Taking equity in an FIE

3. Successor liabilities. As compared with assets acquisition, a legal exposure of concern is successor liabilities. Conducting a thorough environmental test, such as on soil and groundwater, and incorporating the test results into the definitive agreements, would provide certain contractual protection to the acquirer in case of any future environmental claims. Other successor liabilities shall be taken into consideration include pending or threatened legal actions, proceedings, arbitrations, litigation, etc.

4. Mandatory laws. If both the acquirer and the FIE account for a significant market share in the relevant market, it is advisable to seek guidance from the Ministry of Commerce (Mofcom) to determine whether an Anti-monopoly Law (AML) filing is needed. Engaging an experienced legal counsel to help navigate the treacherous waters of an AML filing is highly recommended.

In addition, the deal structure is another key issue to be considered. Buying into the FIE's offshore parent may make the life of the acquirer easier. The benefits are two-fold: first, it avoids the redundant administrative procedures in China; secondly, the payment terms are more flexible and not subject to the regulations of the State Administration of Foreign Exchange, which provides that the payment shall be made through a designated account allotted within three to six months.

James Liu
Partner
Jingcheng Tongda & Neal







International perspective

Foreign investors considering acquiring an equity interest in a wholly foreign-owned enterprise (WFOE) in China may think that the procedure is simple as it is a foreign-to-foreign equity transfer. There are in fact various issues that the foreign investors should bear in mind so as not to fall foul of the PRC laws and regulations.

1. Due diligence. The importance of due diligence need not be emphasised. In China, however, publicly available records are either not available or unreliable. Typical problematic areas are legal title to land use rights, whether there are pending legal actions and the priority of security interest. In many cases, foreign investors will have to rely on extensive representations, warranties and indemnities in the sale and purchase agreement.

2. Structuring the acquisition. It is common for foreign investors to structure the acquisition as an offshore acquisition, with the investors acquiring the offshore holding company that holds the WFOE rather than the WFOE directly. This has the benefit of avoiding PRC government approvals and PRC tax. The PRC Enterprise Income Tax Law (中华人民共和国企业所得税法) and its rules, including Tax Notice 698, change the tax position, as the PRC tax authority may treat the offshore acquisition as an onshore one and tax the seller for income it has obtained from the sale. While the seller has to bear the tax, the buyer may have withholding obligations. The buyer should thus be aware of its potential tax liability under Tax Notice 698.

3. Approvals. If the WFOE is a multi-shareholder WFOE, the other shareholders have to waive their pre-emptive rights. In addition, the equity transfer has to be approved by an examination and approval authority.

A practical problem associated with government approval is that it is difficult to effect a simultaneous closing and transfer of equity in China. Usually the seller will not want to start the government approval process without payment or guarantee of payment in advance. The buyer however will not want to pay the purchase price until government approvals have been obtained. To deal with this, arrangements like escrow are often put in place. Laws on this are not well developed in China. There are often extensive negotiations on the mechanism of escrow arrangements.

4. Anti-trust filing. Depending on the nature and size of the acquisition, the anti-monopoly laws in China may have significant impact. The three key prohibitions under these laws are: 1) “concentration”which exceeds certain thresholds and which prevents or restricts competition; 2) monopoly agreements between competing businesses or trading partners containing certain restrictions on competition; and 3) abuse of a dominant market position. Acquisitions meeting certain financial thresholds have to be notified to the Anti-monopoly Bureau of the Ministry of Commerce, and their potential impact on competition in China will be reviewed before closing. Proper planning before hand is thus important.

Hilda Chiu
Partner
Stephenson Harwood