or may in future be, a party to reviewed deals.

    In particular, business operators should find that consulting the Divestiture Rules may assist them to streamline any negotiations they may need to have with Mofcom regarding remedies for addressing identified competition concerns that may arise from a reviewed deal. Specifically, divestment proposals can be crafted to strictly adhere to the Divestiture Rules, which should (provided the proposed divestment properly addresses the identified competition issue) enhance the prospect of more rapid (conditional) clearance of the reviewed deal.

Alignment of the Divestiture Rules with international best practice

Many of the provisions in the Divestiture Rules appear to be closely modelled on 'best practice' guidelines published by the European Commission and intended to guide negotiation and implementation of any divestiture remedies that may be imposed in European merger control decisions (European Divestiture Guidelines).

    In particular, the 'two-phase' approach that applies to mandated divestiture under the Divestiture Rules largely mirrors the process that is proposed under the European Divestiture Guidelines, and those guidelines suggest similar timeframes and conditions for divestiture obligors in relation to the selection of purchasers and entry into relevant Purchase Agreements.

    However the Divestiture Rules are less detailed and of a narrower scope than the European Divestiture Guidelines, and it can be argued that Mofcom has a much wider sphere of discretion than the European regulator when it comes to the terms that can be imposed on divestiture obligors in relevant cases.

Concerns about mandated divestitures under the AML merger control regime

Notwithstanding the alignment between certain aspects of the Divestiture Rules and analogous rules or guidance in more mature competition law jurisdictions, the Divestiture Rules have attracted some criticism. Additionally, more general concerns have been expressed about the potential for Mofcom's broad power to order divestitures to be misapplied.

    In relation to the content of the Divestiture Rules, many of the criticisms that have been levied may be appear to stem from their relative brevity.

    For example, the Divestiture Rules focus on the process and requirements that will apply to divestments occurring after closure of a relevant reviewed deal, and thus have been criticised for not contemplating the possibility that an upfront buyer for a Divestment Business may be required. However, the absence of any reference to upfront buyers in the Divestiture Rules should not preclude Mofcom from requiring an upfront buyer if it felt this approach was appropriate in relation to a particular reviewed deal.

    It has also been noted that while the European Divestiture Guidelines provide for the trustees supervising relevant divestitures occurring under the European merger control regime to be able to send a non-confidential copy of their supervision reports to the divestiture obligor, the Divestiture Rules prohibit Monitoring Trustees from making any disclosure of the analogous reports they provide to Mofcom. However, as the Monitoring Trustees are ultimately responsible to Mofcom, it may be possible in practice for divestiture obligors to request Mofcom's permission to obtain suitably redacted copies of such reports from the Monitoring Trustees.

    A further area of concern that has been identified is that the Divestiture Rules are unclear on the extent to which the Divestment Trustee (who, though engaged and paid by the divestiture obligors, have a primary duty to follow Mofcom's directions) should consider the protection of the financial interests of the divestiture obligor when it is required to arrange for the sale of a Divestment Business. In contrast, the European Divestiture Guidelines note that divestment trustees operating under the European regime should “protect the legitimate financial interests of the divesting parties”.

    In practice, however, it should be possible for the divestiture obligor to include some level of checks and balances in its agreement with the Divestment Trustee to ensure a fair balance is struck between potentially competing concerns of achieving a fair price for the divestiture obligor while facilitating the required divestment within an appropriate timeframe. More generally, careful selection of Divestment Trustees (or at least the candidates for such roles, whose appointment will remain subject to Mofcom's approval) will go a long way to ensuring that the terms of sale for a Divestment Business will be prudently negotiated.

    Commentators have also noted that the European Commission has published standard templates for the agreements to be entered into by divestiture obligors and trustees, however the Divestiture Rules contain no indication that Mofcom intends to do likewise. It is hoped that Mofcom may follow the European Commission's lead in this area in due course once it has more experience in administering relevant trustee arrangements. In the interim, business operators will benefit from reviewing the European Commission's template agreements when looking to formalise any required arrangements with trustees in the context of the AML merger control regime.

    Regarding the more general concerns that have been expressed about the potential for Mofcom's power to order divestitures to be misapplied, perhaps the most significant such concern in practice relates to Mofcom's practice of publicly stating the timeframe in which mandated divestments must be made.

    Some observers have queried whether this practice may tempt prospective purchasers of a Divestment Business to draw out their negotiations with the relevant divestiture obligor – in the hope of extracting more favourable purchase terms from the divestiture obligor as that party seeks to close the deal in time to comply with Mofcom's stipulated timeframe.

    In each of the three divestment cases that have arisen so far, Mofcom's public decision statement has stipulated a six month timeframe in which divestment was required. Further, in its decision regarding the Pfizer / Wyeth merger, Mofcom's expressly specified that if a buyer was not found within this period, a trustee would be appointed to dispose of the relevant business at “no minimum price.”

    The Divestiture Rules do not address the concerns that have understandably been raised about the prospect of these type of public divestment order terms undermining the divestiture obligor's negotiation position. The rules contemplate that Mofcom will continue to specify the required timeframe for divestments in decision statements, and provide no indication that such timeframes will be a confidential component of these decision statements in the future.

    Finally, it would be remiss not to mention one further concern that business operators may have about Mofcom's broad powers to mandate divestments as part of merger control decisions. That is, the risk of industrial policy considerations unduly influencing the imposition and enforcement of such orders. This concern has been expressed in relation to many aspects of the AML enforcement regime, but may be especially pronounced in the context of merger control decisions given Mofcom's broad powers to impose structural remedies and thereby affect the transfer of key assets (including intellectual property) to Chinese business operators.

    Although it is unlikely Mofcom would ever specify that a Divestment Business must be transferred to a Chinese purchaser, the regulator's power to review prospective purchasers and deem them unsuitable provides it with the ability to favour the transfer of important assets and technology to domestic Chinese business operators.

    However, there is no suggestion that this has occurred to date. Although it was a Chinese business operator that was approved to purchase Pfizer's swine mycoplasmal pneumonia vaccine, there has been no suggestion that this was due to any undue favouring of that company over other prospective purchasers. Moreover, Mofcom's track record in AML merger control enforcement more generally does not suggest that undue credence should be given to protectionism concerns.

    Nonetheless, the international business community will be closely monitoring development of the regime over the coming years, hoping for further reassurance on this issue.

Conclusion

    Business operators will welcome the additional clarity surrounding AML merger regime enforcement provided by the Divestiture Rules. However, concern will linger about issues such as Mofcom's practice of publicly stating the timeframe in which mandated divestments must be made, and the amount of discretion Mofcom has in relation to setting the terms of (and enforcing) divestment orders.

    For now, business operators who are participating in reviewed deals, or who may be a party to such deals in the future, should ensure their legal advisors and relevant executives are familiar with the Divestiture Rules, and that these are consulted if it becomes necessary to negotiate potential remedies with Mofcom.

Hannah Ha, John Hickin, and Gerry O'Brien, Mayer Brown JSM, Hong Kong