Gun-jumping risks for phased M&A transactions

July 13, 2017 | BY

Katherine Jo &clp articles

DLA Piper

Nathan Bush & Ning Qiao

Disciplining companies for failing timely to report mergers, acquisitions, and joint ventures for mandatory antitrust review under the PRC Anti-monopoly Law (AML) is now an enforcement priority for the Ministry of Commerce (MOFCOM). Recent penalty decisions highlight the risks of failing to obtain MOFCOM clearance for phased acquisitions before proceeding with the initial transactions.

China—like the U.S., EU, and many other jurisdictions—has a mandatory, suspensive merger review regime. If a transaction satisfies the qualitative definition of a concentration and its parties' global revenues and China revenues satisfy the quantitative notification thresholds, the AML then requires the parties to notify the concentration to MOFCOM and suspend implementation pending MOFCOM's clearance. “Failure to File” entails consummating a reportable transaction without notifying MOFCOM. “Gun-jumping” involves beginning the implementation of a concentration before MOFCOM's review is complete. Both practices risk fines of up to Rmb500,000 ($72,503), plus the danger that MOFCOM might subsequently find the transaction anti-competitive and order the parties to unwind the deal. The 2012 Tentative Measures for Investigating and Handling Concentrations of Business Operators that Fail to Report in Accordance with the Law outline procedures for determining whether an unreported transaction should have been notified and then assessing its potential competitive effects.

MOFCOM has issued 17 penalty orders addressing failure to file or gun-jumping, including three in 2014, four in 2015, six in 2016, and four in the first half of 2017. In May 2017, a MOFCOM spokesperson confirmed that the ministry plans to further strengthen its enforcement efforts in this area. Fines to date have ranged from Rmb150,000 ($21,751) to Rmb400,000 ($58,002)—the highest fine for a company that previously received a lower fine for failure to report an earlier transaction.

Significantly, six of these penalty notices addressed failure to notify the formation of joint ventures. Although it is not clear from the decision notices, it is possible that some of these joint ventures were not in “full function.” In many jurisdictions, joint ventures are only subject to merger review if they are capable of ongoing independent commercial operations. Because MOFCOM has not adopted this full-functionality test, many limited joint ventures that would not qualify as reportable transactions in Europe and many other jurisdictions may still trigger merger review in China.

Traps for phased transactions

Acquisitions are often designed as sequences of discrete transactions. Such phased structures may be necessary to sever the target business cleanly from the seller's business, to meet financing constraints, or to allow investors to acquire minority stakes before committing to full acquisitions. Recent MOFCOM penalty decisions illuminate the risk failing to report phased acquisitions before completing the first transaction, even when the first phase alone would not constitute a concentration.

In December 2016, MOFCOM fined Canon Rmb300,000 ($43,509) for failing to notify its 100% acquisition of Toshiba Medical Systems Corp. from Toshiba. Once Canon obtained the exclusive negotiating rights for the acquisition, a special purpose vehicle (SPV) registered to three individuals was formed. In the first step, the SPV acquired 20 shares with special voting rights conferring control over the target, while Canon acquired the remaining shares and equity warrants without voting rights. In the second step, Canon would acquire actual control after antitrust approval was obtained in China and other relevant jurisdictions, by turning the equity warrants into shares with voting rights and cancelling the SPV's shares and other shares. MOFCOM found that the transactions were closely related and inseparable elements of Canon's acquisition of full ownership of Toshiba Medical.

On April 21, 2017, MOFCOM fined South Korean conglomerate OCI Rmb150,000 ($21,751) for failure to notify its acquisition of Tokuyama Malaysia, a Malaysian subsidiary of Tokuyama Corp. According to the penalty notice, in September 2016 the parties and their affiliates entered into three agreements through which OCI would acquire Tokuyama Malaysia in three transactions. First, Tokuyama Malaysia would issue new shares to OCI conferring a 16.5% stake in the target. Second, Tokuyama Malaysia would issue additional new shares to OCI, increasing OCI's stake to 50.7%. Third, OCI would purchase remaining shares from Tokuyama Corporation, resulting in 100% ownership of Tokuyama Malaysia. OCI completed the first step in October 2016 without notifying MOFCOM, and then notified MOFCOM before proceeding with the second and third transactions. Although MOFCOM unconditionally cleared OCI's full acquisition of Tokuyama Malaysia, MOFCOM viewed the transactions as a single concentration involving three inter-dependent steps, and thus completing the initial 16.5% acquisitions without MOFCOM clearance amounted to gun-jumping.

On May 5, 2017, MOFCOM fined Meinian Onehealth Healthcare Rmb300,000 ($43,509) for failing to notify its acquisition of Ciming Health Checkup. According to the penalty notice, Meinian's “ultimate controller” is an individual who also holds majority stakes in two investment companies involved in this transaction. MOFCOM found that Meinian entered into an agreement in November 2014 with the shareholders of Ciming to acquire 100% of Meinian. Between November 2014 and November 2015, Meinian and the two investment companies undertook a series of transactions to acquire a 27.78% stake in Ciming. In May 2016, Meinian entered into an agreement to acquire the remaining 72.22%. Although Meinian reported this last transaction to MOFCOM, a third party publicly complained that prior steps should have been notified. MOFCOM found that Meinian and its ultimate controlling shareholder had led all of the transactions with the goal of control by Meinian, while the investment companies were mere facilitators.

These published penalty notices leave critical questions unanswered. It is unclear whether the initial phases in any of these transactions conferred sufficient equity interests or control rights to confer joint control, thus qualifying as freestanding concentrations. The penalty notices do not discuss whether the relevant contracts required separate decisions to proceed with each phase, or provided exits if the later phases did not receive antitrust approval. It is also unclear whether the initial stages were only commercially rational if the later phases were also completed. Such factors may be relevant in distinguishing minority investments made in contemplation of potential future investments from gun-jumping in an integrated series of transaction steps. At minimum, parties should exercise caution when determining when to notify phased acquisitions to MOFCOM.

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