China Law Insight : China Law Insight: China Commercial and Intellectual Property Lawyers and Attorneys, Full Service Law Firm: King & Wood

The issue was whether duties can be imposed on goods imported from non-market economy countries such as China.  Two types of duties may be applied on imports into the U.S from market economy countries (non-NMEs): 1) antidumping duties on goods sold in the U.S. at less than fair value; and 2) countervailing duties on goods that receive a "countervailable subsidy" from a foreign government.  See 19 U.S.C. Section 1673 (2006).

The fight began in 2007 when U.S. tire manufacturer Titan Tire Co. petitioned the U.S. Department of Commerce to impose both antidumping duties and countervailing duties on certain Chinese tires including those manufactured by the plaintiffs (Hebei Starbright and Tianjin United Tire) in the present case.  Prior to this petition, the U.S. Department of Commerce had maintained the position that countervailing duties did not apply to NMEs because by virtue of definition, subsidy being a "market"  phenomenon.  Under pressure, the U.S. Department of Commerce responded by imposing both antidumping and countervailing duties on the imported Chinese tires.  Complaints were filed by the Chinese tire manufacturers and the cases consolidated by the U.S. International Trade Court, which after a series of rulings and remands, ultimately found for the Chinese manufacturers ordering the U.S. Department of Commerce to not impose the countervailing duties. 

The U.S. and the U.S. tire manufacturers appealed in the instant action and the U.S. Federal Court affirmed the U.S. Trade Court's ruling but on different grounds.  In summary, the U.S. Federal Court's decision was based on the principle of "legislative ratification" finding that the U.S. Congress had effectively ratified prior interpretations that countervailing duties did not apply to NMEs, China included.

The result is a current win for Chinese manufacturers - for now, no countervailing duties will be imposed on Chinese products based on the allegation that they are "subsidized" by the Chinese government.  Only if and when China or certain industries within China are declared as "market oriented"  will U.S. countervailing duty law apply.  We will wait to see if the decision is appealed and further down the road, whether U.S. legislative change to the contrary occurs.

        商务部对未依法申报经营者集中的调查分为两个阶段。在初步调查阶段（“第一阶段”），被调查的经营者应当在立案通知送达之日起30日内，向商务部提交与被调查交易是否属于经营者集中、是否达到申报标准、是否已实施且未申报等有关文件、资料。自收到被调查的经营者所提交的文件、资料之日起60日内，商务部应当作出书面决定：如属于应报未报的，应进行进一步调查（“第二阶段”）；如不属于应报未报的，应作出不实施进一步调查的决定。

        在第二阶段，被调查的经营者应当向商务部提交一整套完整的经营者集中申报材料。商务部应在180日内完成实质性评估，这一时限与正常经营者集中申报的最长审查时限相同。

        对未依法申报经营者集中的，商务部可以对被调查的经营者处50万元以下的罚款，并可责令被调查的经营者采取措施恢复到集中前的状态，如停止实施集中、限期处分股份或资产、限期转让营业等。

        与正常的经营者集中申报程序相比，调查程序对未依法申报经营者集中的被调查经营者有一系列的严重影响。调查程序可能比正常经营者集中审查持续时间更长。商务部的两个调查阶段可能达到10个月甚至更久。一旦商务部作出进入第二阶段的决定，被调查的经营者就应当暂停实施集中。此外，由于这一过程属于调查程序，商务部有权采取《反垄断法》第39条规定的措施，包括：进入营业场所或其他有关场所进行检查；询问被调查的经营者、利害关系人或其他有关单位或个人；查阅、复制被调查的经营者、利害关系人或其他有关单位或个人的有关单证、协议、会计账簿、业务函电、电子数据等文件、资料；查封、扣押相关证据以及查询经营者的银行账户。商务部也有权委托省级商务主管部门协助调查本地区内的未依法申报经营者集中。

        在最近召开的商务部“2011年反垄断工作主要情况”专题新闻发布会上，商务部反垄断局局长、国务院反垄断委员会办公室主任尚明提到，对未依法申报经营者集中的调查处理是反垄断局2012年的执法重点之一。¹ 尚明局长提到，为提高企业的反垄断法律意识，商务部一直在对中国的国有企业和民营企业进行普法宣传。他进一步提到颁布暂行办法的目的之一就是提醒各企业，经营者集中申报是反垄断法规定的强制性要求。有理由相信，在不久的将来，商务部将展开对暂行办法的执法活动。

         以下是商务部调查处理应报未报的经营者集中的流程图：

         商务部未依法申报经营者集中调查处理流程

¹商务部“2011年反垄断工作主要情况”专题新闻发布会全文请见：http://www.mofcom.gov.cn/aarticle/ae/slfw/201112/20111207901483.html

There are two phases to such an investigation.  In the initial investigation stage ("Phase 1"), the company under investigation shall, within 30 days from case acceptance, submit materials regarding whether the transaction is a "business concentration" under the AML, whether the filing thresholds have been met, and the status for implementation of the transaction.  MOFCOM then has 60 days to decide (i) to start an in-depth investigation ("Phase 2"), if it finds that the transaction is a notifiable transaction under the AML; or (ii) otherwise to close the case. 

In Phase 2, the company shall submit a complete package of materials for MOFCOM to review the competitive effect of the transaction.  MOFCOM has 180 days to complete the substantive evaluation, same as the maximum time limit in a normal merger control notification. 

Penalties for failure of notifying a concentration may include a fine of no more than RMB500,000, and an order for the company to take actions to rewind the transaction, such as ceasing implementation of the concentration, disposal of shares or assets, and transfer of business.
 
Compared to the normal merger review process, the investigation process has various serious implications on the companies who fail to honor the mandatory notification obligation under the AML.  The investigation process may last longer than a normal review: the two phases can take 10 months or even more.  Once Phase 2 starts, the company shall suspend implementation of the transaction no matter what.  Besides, since this is an investigation procedure, MOFCOM is entitled to take various measures provided under Article 39 of the AML, including entering the company's business premises for inspection, interviewing the relevant personnel from the company, reviewing and making copies of the company's accounting books, business letters and electronic data, seizing the relevant evidence, and checking the bank accounts of the company under investigation.  MOFCOM is also entitled to authorize its provincial counterparts to assist with investigation of cases within their jurisdictions.

At a recent MOFCOM press release, Mr. Shang Ming, Director General of MOFCOM's Anti-monopoly Bureau ("AMB") and Chairman of the General Office of the State Council's Anti- monopoly Commission, said that enforcement against failure of notifying a notifiable transaction is one of the top priorities for AMB in 2012.²   Mr. Shang mentioned that MOFCOM has been educating Chinese companies, both state-owned and private, of the AML.  He said that promulgation of the Interim Measures intends to work as a reminder to the companies that merger control notification is a mandatory requirement under the AML.  It is reasonable to expect that we will see MOFCOM enforcing the Interim Measures soon.

Set forth below is the flowchart of MOFCOM's investigation procedures.

MOFCOM Investigation Procedures Regarding Failure to Notify a Concentration 

¹A copy (in Chinese) of the Interim Measures (MOFCOM Decree [2011] No. 6) is available at: http://www.mofcom.gov.cn/aarticle/b/c/201201/20120107914884.html?test.

²The complete text of the press release is available at: http://www.mofcom.gov.cn/aarticle/ae/slfw/201112/20111207901483.html (in Chinese).

As to the prospects in 2012, Mr. Shang stated that MOFOCM will promulgate a series of regulations such as the Rules on Imposing Restrictive Conditions for Concentration of Business Operators (《经营者集中附加限制性条件的规定》), the Interim Measures on Investigation and Punishment of Failure to Duly Notify Concentrations of Undertakings (《未依法申报经营者集中调查处理暂行办法》),³  and the Measures on Investigation and Punishment of Concentrations of Undertakings Below Filing Thresholds Yet Suspected of Monopoly  (《未达申报标准涉嫌垄断经营者集中查处办法》). 

Mr. Shang also mentioned that MOFCOM will update the merger filing report form currently in use. In the meantime, MOFCOM will continue to work on developing a summary procedure for relatively easy and straightforward cases to shorten the case review time and to focus the limited resources on more complicated cases.
 

¹The complete text of the press release is available at: http://www.mofcom.gov.cn/aarticle/ae/slfw/201112/20111207901483.html (in Chinese).

²For more information about the Memorandum of Understanding on Antimonopoly and Antitrust Cooperation, please refer to our previous article entitled The PRC Antimonopoly Enforcement Agencies and the US Antitrust Agencies signed Antitrust MOU.

³This measure has been promulgated on December 30, 2011 and will come into effect on February 1, 2012.

1  Governmental Structure

1.1 China's Political System

Political System of China refers to the political structure, fundamental laws, rules and regulation and practices that are implemented in China, and which control the state power, government, and the relationships between the state and society.  Being a socialist country, based on the worker-peasant union and practicing people's democratic centralism, the primary system in the country is the socialist system.

The main political structure of the PRC is comprised of two vertically integrated, but interlocking institutions: the Chinese Communist Party (the "CCP" or "Party"), headed by the Party Politburo and its Standing Committee; and the state government (the "state" or "government") apparatus, headed by the premier, who presides over the State Council, a de-facto cabinet.  Throughout China, Party and government structures closely parallel one another, with Party committees and representatives present not only in government agencies, but also in most organizations and institutions, including universities and foreign owned enterprises.

Two other major institutions play roles in Chinese politics.  One is the National People's Congress (the "NPC").  According to the PRC Constitution, the NPC of China is the highest organ of state power.  Its highest officers are the president and vice president of the NPC, who are directly elected by the members of the NPC.  Articles 85 and 92 of the Constitution state that the State Council is the executive arm of the government and reports to the NPC.

The other is the Chinese People's Political Consultative Conference ("CPPCC").  The CPPCC is an organization of the patriotic united front of the Chinese people.  It is also an important organ of multi-party cooperation and political consultation under the leadership of the CPC, and an important instrument of democracy in the nation's political life.  The CPPCC exercises the functions of political consultation, democratic supervision, and participating in the administration and discussion of state affairs.  This is a key link for the CPC and the governments at all levels to ensure that decision-making is scientific and democratic.

Another key institution in Chinese politics is the People's Liberation Army ("PLA"). The distinction between civilian and military leadership in the PRC is tenuous. There are, for instance, two authoritative bodies ostensibly tasked with authority over military policy and decisions: the Central Military Commission of the PRC, a state entity; and the Central Military Commission of the Communist Party, a party organ.  Although the former is nominally considered to be in supreme command of military and defense affairs, including the formulation of military strategy, in reality it is the Party-controlled Central Military Commission ("CMC") that exercises command and control over the PLA.  Since the membership of the two 11-member commissions is usually identical, it has become customary to refer to the CMC alone without distinguishing between the two.  The CMC is chaired by the Party general secretary, emphasizing that leadership of the military is a Party prerogative.

1.2 Government

The PRC is governed under the leadership of the CCP.  The PRC government is organized in two tiers.  The central government, State Council is the highest administration authority of PRC and leads various departments, bureaus and public service units, while local governments have authority over the provinces, autonomous regions, centrally governed municipalities (Beijing, Shanghai, Tianjin and Chongqing), and special administrative regions (Hong Kong and Macau).

The PRC's legal system, administrative apparatus, policy-making and government organizations are broadly divided into three levels, namely, the central government level, provincial or municipal government level, and local municipal or county government level.  Foreign investors need to understand which authorities are relevant to their particular activities and it is important to appreciate that the role of government is very significant in PRC business matters.

1.3 Foreign Investment Approval Authorities

There are several authorities responsible for overseeing different aspects of foreign investment through their central and local branches.

(a) Project Approval involves the National Development and Reform Commission (the "NDRC")

The NDRC co-ordinates development policy and also takes a major role in approving foreign investment projects.  Along with the project approving procedure, opinions from other relevant authorities (such as the opinion from the Ministry of Environment regarding the environmental protection for a plant project) are often involved in this process.

(b) Approval of establishment of foreign invested enterprises (the "FIE") by the Ministry of Commerce (the "MOFCOM")

MOFCOM is responsible for examining and approving the establishment of FIEs, including the form of their constitutional documents and the approved areas in which they will be permitted to conduct business. 

(c) Special Industry Approvals

Although the main approving authorities are the NDRC and MOFCOM, other authorities may also be involved in approving procedures particularly where there is some limitation on the entrance by foreign investors into a special industry.  For example, the pre-approval from the State Food and Drug Administration ("SFDA") or its branches is needed if the investment involves the pharmaceutical production.

(d) Registration with the State Administration for Industry and Commerce (the "SAIC")

All business entities need to maintain records of corporate documents with local branches of SAIC including basic information regarding registered capital, directors, shareholders and the constitutional documents.  SAIC also oversees initial approvals for special industries such as advertising.

(e) Other business administrations relevant to foreign investors

The tax bureau, the administration of foreign exchange, the finance bureau, the customs and the administration of quality supervision, among others, are all involved in the routine management of FIEs.

1.4 Constitutional Protection

A number of constitutional changes have occurred in recent years.  Businessmen have been allowed to join the CCP since November 2002 which is indicative of the importance now placed on the private sector in modern China.  The amendment to the state constitution in March 2004 and enactment of the PRC Property Law in 2007 both demonstrated the PRC government's commitment to the protection of property rights and investors' interests.  Measures such as these have also helped to strengthen foreign investors' long term confidence in China.

2  Legal System

Shortly after its founding in 1949, the PRC government dismantled the former legal system and created a socialist legal system. The modern Chinese legal system mainly consists of seven (7) branches and four (4) levels of law.  The seven (7) branches of law are: the Constitution and laws related to the Constitution; civil and commercial laws; administrative laws; economic laws; social laws; criminal laws; and litigation and non-litigation procedural laws.  The four (4) levels of law are: the Constitution; laws; administrative regulations; local regulations, and autonomous regulations, specific rules and rules.

Amendments to the Constitution are rectified by a two-thirds majority vote from all deputies of the NPC.

Laws on the following matters are enacted exclusively by the NPC and its Standing Committee: state sovereignty; the formation, organization, functions and powers of state organs; the system of regional autonomy by ethnic minorities, the system of special administrative regions and the system of autonomy at the grass-root level; criminal offences and punishment; the deprivation of citizens' political rights and mandatory measures and penalties involving the restriction of personal freedom; the expropriation of non State-owned property; the basic civil system; the basic economic system and basic systems of finance, taxation, customs, banking and foreign trade; the litigation and arbitration systems and other matters for which laws must be enacted by the NPC or its Standing Committee.  The Standing Committee of the NPC follows the "system of three deliberations" in the enactment of laws, which means that a bill should be deliberated at three (3) meetings of the Standing Committee of the NPC before it is voted on.  An important or controversial bill may undergo more than three (3) deliberations.

The State Council enacts administrative regulations in accordance with the Constitution and the laws.

The people's congresses of the provinces, autonomous regions and municipalities directly under the central government, or their standing committees, have the power to enact local regulations.  The people's congresses of the ethnic autonomous regions have the power to enact autonomous region regulations and also other specific regulations based on local political, economic and cultural conditions.

Ministries and commissions of the State Council and other organs endowed with administrative functions directly under the State Council, such as MOFCOM, SAIC and the China Securities Regulatory Commission (the "CSRC") may, in accordance with the laws and administrative regulations, enact departmental rules within the limits of their power.  The people's governments of the provinces, autonomous regions, municipalities directly under the central government and larger cities may, in accordance with the laws, administrative regulations and local regulations of their respective province, autonomous region or municipality, enact local rules.

Bills are usually deliberated on a non-public basis.  The process is not published in government publications, nor are the bills announced to the public.  However, in recent years, laws, regulations and rules that are controversial or will have a significant social and economic impact on Chinese society, such as the PRC Property Law, the PRC Labor Contract Law, the PRC Food Safety Law and the Administrative Regulations on the Registration of Resident Representative Offices of Foreign Enterprises, have been released on the Internet to solicit public opinion.  Public seminars and public hearings have also been held, for example, in respect of revisions proposed for the PRC Individual Income Tax Law and the PRC Intangible Cultural Heritage Law, as well as the formulation of the Regulations on the Expropriation of Houses on State-owned Land and Compensation.  These signify a major change in the PRC legislative system.

In general, legislative bodies are entitled to construe and interpret the laws and regulations that they have enacted, although such laws and regulations are also subject to the construction and interpretation by other legislative bodies of a higher level.  The PRC body of laws has undergone a comprehensive overhaul since 1979 with the passage and revision of many major pieces of legislation, including laws and regulations applicable to foreign investment.

3  Establishing a Business Vehicle in China

3.1 General Policy

Provisions on Guiding the Orientation of Foreign Investment promulgated by the State of Council came effective on 11 February 2002, which classifies foreign investment areas into four (4) different sectors, the encouraged, permitted, restricted and prohibited.  In the Catalogue of Industries for Guiding Foreign Investment (the "Catalogue") jointly published by the MOFCOM and NDRC further specifies which areas are prohibited, restricted and encouraged for foreign investors, and those areas which are not provided in the Catalogue should be permitted for foreign investors.  According to the Catalogue, we understand the prohibited are areas which cannot be invested by foreign investors, the restricted may have some investment requirements or limitations such as only permitting cooperation jointly by Chinese and foreign investors, or only permitting foreign investor to hold minority interests of the proposed company (or other kinds of organizations) up to 49% etc., and the permitted and encouraged are areas which permit the structure wholly invested by foreign investors.

3.2 Types of Foreign Investment Vehicles

Companies that desire a permanent presence have to set up operations as an appropriate legal entity, depending on the intended business scope, and be compliant with Chinese legal and tax requirements.  The most common legal structures used for establishing a presence in the PRC are:

•  A Representative Office (the "RO")
•  A Wholly Foreign-owned Enterprise (the "WFOE")
•  An Equity Joint Venture (the "EJV")
•  A Contractual Joint Venture (the "CJV")
•  A Foreign-invested Partnership Enterprise (the "FIPE")

Each of these structures has unique advantages, restrictions and drawbacks, and it is essential to choose the option best suited to your business aims.  Among of the above forms, the WFOE, EJV, CJV and FIPE are collectively referred to as FIEs.

(a) RO

ROs are often the first step taken by foreign companies when establishing a permanent presence in China.  ROs can undertake market investigation, display, publicity activities in connection with the products or services of foreign companies, and liaison activities in connection with the products sales, services provision, domestic procurement and domestic investment of foreign companies.  However, ROs are not permitted to engage in any profit activity which means that they cannot sign contracts, receive income, or issue invoices and business tax receipts.  Under PRC law, an RO is considered to be an extension of its establishing company, and does not have the status of a legal person.

To establish an RO in China is relatively easy.  Generally, a foreign company only needs to register with the SAIC to establish an RO.  Law firms, financial and insurance companies and other certain industries may require substantive approvals, but for most industries no substantive government approval is required.  In addition, ROs are not subject to the capital contribution requirement imposed on companies and their investors.

(b) WFOE

A WFOE refers to a company incorporated in China with limited liability that is owned by one or more foreign investors.  Where permitted, a WFOE is now a popular option for foreign business, as the investor may completely control over their business entity as well as enjoy the full profit from its operation.  Moreover, WFOEs also provide a better protection to the investor's intellectual property rights in comparison to other types of entities.

The WFOE is an appropriate structure for companies whose main activities in China are to manufacture and sell products, or provide services such as research and development or business consultancy.  A WFOE allows the foreign investor to issue invoices and receive revenues in Renminbi (the "RMB") that can then be converted and repatriated out of China.

Compared to an RO, to establish a WFOE is a little more complex and time consuming, since generally the WFOE has to get the approval from MOFCOM prior to registration with SAIC.  In addition, besides the approval from MOFCOM, the WFOE usually should obtain approvals from other governmental authorities such as NDRC and SFDA etc., depending on the WFOE's business scope.

(c) EJV

An EJV is typically used for long-term projects and is formed by foreign companies, enterprises, other economic organizations or individuals and Chinese companies, enterprises or other economic organizations.  An EJV is typically a limited liability company.  The proportion of an EJV's registered capital contributed by the foreign investors shall not be less than 25%.

The board of directors is the highest authority of an EJV, which should decide all major issues concerning the EJV.  An EJV must have at least three (3) directors, including a chairman and a vice chairman.

For foreign investors who are not familiar with Chinese market, an EJV may be beneficial for such foreign investors.  A good local partner may contribute market knowledge and strong marketing and distribution channels, and they may help reduce the costs and risk of market entry.  In certain restricted sectors, such as automotive and insurance, forming an EJV with a Chinese company is still the only permitted route for establishing a permanent presence in China.

The challenge of establishing and running a successful EJV is finding and nurturing the right partnership.  Partners have to overcome issues such as mismatched expectations and differences in business culture and practices.  The ability to maintain effective communication, and control where necessary, is also crucial.

(d) CJV

A CJV is often adopted for shorter-term projects or built-operate-transfer projects, and are formed with join capital or terms of cooperation between foreign enterprises, other economic organizations or individuals and Chinese enterprises or other economic organizations.  CJV can be registered as a limited liability company which owns the status of legal person, but it is not mandatory.  A CJV should set up a board of directors (a CJV which has the status of legal person) or a joint management committee (a CJV which has no status of legal person) which is the authority of CJV.

CJVs are similar in many ways to EJVs but have the potential to be more flexible in certain aspects.  Unlike EJVs, the profits, risks and losses of CJVs may be allocated between the parties in a proportion that differs from the equity contributions by the parties.  It may also be possible for the foreign investor to recover its investment before the end of cooperation term of the CJV.

(e) FIPE

On 1 March 2010, Administrative Measures on the Establishment of Partnership Enterprises in China by Foreign Enterprises or Individuals came into effect, allowing foreign individuals or organizations to participate in partnership enterprises, offering a further alternative to the RO, WFOE, EJV and CJV.  FIPEs allow for partnerships between two or more foreign enterprises or individuals, or a combination of foreign enterprises or individuals and Chinese individuals, legal persons or other organizations.

FIPEs do not need to obtain the approval from MOFCOM.  They only require registration through the local branches of SAIC.  However, businesses in certain sectors will need to comply with other specific regulations and the FIPE should submit approvals from relevant authorities when applying for its registration.

The types of FIPEs include foreign-invested general partnership and foreign-invested limited partnership.  Solely State-owned companies, State-owned enterprises, listed companies and public welfare institutions and social organizations shall not be general partners of FIPEs.  Limited partners cannot be the executive partner of a FIPE.

The FIPE provides a good channel to enter into Chinese market for foreign investors, especially for those private equity firms.

(f) Branch Office

Besides the above forms, a foreign company can set up a branch office in China if certain prerequisites, which may vary for different industries, can be met.  Such branch office does not have independent legal person status and its parent company will be held liable for all of its business activities in China.  Generally, in practice not all industries are permitted to establish a branch office by the foreign company in China.

The approval authority for the establishment of branch offices is generally MOFCOM or its local counterparts, while for certain regulated industries, it is the industry administration authority, such as China Insurance Regulatory Commission ("CIRC") or China Banking Regulatory Commission ("CBRC") that is charged with the approval responsibility.  Following the obtaining of approval of establishment, a branch office must apply to the local branch of SAIC for a business license.

3.3 Investment Process

(a) Establish a New Company

As analysis in Item 3.2, there are several different choices for foreign investors if they want to establish a new company in China.  Foreign investors may select a proper vehicle in accordance with their business considerations.

(b) Merger and Acquisition (the "M&A") of Domestic Chinese Enterprises

(i) General rules

Instead of setting up a brand new company, a foreign investor may acquire the equity interest in or the assets of a domestic Chinese company, assuming that such domestic company is engaged in an industry which is open to foreign investment under the Catalogue, and the shareholding ratio of foreign investors is compliant with the relevant rules and regulations.  There are two ways of achieving this, namely: ⑴ by establishing a FIE with the purpose of using such FIE to purchase assets from a PRC domestic company, or by directly acquiring assets from a PRC domestic company and then using those assets to establish a FIE; and ⑵ by acquiring the equity interest in, or by subscribing for new equity in a PRC domestic company, resulting in the conversion of such PRC domestic company to a FIE.

(ii) Special provisions on State-owned Enterprises

If the subject matter of the M&A involves the equity interest or assets of a State-owned enterprise (the "SOE"), a qualified asset valuation company must be appointed to carry out a valuation of the State-owned equity interest or assets in question.  The valuation result must be approved by or filed with the appropriate level of the State-owned Assets Supervision and Administration Commission of the State Council (the "SASAC"), and will be used as a reference for the determination of the transfer price of the State-owned equity interest or assets.  Where the agreed transfer price falls below 90% of the valuation, approval from the relevant property rights transfer government authorities must be obtained before the transaction may continue.  Moreover, the sale of State-owned equity interest or assets to foreign investors must be conducted publicly through holding public tender, or by listing or being auctioned on a recognized property rights exchange.

(iii) M&A  procedures

When acquiring the equity interest in or assets of an existing domestic company, it is necessary to conduct a thorough due diligence investigation on the Chinese target company or the assets to be acquired.  It is important to confirm that the target company was duly organized and are validly existing, and to investigate any loans borrowed or extended, and the title of any assets (including but not limited to land use rights, intellectual property rights etc.) owned by the target company.  The results of such thorough due diligence can provide guidance to the foreign investor when negotiating the contractual terms of the acquisition.

As the completed M&A will result in the conversion of the domestic company into an FIE, it is essential to obtain approval from the government authorities at the correct level.

If the proposed M&A by foreign investors of a domestic company satisfies the reporting standards as stipulated in the Rules on Standards of Reporting Business Operator Concentration promulgated by the State Council, the foreign investors shall report to the MOFCOM beforehand, and no transaction shall be conducted without reporting.

In 2011, the State Council released certain rules on the national security review.  Where the target domestic enterprise is involved in a business that concerns national defense security issues or national economic security issues, the national security review process will be conducted by the Joint Committee led by NDRC and MOFCOM.  If the proposed transaction is determined by the Joint Committee that it has or is likely to have a major impact on national security, the merging parties will be required to terminate the transaction or to undertake certain remedies such as the transfer of relevant shares, assets to eliminate any impact on national security.  It's worth noting that the variable interest entities mode (the "VIE") which was common used in foreign investments will face restrictions for certain industries in the future.

Following the obtaining of governmental approvals, registration with the local branches of SAIC and other relevant governmental authorities, such as tax administration authority, customs administration authority and foreign exchange administration authority, will have to be conducted within specified time periods.

(c) M&A of FIEs

Alternatively, a foreign investor may acquire the equity interests of a FIE held by another foreign investor.  Acquiring the equity interests in an already established FIE requires the consent of all other original shareholders, approval by the government authorities which initially approved the establishment of the FIE, and re-registration with SAIC.  In the case of an EJV, unanimous approval of the EJV's board, or in the case of some CJVs, the "joint management committee", is also required.

(d) Merger and Division of FIEs

Merger and division of FIEs are allowed in the PRC.  The merger of two or more FIEs requires approval from the relevant PRC government authorities that originally approved the establishment of each of those FIEs.  Similarly, the division of a FIE requires approval from its original examination and approval authority.

(e) Purchasing Shares in PRC Public Companies

Shares in PRC companies listed on the Shenzhen or Shanghai stock exchanges are classified into "A" shares, which can only be sold to Chinese citizens and organizations, Qualified Foreign Institutional Investors (the "QFII") and strategic foreign investors, and B shares, which can be sold to foreign citizens and organizations, including persons from Hong Kong, Macau and Taiwan, and (since February 2001) also to Chinese nationals residing inside the PRC.

3.4 Government Approval

(a) Approval Level

According to PRC law, the foreign invested projects should be submitted to NDRC or its local branches for the project review (if necessary) and the contract and articles of association (the "AOA") should be submitted to MOFCOM or its local branches prior to registration with SAIC.  The following chart shows which level of government approvals should be obtained.

Moreover, for the approval of an investment company by MOFCOM, if its registered capital is less than USD300 million, the approval level should be provisional or local MOFCOM, and only if its registered capital is or exceeds USD300 million it should obtain the approval from central MOFCOM.

(b) The Basic Approval Process

An FIE may be established only with the approval of the Chinese government.  The approval process for forming new entities or for acquiring existing companies (thereby converting them into FIEs) is largely the same.  The approval process begins with a name reservation application to the SAIC to check on the proposed name for the FIE.

After the company name has been reserved, the applicant must obtain substantive examination and approval of the investment by MOFCOM.  Examination and approval by MOFCOM is the key stage in the approval process.  It requires submission of the full definitive documents for the proposed FIE to MOFCOM, and may also require a feasibility study report describing background on the project, along with other supporting documents.  MOFCOM has the flexibility to request documents not expressly set forth in the statutes if they believe such documents would be helpful to its decision.

Project Verification from NDRC is technically required for any foreign investment project, but in practice, the NDRC's approval is critical only in certain industries, such as automotive industry, oil exploitation industry, etc.

After approvals from MOFCOM and NDRC (if necessary), the FIE may be registered with SAIC for issuance of a business license.  Under PRC law, the date of issuance of the business license is the date of incorporation of a company.  After obtaining the business license, the FIE should complete remaining registrations with relevant authorities including branches of State Administration of Foreign Exchange (the "SAFE"), General Administration of Customs of the People's Republic of China (the "Customs") and State Administration of Taxation ("SAT"), etc.

(c) Special Approvals

For some certain industries, the FIE should obtain special approvals.

Environmental approval from State Environmental Protection Agency (the "SEPA") may be required prior to applying to MOFCOM for manufacturing enterprises, or for any investment project that entails a construction project.  Before registration with SAIC, for companies involving food or pharmaceutical production, they have to get the approval from SFDA.

The approval from SASAC will be required for investments involving Stated-owned assets.
Some typically regulated industries (including, for example, securities, banking and insurance) involve special approval regimes in addition to, or in place of, MOFCOM examination and approval.  CSRC reviews applications to set up or acquire securities companies, CBRC covers banks, and CIRC reviews insurance company applications.

4  Operating in China

Whereas the previous parts addressed the basic political and legal system of China and the entry into Chinese market, this part will outline the principle business and commercial regulations governing the operations of FIEs in China.

4.1 Taxation

(a) Tax System

Under the current tax system, the PRC imposes about twenty (20) types of taxes, including enterprise income tax (the "EIT"), value added tax (the "VAT"), business tax, property tax, consumption tax, land appreciation tax (the "LAT"), land use tax, deed tax, stamp duty and individual income tax (the "IIT").  PRC has signed income tax treaties and arrangements with more than 80 countries and regions, including two special administrative regions of the PRC, Hong Kong and Macau.

(b) EIT

On 1 January 2008, the new unified PRC Enterprise Income Tax Law (the "EIT Law") became effective.  It consolidated the previous two separate income tax regimes for domestic enterprises and FIEs into one single income tax regime. The new EIT Law introduced the concept of resident enterprises, unified the tax rate for Chinese domestic enterprises and FIEs, replaced the old tax incentive system with a new model and addressed special tax adjustments, such as adjustments made pursuant to transfer pricing, or thin capitalization rules.

(i) Resident Enterprises vs. Non-resident Enterprises

A resident enterprise refers to an enterprise which is legally established in accordance with PRC law, or an enterprise which is legally established in a foreign country or region whose actual administration institution is in China.  The actual administration institution refers to the institution that actually and comprehensively manages and controls the production and operation, staff, account, property and other aspects of the enterprises.  A resident enterprise should pay EIT on its worldwide income, i.e., income derived from sources both inside and outside the PRC.

A non-resident enterprise refers to an enterprise which is legally established in a foreign country or region whose actual administration institution is outside China, but which either has an establishment in the PRC or has no establishment in the PRC but derives PRC-sourced income.  A non-resident enterprise which has an establishment or place in the PRC pays EIT on income which is derived from sources inside the PRC, as well as on income which, although derived from sources outside the PRC, is effectively connected with such establishment.  If a non-resident enterprise has no establishment in the PRC, or has an establishment in the PRC but has derived income not effectively connected with such establishment, it pays EIT only on income derived from sources inside the PRC.

(ii) Tax Base and Tax Rate

The taxable income of an enterprise is defined as the amount remaining from its gross income in a year, after non-taxable income, tax-exempt income, various expenses and losses have been deducted.  Losses incurred by an enterprise may be carried forward for a period of five (5) years.  No carry-back is permitted.  Reasonable expenditures which have actually been incurred and are related to the generation of income, including costs, expenses, taxes, losses and other expenditures are deductible.

A PRC resident enterprise is subject to EIT at a rate of 25% on its worldwide income.  A non-resident enterprise having an establishment in the PRC is subject to EIT at a rate of 25% on its PRC-sourced income received by the establishment as well as its non-PRC-sourced income actually connected with the establishment.  Where a non-resident enterprises that does not set up an institutions or establishments in China, or where institutions or establishments are set up but there is no actual relationship between the income and such institutions or establishments, the non-resident enterprise should pay EIT at a rate of 10% in relation to the income originating from China, which should be subject to tax withholding at source with the payer as the withholding agent.  Under certain tax treaties between China and other countries and/or regions, non-resident enterprise may enjoy more preferential tax treatment depending on the provisions of such treaties.

(iii) Tax Incentives

Various EIT incentives are provided in the EIT Law.  Preferential treatment is generally granted to industries and projects, the development of which is supported and encouraged by the State.

Qualified high-new technology enterprises (the "HNTEs") enjoy a 15% preferential tax rate nationwide.  Further, in respect of HNTEs established in the five special economic zones (Shenzhen, Zhuhai, Xiamen, Shantou and Hainan) and Pudong New Area of Shanghai, a tax holiday of a two-year exemption of EIT and a three-year half reduction of EIT will apply commencing from the first profitable year.

Venture capital investment enterprises enjoy a bonus deduction equaling 70% of the investment made to qualified medium and small sized high-tech enterprises, upon reaching two (2) years of ownership.  A bonus deduction or amortization of 50% of expenses incurred for research and development activities for new technology, new products, or new craftsmanship is also available to most enterprises.

Incomes earned from projects of agriculture, forestry, husbandry and fishery, incomes earned from business operations of important public infrastructure investment projects supported by the state, and incomes earned from eligible projects of environmental protection, energy and water saving may be exempted or reduced.

(c) IIT

China has a progressive IIT ranging from 3% up to 45%.  Generally, an individual who has a domicile in the territory of China or who has no domicile but has stayed in the territory of China for one (1) year or more should pay individual income tax for his/her incomes obtained in and/or outside the territory of China.  An individual who has no domicile and does not stay in the territory of China or who has no domicile but has stayed in the territory of China for less than one (1) year should pay individual income tax for his incomes obtained in the territory of China.

An FIE must generally serve as a withholding agent for its employees, and withhold and pay IIT on their behalf each month.  China relies principally on withholding to collect IIT, and only those individuals whose annual income is RMB120,000 or more, whose income from outside the territory of China, who receive wage and salary income from at least two (2) sources within the territory of China, or who receive taxable income but have no tax withholding agent, are required to file separate annual tax returns to the competent tax authorities.

(d) VAT

VAT is levied on the sale of goods inside the PRC, the import of goods into the PRC and the provision of processing, repair and maintenance services in the PRC.  The standard tax rate for most goods is 17%, though a concessionary rate of 13% applies to certain goods such as agricultural machinery, books and utilities.
The PRC VAT regime distinguishes between general VAT taxpayers and small scale VAT taxpayers.  The threshold to qualifying for general VAT taxpayers are those whose annual sales are above RMB 0.5 million for manufacturing enterprises and above RMB 0.8 million for trading enterprises.  The small VAT taxpayers should pay VAT at a lower rate of 3%.

(e) Business Tax

Business tax is levied on the provision of most services within the PRC, the transfer of intangible property in the PRC and the transfer of real property in the PRC.

Business tax rates

(f) Consumption Tax

Consumption tax is imposed as a measure to monitor the consumption of goods deemed as luxury or unhealthy.  It is charged to any person or unit engaged in the manufacturing, subcontracting, importing or processing of the prescribed goods.  The rate varies, depending on the exact taxable items.

(g) Stamp Duty

Stamp duty is levied on specific documents executed or obtained in the PRC. The rates generally range from 0.01% to 0.003%, depending on the type of document. To the extent that a document is a contract to which there is more than one contracting party, each party needs to pay stamp duty at the full statutory rate.

(h) Deed Tax

Deed tax is levied on the transfer of land use rights and real property.  The rate is 3% to 5%, depending on the location of the land or property.  Deed tax is payable by the transferee.

(i) LAT

LAT is levied on the gain from the transfer of State-owned land use rights and the property situated on the land.  The rates are progressive ranging from 30% to 60%, depending on the percentage of the appreciation.

(j) Property Tax

Property tax is levied on the ownership of real property in urban areas.  It is assessed at an annual rate of 1.2% of the original cost of the building with less a 10% to 30% deduction (this percentage of deduction is determined by the relevant local authorities and thus may vary from location to location) or at a rate of 12% of the annual rental income.  From 1 January 2009, Chinese companies or individuals have stopped paying property tax; however, FIEs, foreign enterprises and organizations and foreign individuals continue to pay property tax.  In early 2011, Chongqing and Shanghai has begun to levy property tax again.

(k) Urban Land Use Tax

Urban land use tax is levied on the ownership of land use rights in urban areas.  The exact rate depends on the location of the relevant land.  According to the national regulations, the applicable rates per square meter are RMB 1.5 to RMB30 per year for large cities, RMB1.2 to RMB24 per year for medium-sized cities, RMB0.9 to RMB18 per year for small cities and RMB 0.6 to RMB12 per year for counties.

(l) Customs Duty

Customs duty is levied on the imported and exported goods and articles entering or leaving the territory of the PRC. Customs duty is payable according to a tariff schedule.  With free trade agreements (the "FTA"), goods traded between the PRC and the FTA signatory countries qualify for lower customs duty rates.  Qualified enterprises enjoy duty reduction or exemption as a tariff preference measure.

4.2 Employment

(a) Regulatory Environment

The foundation for China's employment laws, rules, and regulations is the PRC Labor Law, which was enacted on 1 January 1995 by the NPC.  Another milestone in the development of China's labor and social security legislation is the PRC Labor Contract Law, which was passed by the NPC and came into force on 1 January 2008.  Later, the Regulations of Implementation on the PRC Labor Contract Law became effective on 18 September 2008, which specifies certain issues on labor.

Employment matters, including those of FIEs, within the territory of the PRC are all subject to the PRC Labor Law, the PRC Labor Contract Law, and other laws and regulations issued by the NPC or the central government.  There are also local regulations and rules issued by provincial, municipal, and other lower level government authorities that are only applicable to the relevant local regions.

(b) Contract of Employment

PRC law allows the employer to engage a part-time employee with an oral contract.  However, in case of any employment of full time employee, the parties are required to enter into a written labor contract within one month from the date of commencement of employment.  Failure to comply with this provision results in the employer being required to pay to the employee twice the amount of the agreed remuneration as salary.

(c) Minimum Wage

There is a system of guaranteed minimum wages and salaries for Chinese workers.  Local people's government will formulate its own specific standards for minimum wages and salaries.  The payable wages and salaries (exclusive of any overtime pay, social insurance/housing fund contributions borne by the employee, or any allowance for middle/night shifts, high/low temperature etc.) shall be in no case lower than the local minimum wage and salary standards if the workers have provided "normal work" pursuant to their labor contracts.

(d) Working Day and Overtime

There are three kinds of work hour systems, i.e., standard work hour system, comprehensive work hour system and indefinite work hour system.

(e) Social Insurance

The employer is obliged to have their PRC employees enrolled in the applicable social insurance schemes provided by the local labor authorities, and withhold the contributions borne by the employee (referred to as the "Individual Contributions" below) from his/her monthly salary and pay the individual contributions as well as the contributions borne by the employer (the "Company Contributions") to the local social insurance institution each month.

The rate and contribution basis of social insurance premium depends on the relevant local regulations.  Different localities provides for different categories of social insurance schemes, which mainly depends on the localities of the domicile of the employees.

(f) Health and Safety

Employers are required to strictly implement the rules and standards of the State with regard to occupational safety and health, carry out relevant education among employees, prevent accidents in the process of work, and lessen occupational hazards.  Facilities of occupational safety and health must meet the standards set by the State.

(g) Termination of Employment and Economic Compensation

(i) Termination initiated by employer

The employer is generally not allowed to unilaterally terminate the labor contract at will or without cause.  The termination of employment initiated by the employer is not allowed unless some specific conditions (i.e., the statutory termination grounds) have occurred, for instance, the employee seriously violates work rules and regulations of the employer.

If the employer terminates the employment of the employee in violation of law, the employee may request for specific performance, i.e., reinstatement to his/her job position.  If the employee does not so request or the contract is no longer capable of being performed, the employer shall pay twice the usual severance pay amount as damages to the employee.

(ii) Termination by mutual consent

If the employer proposes to terminate the employment of the employee, and the employee so agrees after negotiation between the parties, the labor contract can be terminated, which is referred to as the "termination by mutual consent" in the PRC employment law.

(iii) Termination initiated by employee

The employee may: ⑴ unilaterally early terminate the labor contract without cause as long as he/she gives a 30-day prior written notice to the employer (in case such employee is in probationary period, such prior notice period is three (3) days); or ⑵ immediately terminate his/her labor contract without any prior notice under some specific circumstances, such as when the employer does not pay the employee in full and on time.

(h) Labor Secondment or Contractual Worker

The ROs set up by foreign companies are not allowed to employ staff directly in the PRC but may only obtain the staff through certain designated labor agencies (the "Agency") like Foreign Enterprise Services Corporation (the "FESCO"), which is generally referred to in China as the labor secondment arrangement.  Local labor bureau are in charge of monitoring compliance.  Under this arrangement, the RO as the Secondee Company signs a service contract with the Agency for engagement of their labor secondment services, and the employee as the Seconded Employee, who may be appointed by the Secondee Company or the Agency, signs labor contract with the Agency and is seconded to work in the Secondee Company.

(i) Employment of Foreigners

In most cases, employers must recruit Chinese nationals if at all possible.  In order to bring in a foreign employee, the employer must first apply to the local labor bureau for an employment permission certificate to bring in the intended employee.  Once the employer has received the employment permission certificate, the foreign employee must apply for a work visa at his local Chinese consulate.  After entering China, the employee must obtain a work permit and residence card prior to commencing employment.  Foreign experts, off shore petroleum workers, cultural and artistic performers, and representatives of ROs enter China under different procedures.

4.3 Antitrust & Competition

(a) Legislation

A broad range of PRC laws contain one or more provisions prohibiting anti-competitive practices such as price-fixing, market-sharing and below-cost sales. These include the Anti-Unfair Competition Law and the Price Law.  Many of these provisions have not been widely enforced, and the fragmented structure of the competition legislation reflects the historical absence of a cohesive competition policy in the PRC.

However, a comprehensive Anti-Monopoly Law (the "AML") came into effect on 1 August 2008.  A number of provisions in the AML overlap with pre-existing competition provisions, but it is expected that the AML will be the primary law used to tackle anti-competitive conduct going forward.  The AML regulates three (3) main areas of business conduct: monopoly agreements, the abuse of a dominant market position, and concentrations (i.e., M&A deals and certain other transactions) with anti-competitive impacts.  These prohibitions are understood to apply to nearly all businesses, although SOEs may receive some special treatment under the AML, and certain activities of agricultural producers and farming entities are exempt from the law.

(b) The Development Nature of the PRC Competition Regime

Prior to the commencement of the AML, most PRC competition-related provisions were rarely enforced.  The main exception was the merger control regime under the M&A regulations.  However, the commencement of the AML, and the introduction of significant new legal liabilities relating to anti-competitive practices, reflects an increasing focus on competition issues in China.  This suggests that, going forward, competition provisions may be enforced with more vigor than historically has been the case – particularly once further detailed implementing regulations and guidelines regarding application and enforcement of the AML are released.

It should also be noted that many of the laws prior to the AML that incorporate competition-related provisions remain in force.  While many of these provisions overlap with the AML, in some cases they may have a potentially broader application.  Additionally, some competition provisions are sector-specific, relating to industries such as banking and telecommunications.  It is possible these provisions may still be applied going forward, either in conjunction with the AML or on a stand-alone basis.

4.4 Intellectual Property

Intellectual property protection is a key consideration for foreign investors entering Chinese market.  The PRC has a comprehensive regime of intellectual property laws which provide a wide range of remedies and channels for enforcement, including civil and criminal courts, several different administrative enforcement authorities, prosecutors and polices.  Legislation facilitating private prosecution by intellectual property owners came into effect in 1997.  These intellectual property laws are compliant with the requirements under the Agreement on Trade-Related Aspects of Intellectual Property Rights (the "TRIPs Agreement") of the World Trade Organization.  Also, China is a party to most of the international conventions on intellectual property rights, including:

•  the Paris Convention for the Protection of Intellectual Property Rights
•  the TRIPs Agreement
•  the Berne Convention for the Protection of Literary and Artistic Works
•  the Universal Copyright Convention
•  the WIPO Copyright Treaty
•  the Locarno Agreement for International Classification for Industrial Designs
•  the Madrid Agreement for the International Registration of Trademarks
•  the Nice Agreement for the International Classification of Goods & Services
•  the Patent Co-operation Treaty
•  the Strasbourg Agreement for International Patent Classification
•  the Budapest Treaty for Deposit of Micro-organisms
•  the Geneva Convention on Unauthorized Duplication of Phonograms
•  the WIPO Performances and Phonograms Treaty

Although the laws are there, the level of infringement and the inadequacy of enforcement has been the subject of disputes with Chinese trade partners, particularly the United States of America.
In China, PRC law provides protection for the patent, trademark and copyright.

(a) Patent

There are three (3) types of patents in China: invention patents, utility model patents and design patents.   Invention refers to any new technical solution relating to a product, a process or improvement thereof.  Utility model refers to any new technical solution relating to the shape, the structure, or their combination, of a product, which is fit for practical use.  Design refers to any new design of the shape, pattern or their combination and the combination of color and shape or pattern, of a product, which creates an aesthetic feeling and is fit for industrial application.

Patents may be assigned or licensed, but only upon registration with the State Intellectual Property Office of the People's Public of China (the "SIPO").  Invention patents are the most robust of the three (3) kinds of patents, involving a meticulous review process that takes several years to complete, and providing protection for a period of twenty (20) years from the date of filing to SIPO.  Utility model patents and design patents have a less meticulous and lengthy review process, and also provide a shorter period of ten (10) years after the date of filing.  China's patent system works on a first to file basis.

(b) Trademark

In China, trademarks include registered trademarks and unregistered trademarks.  Only if trademarks are registered with the Trademark Office of the State Administration for Industry and Commerce of the People's Republic of China (the "Trademark Office") can such trademarks seek protection under the PRC Trademark Law, unless the unregistered trademarks are be defined as well-known trademarks.  The period of validity of a registered trademark is ten years commencing from the date of approval for the registration, with subsequent ten-year extensions being available.  Registered trademarks may be assigned or licensed provided such assignments or licenses are registered with or approved by the Trademark Office.

(c) Copyright

The PRC Copyright Law provides protections for creative works, including software.  The National Copyright Administration of the People's Republic of China (the "NCAC") oversees the copyright system.  The NCAC oversees a non-mandatory registration process covering the both registration of copyrights themselves and of assignments or licenses thereof.

4.5 Real Property

(a) Overview

In China land in urban areas shall be owned by the State, and land in rural and suburban areas, unless otherwise prescribed by the State, shall be collectively owned by farmers, including land for houses and private plots in fields and on hillsides.  Neither domestic companies nor FIEs can own land, although they may hold land use rights.

For State-owned land use rights, there are two (2) different types, allocated land use rights and granted use rights.  Generally, the State-owned land use right shall be obtained by paid means such as grant.  However, upon the approval from the government at or above the county level, the State-owned land may be allocated for government institutions or the military; urban infrastructure or public welfare projects; or energy, transportation and water conservancy projects as well as other infrastructure projects supported by the government.  In general, allocated land use rights cannot be transferred or leased without first being converted into granted land use rights (for which a grant fee must generally be paid to the government).  The government may reclaim allocated land use rights at any time without compensation. 

Granted land use right is the right to use land for a specific purpose for a fixed term, seventy (70) years, fifty (50) years or forty (40) years, depending on the purpose of land.  A grant fee must be paid to the government for granted land use rights.

Buildings on land generally should be owned by the same person that holds the corresponding land use rights.  Nevertheless, land use rights and buildings on the corresponding land are sometimes owned by different persons.

(b) Land use rights transfers

Under PRC law, only granted land use rights may be transferred.  Nobody will obtain title to allocated land, even if someone purports to sell it to you, provided that it is first converted to granted land use rights (for which a grant fee must first be paid to the government).  Vacant land is required to be at least 25% developed before the corresponding land use rights can be transferred.  The government may reclaim vacant land if development is not started within two (2) years of transfer.

(c) Renewal of land use rights

From 1 October 2007, the term of residential land use rights will be automatically renewed upon expiry.  This is a welcome relief to those owning residential properties in China.  It will also ensure that financing remains available for residential property approaching expiration of its land use right term.  Non-residential land use right terms are not granted automatic renewal under the Property Law.  Rather, renewal will be subject to other laws and regulations.

(d) Easements

The creation of easements has been recognized since the PRC Property Law became effective on 1 October 2007.  The ability to create easements recognized by law is likely to be of particular importance for infrastructure projects that involve the construction of pipelines or other networks requiring access to land over which the project owner does not hold the land use rights.

(e) Leasing

Land must generally have been developed before it can be leased.  A lessee is required to comply with the terms and conditions of the land use rights grant contract.  A registered lease with authorities will gain priority over any unregistered lease.

(f) Expropriations

Land may be expropriated by the government only in special circumstances and in the public interest.  Compensation is required to be paid if land is expropriated.

4.6 Foreign Exchange

China's currency, the RMB, is not fully convertible.  The RMB is ultimately monitored and controlled by China's State Administration of Foreign Exchange (the "SAFE").  In the past, all foreign currency transactions involving the purchase or sale of RMB were subject to SAFE's review and approval.  Since China became a member of the WTO in 2001, China's foreign currency policy has become increasingly less restrictive.

Under PRC law, foreign currency transactions are categorized as the capital account transactions and the current account transactions.  Capital account transactions refer to the transaction items in the balance of payments leading to changes in external assets and liabilities, including capital transfers, direct investments, portfolio investments, derivatives, loans, etc.  Current account transactions refer to the transaction items in the balance of payments involving goods, services, income, and current transfers, etc.  Compared to payments of capital, current account items may face relatively easier control.

An FIE may, subject to SAFE approval, open a foreign exchange account with a designated foreign exchange bank.  Usually, the account must be opened within the same area in which the FIE is registered.  The approval is required to open an account in another area.  An FIE may purchase foreign exchange if it has insufficient funds in its foreign exchange account to meet a foreign exchange obligation.  Foreign currency accounts of FIEs are subject to annual inspections by SAFE.  Moreover, foreign investors without an FIE in China may open a multicurrency account with a bank to fund the pre-establishment expenses of an FIE.

4.7 Environmental Regulation

The PRC Environmental Protection Law is the national law governing all environmental protection matters in the PRC.  In addition to the Environmental Protection Law, other laws and regulations such as the Prevention of Atmospheric Pollution Law and the Prevention of Water Pollution Law have been enacted to regulate different parts of the environment.  Different provinces and municipalities have also implemented their own environmental protection regulations which are of regional application.

It should be noted that the PRC government has not separately formulated a set of rules and regulations concerning environmental protection for FIEs and FIEs within the territory of the PRC are subject to the same regulatory regime as domestic enterprises.

It's also worth noting that China's recent green policy link benefits in other areas to environmental compliance.  Green insurance policies require enterprises in certain sectors to insure against environmental damage.  Green trade policies may result in higher export taxes on products made in pollution-intensive industries.  The EIL Law also contemplates green taxation polices, providing tax incentives and sanctions concerning the environment.

4.8 Product Safety

China does not have a single, codified product safety law.  Manufacturers and sellers of products and other stakeholders in this area must follow legal requirements as set out in various laws and regulations, including the General Principles of the Civil Law, the Law on Protection of the Rights and Interests of Consumers, the Criminal Law, and laws on the Administration of Pharmaceuticals and on Product Quality.  China issued important legislation on food and product safety in the past several years, including the Law on the Quality and Safety of Agricultural Products in 2006; several sector-specific regulations covering the recall of vehicles, toys, food, and drugs in 2007; and the Food Safety Law and its implementing rules in 2009, which represented a milestone in the formation of China's product safety regime.  These laws and regulations responded to the public's rising concern about product safety in China.  Despite these laws and regulations, China has experienced a number of significant product safety issues in the recent years.

4.9 Dispute Resolution

As an increasing number of foreign investors penetrate the Chinese market, commercial disputes are expanding quickly both in number and in scale.  China has made significant progress in increasing the integrity and reliability of its courts.  The formal processes available for resolving such disputes in China have, in recent years, become increasingly similar to those elsewhere in the world.

If a dispute cannot be settled through negotiation between the parties, the case must be submitted for litigation or arbitration.  Under PRC law, it is permitted for the parties to choose for binding arbitration to resolve their disputes and the courts will generally enforce arbitration judgment without inquiry into the merits.  It is worthy noting that arbitration is only possible if the parties expressly agree to arbitrate. In practice, the arbitration is favored by many foreign investors in China.

(a) Litigation

The PRC courts consist of four (4) layers: the People's Court (at the district or county level), the Intermediate People's Courts (at the municipal level), the High People's Courts (at provincial level), and the Supreme People's Court (at the national level).  The level of the competent court should be generally subject to the nature and size of the disputes.  In most cases, disputes with a foreign connection may be initially in the Intermediate People's Courts.

Court judgments may be appealed once, but the judgment of the second instance is final and binding upon the parties immediately.  Under the PRC Contract Law, it is permitted to select a foreign law to govern the contract with a foreign connection and to provide for exclusive jurisdiction in foreign courts.  In fact, it may be difficult for Chinese courts to enforce a judgment made by a foreign court, but Hong Kong's judgments are exceptions.

(b) Arbitration

In comparison to litigation, the arbitration seems much quicker, more efficient and more reliable, thus major foreign investors would like to include an exclusive arbitration clause in their contracts.

 Under PRC law, an express clause clearly indicating the parties' selection of binding arbitration is enforceable, which should be in writing and contain a clear statement of the parties' intention to submit the dispute to arbitration, the scope of disputes subject to arbitration, and the specific arbitral commission to resolve the dispute.  In addition, it is possible for the parties to reach an arbitration agreement after a dispute arises, but in most cases an arbitration clause is included from the outset in the operative contracts.

The China International Economic and Trade Arbitration Commission (the "CIETAC") is one of the most frequently selected arbitration forums when the arbitration will be held within the PRC.  Foreign investors sometimes do not agree to arbitration in PRC, including arbitration at CIETAC, because they believe that Chinese parties will have a home advantage, meanwhile, Chinese parties concomitantly often object to arbitration aboard.  Therefore, Hong Kong seems as acceptable compromise to both parties.  Of course, to select a third country's jurisdiction for arbitration is also common in practice.  Since China is a party to the United Nations Convention of Recognition and Enforcement of Foreign Arbitral Awards, it is generally possible to obtain the enforcement of an arbitration award issued by a panel in any member country.

Relevant Market 

According to the Announcement, the relevant market is the worldwide HDD market. Although MOFCOM found that the HDD market could be further divided into narrower market segments based on the end use application (such as desktop computers, mobile computers), it considered the HDD market as a whole and carried out competition analysis only in the HDD market.

Competitive Assessment 

MOFCOM mainly considered the following factors in its analysis:

Market Structure. MOFCOM noted that the worldwide HDD market is highly concentrated with only five players, i.e. Seagate (33%), Western Digital (29%), Hitachi (18%), Toshiba (10%) and Samsung (10%), whose market shares are similar in China. It found that the HDD market is very transparent. Since the HDD products are homogenous and large computer manufacturers as the main downstream customers are relatively few in number, it is easy for HDD manufacturers to gain competitor' s information.

Purchasing Pattern. MOFCOM emphasized the importance of the current purchasing pattern on the maintenance of competition in HDD market. In order to ensure stable supply, large computer manufacturers procure through a confidential bidding process and split the order among two to four HDD manufacturers based on the competitiveness of their prices. This model incentivizes HDD manufacturers to compete for larger orders.

Buyers' Bargaining Power. MOFCOM found that large computer manufacturers generally will not oppose price increases and will instead shift such price burden to end consumers that have little countervailing buyer power. As pragmatic evidence, MOFCOM cited an example indicating how the recent price increases by Western Digital due to its impaired production by the floods in Thailand were passed on to end consumers.

MOFCOM also found that the capacity utilization rate of the HDD manufacturers are very high (90% in the fourth quarter of 2010), entry barriers are significant (no new entry into the worldwide HDD market in the past 10 years) and that innovation is quite important for HDD manufacturers to obtain competitive advantages.

Taking into account the above, MOFCOM was of the view that this merger will cause negative impact on Chinese consumers. It is likely to restrict competition by removing an important competitor from the market, undermining the effect the purchasing pattern has on bringing competitive pressures on HDD manufacturers and increasing the possibility of coordination among the remaining players considering the relative transparency of the HDD market.

Remedies
 
According to MOFCOM's decision, Seagate shall have the following obligations:

(1) Seagate shall adopt measures to keep Samsung's brand as a separate competitor, such as establishing an independent subsidiary for independent pricing and sales of Samsung products, creating firewalls to avoid information exchange etc.;

(2) Seagate shall keep its promise to expand the Samsung production capacity within six months of the decision, and reasonably determine and report the production capacity and volumes of Samsung's products thereafter;

(3) Seagate shall not materially change its current business model, forcing customers to buy HDDs exclusively from Seagate or its controlled entities;

(4) Seagate shall not force TDK (China) Investment Co. to supply magnetic pickup head for HDDs to Seagate or its controlled entities exclusively or restrict the quantity TDK sells to other HDD manufacturers; and

(5) Seagate shall invest at least USD800 million per year for three years in R&D.
 

It is interesting to note that Seagate is entitled to apply to MOFCOM for release of the first two of the above obligations after the elapse of 12 months from the date of the decision. MOFCOM will then decide whether to approve based on the market conditions.

Comments

The decision is the most comprehensive decision MOFCOM has published to date. Whereas MOFCOM still relies heavily on market share and market structure, it also takes in account a comprehensive set of factors as well as pragmatic evidence in its analysis.

Moreover, this deal was also notified in the U.S. and the EU. But MOFCOM is the only authority that has imposed remedies, showing that MOFCOM is getting increasingly independent in reaching its own decision. This raises another interesting issue: how and to what extent would antitrust authorities in different jurisdictions cooperate with each other in the face of a cross-jurisdictional merger filing if significant divergence is likely to happen?  

In relation to the remedies, it is also interesting to note that for the first time, MOFCOM included a periodic review clause in its clearance.  Western Digital/Hitachi, the other major transaction in HDD market, obtained conditional approval from the European Commission in November. MOFCOM may have considered that the Western Digital/Hitachi transaction and the divesture commitments made by Western Digital may eventually change the competitive landscape of the HDD market and therefore Seagate's obligations may merit review at a later stage.

 1. A copy of MOFCOM' s Announcement [2011] No. 90 could be found here(in Chinese): http://fldj.mofcom.gov.cn/aarticle/zcfb/201112/20111207874274.html
 
2. The Extended Phase II lasted 62 days in this case.The statutory Extended Phase II should be 60 days; however, since the last day of the review period was a Saturday, MOFCOM extended the period for another 2 days.

The Provisional Measures have not been officially released to date, and are expected to be published early next year. 

A draft of the Provisional Measures was published for comments on June 13, 2011 (see our previous article entitled "MOFCOM publishes draft rules on investigation procedures re failure to notify on concentrations" for more information).  According to earlier report, the Provisional Measures are among the three new rules on merger control that are expected to be released within this or next year.  The other two new rules deal with merger remedies and notification of concentration below notification thresholds respectively.

¹ MOFCOM's press release can be found here (in Chinese): http://bgt.mofcom.gov.cn/aarticle/c/d/201112/20111207869504.html.

Parties and Transaction. The proposed transaction was announced as early as January, 2011 as part of President Hu Jintao's state visit to the United States ³.  GE China and CSCLC are to establish a 50/50 JV mainly to license coal-water slurry (CWS) gasification technology to industrial and power projects in China. GE Infrastructure Technology, another subsidiary of GE will license GE's CWS gasification technology to the proposed JV.

The parent company of CSCLC - Shenhua Group Corporation Limited (Shenhua Group) is a State-owned mining and energy company in China. Its core businesses include production and supply of coal, electricity and heat, as well as rail and port transportation services.

Relevant Market. MOFCOM paid close attention to the market in which the proposed JV will be active, and found that this transaction might exclude or restrict competition in the CWS gasification technology licensing market. Considering the significant differences between CWS gasification technology and other coal gasification technologies, MOFCOM was of the view that CWS gasification technology licensing market constitutes a separate relevant product market.

Since the propose JV will only be active in China and the Chinese licensees only acquire such technology on the China market, MOFCOM found that the relevant geographic market is China.

Competitive Assessment. Apparently, market share, market concentration level and market entry are still the major factors MOFCOM considered in its competitive assessment process.

MOFCOM indentified that China's CSW gasification technology licensing market is highly concentrated with only three major players – CWS gasification technology provided by GE Infrastructure Technology, multi-nozzle-mounted CWS gasification technology jointly developed by Yankuang Group and East China University of Science and Technology, and multi-component slurry gasification technology provided by the Northwest Research Institute of Chemical Industry. It was noted by MOFCOM that GE's CWS gasification technology has the highest share in this market.

MOFCOM further looked into an adjacent market involved in this transaction. Since CWS gasification technology has specific requirements for the properties of the raw coal, operators of CWS gasification projects need to have a reliable supply of the specific coal. MOFCOM noted that in 2010, Shenhua Group was the largest supplier of raw coal that is suitable for CWS gasification projects.

MOFCOM also found that there are significant barriers for entry into the CWS gasification technology market due to the complexity of the technology, high investment cost, existing IP rights and long R&D and industrialization cycles. 

In light of the above, MOFCOM concluded that the proposed JV is likely to restrict competition in the CWS gasification technology market by making use of the dominant position of Shenhua Group in the raw coal market.

Remedies.  In order to solve the competition concerns, MOFCOM requested CSCLC and Shenhua Group not to compel licensees of CWS gasification technology to use JV's technology by restraining the supply of raw coal, or by conditioning such supply on licensing of JV's technology, nor to raise the cost of such supply for those using other technologies.

Comments
 
There are a few points about this decision that are worth mentioning. As mentioned above, it is the first conditional merger control decision where an SOE is involved. If read together with the recent antitrust probe of China Telecom and China Unicom by the National Development and Reform Commission⁴, it appears that contrary to protectionism accusations from overseas, Chinese antitrust enforcement agencies are indeed increasing their antitrust scrutiny of SOEs.

It is also the first conditional clearance of a joint venture project. Whether JV is caught by China's merger control regime is not expressly stipulated in the AML. However, based on our experiences, MOFCOM considers joint ventures to be a type of notifiable transactions under the AML. This decision officially affirmed MOFCOM's position in this regard.

Furthermore, this is the first time MOFCOM defined a technology licensing market. This decision (as well as the previous decision on Alpha V/Savio deal) has become more detailed in terms of competitive analysis. It is also interesting to note that MOFCOM imposed behavioral remedies in this case after it requested divestiture in the Alpha V/Savio case. All these suggest that MOFCOM is getting increasingly sophisticated and holds a flexible and pragmatic approach towards merger remedies.

1. See our article entitled MOFCOM's 8th Conditional Clearance - Alpha V/Savio Deal.    

2. A copy of MOFCOM's Announcement [2011] No. 74 could be found here (in Chinese): http://fldj.mofcom.gov.cn/aarticle/zcfb/201111/20111107824342.html.

3. See the press release of the deal on GE's website:

http://www.genewscenter.com/Press-Releases/GE-and-Shenhua-Announce-Formation-of-Cleaner-Coal-Technology-Joint-Venture-in-China-2ddd.aspx.

4.See our article entitled Earlier Rumor Confirmed: China Telecom and China Unicom under Antitrust Investigation  on details of this incident.

Parties. The acquirer, Alpha V is a private equity fund, whose investments mainly relate to non-ferrous metal recycling, supply of household textile, and production and supply of textile machinery.  Specifically, Alpha V holds 27.9% shares of Uster Technologies Ltd (Uster),the global leader in textile testing and quality control machines. 

The target, Savio, is a manufacturer of textile machinery, and its main products include automatic cone winders, yarn clearers, rotor spinning machines, and double twisters. 

Relevant market. MOFCOM found that Uster and Leopfe (a wholly-owned subsidiary of Savio) are the only two suppliers of yarn clearers in the world. Since there are no other machines that are substitutable, MOFCOM considers that yarn clearer is the relevant product market here. In the yarn clearer market, Uster has 52.3% market share of the global market while Leopfe has the remaining market share. Their performance in China largely resembles their performance in the global market. 

MOFCOM did not specify the relevant geographic market but indeed looked into both the global market and the China market.

Competition concerns. MOFCOM paid a lot of attention on whether Alpha V may influence Uster's operations and management.  For this purpose, MOFCOM reviewed, among other things, Uster's shareholding structure, voting mechanism of the shareholders' meetings, meeting minutes of the shareholders meetings, composition and the voting mechanism of the board of directors.  After the review, MOFCOM decides that it can not rule out the possibility that Alpha V may influence Uster's operations.

In light of the above, MOFCOM considers that after the transaction, it is likely that Uster and Leopfe can coordinate with each other through Alpha V to restrict and/or eliminate the competition in yarn clearer market; on the other hand, it is also likely that Alpha V can restrict and/or eliminate competition through its control and/or influence over Uster and Leopfe. 

Barriers to entry. In order to fully assess the potential anti-competitive effects of the transaction, MOFCOM also carried out a detailed study of the barriers to entry in the yarn clearer market. The result shows that there are significant entry barriers to new entrants due to the existing IP rights, importance of the economies of scale, and customer recognition.  MOFCOM specifically notes that there has been no successful new entrant for the past three years. 

Remedies. In light of the above, MOFCOM was of the view that the transaction is likely to restrict or exclude competition in the yarn clearer market. In order to counter these anticipated anti-competitive effects, MOFCOM imposed the following four conditions on Alpha V:

(1) Alpha V shall divest its shares in Uster to an independent party within 6 months upon MOFCOM's approval of the transaction;

(2) Alpha V shall notify MOFCOM of the transferee of the shares of Uster, the transaction amount, and the estimated closing date of the transaction, to make sure such transfer would not raise any new competition concerns;

(3) Alpha V shall not participate in or influence Uster's operations and management before completion of the divesture process; and

(4) Alpha V shall entrust a monitoring trustee to supervise the divestiture.

Comments

This is the first conditional clearance decision MOFCOM issued after the promulgation of the Interim Rules on the Assessment of the Impact of Concentrations on Competition (see our article entitled MOFCOM's New Antitrust Rules Shed Light on Its Competitive Assessment Process).  In line with the Interim Rules, in its competitive assessment process, MOFCOM considered, in particular, market shares, market structure, market entry, and examined both the unilateral effects and coordinated effects that may arise from the transaction.

The most notable issue in this case is MOFCOM's reading of Alpha V's potential influence in Uster's operations through its minority interest. It appears to be the major reason underlying MOFCOM's concern over this Transaction and MOFCOM appears to consider that this concern can only be properly addressed by divestiture of Alpha V's entire interest in Uster.  The fact that the relevant market is a highly concentrated oligopoly market may partly explain MOFCOM's approach. The takeaway for funds with portfolio companies is that even if they believe they do not have control over portfolio companies in which they only hold a minority interest, MOFCOM may think otherwise.    

It is also interesting to note that MOFCOM did not specify whether the geographic market in this case is worldwide or China-wide. In practice, MOFCOM would look into both the global market and China market, and would require the parties to provide the market data of both.

 
According to the announcement, during the review process, MOFCOM sought opinions from the following third parties: government agencies, trade associations, competitors, downstream undertakings and industry experts.

For a more detailed analysis of MOFCOM's decision, please see our article entitled MOFCOM's 8th Conditional Clearance – Alpha V/Savio Deal.
 

¹A copy of MOFCOM's Announcement [2011] No. 73 could be found here (in Chinese):  http://fldj.mofcom.gov.cn/aarticle/zcfb/201111/20111107809156.html.

1. Scope of Offshore RMB

The Offshore RMB mainly includes (1) RMB legally acquired by foreign investors through settlement of international trade; (2) RMB remitted outbound which acquired through  profit distribution, equity transfer, reduction of registered capital, liquidation or early return of investment in mainland China and (3) RMB legally acquired or raised through issuing RMB bonds or stocks outbound and other legal channels.

2. The Industries the Offshore RMB Can Be Invested in

The Circular provides that Offshore RMB investment shall comply with foreign direct investment rules in China, and it also provides some exceptions for Outbound RMB investment, such as the securities or financial derivatives in mainland China. In addition, the Outbound RMB can not be invested in entrustment (inter-company) loans.

3. Investment Approval Procedure

Generally, the approval authorities are unchanged. The commerce departments at all levels are responsible for examination and approval of offshore RMB direct investment review. The provincial authorities must submit with MOFCOM for review before approving of investment under the circumstances that: (1)investment amounts to RMB300 million Yuan or above or investment  in financing guarantees; (2) investment in foreign invested investment companies ; and (3) investment in sectors that are subject to macro-economic control of the State, such as sectors as cement, steel and iron. MOFCOM will gradually simplify the procedures concerned based on the practice of cross-border RMB direct investment.

It can be inferred that Offshore RMB can be used to invest in a foreign invested investment company (e.g. a PE firm) in China.  However, in addition to the usual approval procedures for all foreign investments, it is also subject to MOFCOM approval (as described above). The prolonged approval procedure may cause more uncertainties.

1. 境外人民币的范围

境外人民币主要包括：（1）通过跨境贸易人民币结算取得的人民币；（2）汇出境外的人民币利润和转股、减资、清算、先行回收投资所得人民币；（3）在境外通过发行人民币债券、人民币股票以及其他合法渠道取得的人民币。

2. 境外人民币投资流向

《通知》规定境外人民币直接投资应符合现行外商投资管理体制，并且规定了一些禁止投资的行业，例如跨境人民币直接投资在中国境内不得直接或间接用于投资有价证券和金融衍生品，以及用于委托贷款。

3. 境外人民币投资许可

《通知》总体上没有改变现有外商直接投资的审批权限，由各级商务主管部门按照现行外商投资审批管理规定审批跨境人民币直接投资。对于（1）3亿及3亿以上投资项目以及融资担保；（2）外商投资性公司；（3）宏观调控行业等项目，省级商务主管部门需报商务部审核同意后予以批准，商务部将根据跨境人民币直接投资的实践情况逐步简化有关程序。
从上面可以看出，境外人民币可以投向外商投资的投资性公司或私募公司，但除了通常的外商投资审批程序，投资还要经商务部进行批准，这无疑对投资过程造成更多不确定性。

As of August 2011, the Anti-Monopoly Bureau of MOFCOM has received 142 merger control filings, among which 118 were officially accepted and only 1 was approved with conditions (see our article entitled The Russian Potash Deal - first conditional clearance of 2011). It was expected that more than 200 mergers will be reviewed in 2011.

Comment

The number of merger control notifications has been steadily rising since the Anti-monopoly Law is enacted in August 2008.  One of the major reasons for the increase is that more and more companies doing business in China are becoming aware of the merger control regime in China and start to acknowledge the potential influence of MOFCOM in international commercial transactions. 
 

MOFCOM has been preparing these rules for quite a while.  The draft of the Rules on Mergers Below Thresholds has been published by MOFCOM on 6 February 2009 for comments; and the draft of Rules on Violation of Notification Obligations was published for comments on 13 June 2011 (see our article entitled "MOFCOM publishes draft rules on investigation procedures re failure to notify on concentrations").  One thing in common for the three new rules is that they all involve different kinds of "sanctions" to be imposed on the operators.  Compare with the rules dealing with technical or procedural issues, the three new rules seem to be much more sensitive.  This may be one of the reasons why it took longer for MOFCOM to finalize these rules. 

It is expected that the three new rules may provide guidance as to:

• how MOFCOM would choose between structural and behavioral conditions;
   
• how MOFCOM would treat a concentration that does not reach the notification thresholds but has or may have the effect of eliminating or restricting competition;
   
• whether and how MOFCOM would impose sanctions on a concentration that does not reach the notification thresholds but has or may have the effect of eliminating or restricting competition;
   
• what conducts would constitute pre-mature implementation of a concentration;
   
• how MOFCOM would impose sanctions on operators for violation of notification obligations.

Noticeably, the Rules have the following major breakthroughs/new features:

1.The Rules outlined the basic methodology MOFCOM applies in assessing competitive effects of a concentration. 

According to Article 4 of the Rules, in its competitive analysis, MOFCOM will first evaluate whether a concentration will create or strengthen the capability, incentive and likelihood for a single operator to unilaterally exclude or restrict competition, or for relevant operators to jointly exclude or restrict competition if there are only a limited number of operators in the relevant market.  Where the operators are not actual or potential competitors in the same relevant market, MOFCOM will focus on whether the concentration is likely to exclude or restrict competition in the upstream/downstream market or adjacent market.

Comment

MOFCOM did not use such terms as "unilateral effects/coordinated effects" (as in the U.S.) or "non-coordinated effects/coordinated effects" (as in the E.U.) in the Rules.  Neither did it explicitly refer to "foreclosure effect" (likely caused by a vertical merger) or "portfolio effect" (likely caused by a conglomerate merger).  However, it appears, both from the Rules and its own practices, that MOFCOM adopts essentially the same methodologies as its counterparts in major foreign antitrust jurisdictions. 

For example, in the Coca Cola/Huiyuan case, the only deal prohibited by MOFCOM thus far, it appears that MOFCOM relied on the "portfolio effect" theory in finding that "Coca Cola is capable of leveraging its dominance in the carbonated soft drinks market to the juice beverage market".² In the Mitsubishi Rayon/Lucite case, MOFCOM appears to have relied on the "foreclosure effect" theory in establishing that since post-merger, Mitsubishi Rayon will achieve dominance in the Methylmethacrylate ("MMA") market, Mitsubishi Rayon "is capable of foreclosing the downstream operators" of the supply of MMA.³

2 .The Rules outlined the elements that are relevant for assessment of whether the merging parties have "market control power".

Article 5 of the Rules explicitly listed 7 factors that are relevant for assessing the merging parties’ market control power, such as merging parties' market shares, substitutability of the their products or services, their ability to control the sales market or the procurement market for raw materials, production capability of non-merging parties, and purchasing power of the merging parties’ downstream customers.

Comment

In determining if the merging parties have market control power, the Rules copied a number of factors from Article 18 of the AML, which are relevant for determining dominant market position of a business operator.  Nevertheless, we understand that it would require a lower threshold to establish "market control power" than "dominant market position".

3 .The Rules confirmed that market concentration level can generally be measured by the Herfindahl-Hirschman Index ("HHI") and the Concentration Ratio Index ("CRn").

Under Article 6 of the Rules, HHI is defined as the sum of the squares of the market shares of individual operators in a relevant market; CRn is defined as the sum of market shares of the leading N operators in a relevant market. 

The Rules further set out the basic rule for assessment of competitive effects by the concentration levels, namely the higher the concentration level of a relevant market and the higher the increase of the concentration level post-merger, the more likely a merger will have anti-competitive effects.

Comment

Both the HHI and CRn are economic concepts that are widely accepted by major antitrust jurisdictions in determining the level of concentration in a relevant market.  MOFCOM itself had applied the HHI in the Pfizer/Wyeth case.  In this case, MOFCOM found that post-merger, the HHI of the relevant market (the PRC market for swine mycoplasma hyopneumoniae vaccines) will reach 2182 with a delta of 336.  On this basis, MOFCOM reached the conclusion that the relevant market is highly concentrated, which contributed to its finding that this particular deal is likely to have anti-competitive effects.⁴

It appears that MOFCOM is willing to rely more on these economic tools in determining the concentration levels in its merger review process.  However, unlike the practice in U.S. and E.U. where the post-merger level of the HHI and the increase in the HHI resulting from a transaction can be a direct indicator of whether a transaction will likely have adverse competitive effect, the Rules did not provide a scale of measurement for any competitive assessment by HHI or CRn. 

The Rules have also explicitly identified (without furnishing any details though) public interests, economic efficiency, bankruptcy defense and countervailing buyer power as additional factors that MOFCOM will weigh in during its review process.

Understandably, although having drawn upon its three years of practice, the Rules are still lacking in details.  Nevertheless, it demonstrates the efforts of MOFCOM to be in line with its more experienced foreign antitrust counterparts and to further improve transparency of its decision-making process.  It will be interesting to see how MOFCOM applies and further develops the Rules in its future practice.

1 Under Article 27 of the AML, factors to be considered when assessing the competitive effects of a concentration include (i) market shares and market control power of the merging parties in the relevant market; (ii) concentration levels of the relevant market; (iii) impact of the concentration on market entry and technological development; (iv) impact of the concentration on consumers and other relevant operators; (v) impact of the concentration on national economic development; and (vi) other factors that should be considered.

2 See MOFCOM’s decision in the Coca Cola/Huiyuan case at http://fldj.mofcom.gov.cn/aarticle/ztxx/200903/20090306108494.html (in Chinese). 

3 See MOFCOM’s decision in the Mitsubishi Rayon/Lucite case at http://fldj.mofcom.gov.cn/aarticle/ztxx/200904/20090406198805.html (in Chinese).

4 See MOFCOM’s decision in the Pfizer/Wyeth case at http://fldj.mofcom.gov.cn/aarticle/ztxx/200909/20090906541443.html (in Chinese).

This change shows that the authority would take a rather strict approach in the enforcement of the NSR regime.  It is fair to say that it would be very hard for foreign companies to try to circumvent the NSR process by designing complex transaction structures, including by means of variable interest entities (VIEs).  It is expected that the NSR Rules will have a far-reaching effect on the landscape for foreign mergers and acquisitions in China.

Furthermore, during the foreign investment approval process, the local commerce departments (local counterparts of MOFCOM) are charged with the responsibility to screen transactions that are subject to the NSR regime yet are not voluntarily filed.  According to the Notice on Establishing National Security Review Mechanism for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors issued by the State Council (NSR Notice), MOFCOM has the sole discretion in determining whether a transaction is subject to the NSR process.  As far as we know, a list of sectors that are subject to the NSR process has been circulated to local commerce departments.  Although the list is not publicly available, the scope of industries included therein is said to be broader than expected.  In practice, we have encountered cases where local commerce departments require the foreign investors to file for national security review if the industry involved in the transaction has some bearing on the listed industries (see our article entitled Local commerce administrative agencies and the national security review process). 

Other than being requested to make a filing by local commerce departments during the foreign investment approval process, relevant ministries of the State Council, nationwide industry associations, enterprises in the same industry (in relation to the proposed transaction) and enterprises in the upstream or downstream industries (in relation to the proposed transaction) can also trigger the NSR process by proposing such to the ministerial joint committee (Joint Committee) through MOFCOM.  It is reasonable to expect that competitors who feel threatened by a transaction where NSR may be applicable may wish to trigger the NSR process if the parties have not done so.  Therefore, it is particularly important for parties involved in high-profile or controversial transactions that potentially fall under the NSR regime to carefully examine the implications of the NSR Rules on their transactions to avoid any future surprises or potential delays.

Once MOFCOM officially accepts an application, the proposed transaction would face a compulsory waiting period of 15 working days, during which MOFCOM will determine whether the transaction falls under the purview of the NSR regime and therefore should be passed onto the Joint Committee.

If the proposed transaction is deemed by MOFCOM to be within the scope for national security review, the investor should expect another 30 to 90 working days (30 working days of general review period plus a possible 60 working days of special review period) to obtain the final decision of the Joint Committee. 

The procedural framework of the NSR process is very close to that of the merger control process under the Anti-monopoly Law (AML).  Based on our experiences in handling AML filings, nowadays a greater portion of the AML filings enter Phase II (equivalent to the special review period in the NSR process).  It is yet to be found out whether it would be the same case in the NSR process. 

Since there is no requirement under China's NSR rules for publication of NSR decisions, it is not entirely clear how many NSR filings MOFCOM has accepted thus far and whether MOFCOM has approved (or disapproved) a transaction under the NSR regime.  As part of the government approval procedures for foreign investment in China, the impact of the NSR process on inbound M&As is hard to be neglected.  Foreign investors should always keep the NSR process in mind, plan ahead, and put in place a well-thought-out strategy.
 

Background

The Anti-Monopoly Commission (AMC) is the advisory and policy arm amongst the list of agencies enforcing and implementing the Anti-Monopoly Law (AML).  Specifically, the AMC is responsible for organizing, coordinating, and providing guidance for implementing the AML (see Article 9, AML).  Functions of the AMC include drafting competition policies, formulating and issuing anti-monopoly guidelines and coordinating anti-monopoly administrative enforcement matters.

The AMC was established in 2008 with the enactment of the AML.  It consists of officials from the State Council and other government agencies.  Currently, the officials who serve on the AMC include:

(1) Director: Vice-Premier of the State Council;
(2) Vice-Directors:
a. Minister of MOFCOM;
b. Director of the National Development and Reform Commission ("NDRC");
c. Director of the State Administration for Industry and Commerce ("SAIC");
d. Vice-Secretary-General of the State Council.
(3) Commissioners:
a. Vice-Minister of MOFCOM;
b. Vice-Director of the NDRC;
c. Vice-Director of SAIC;
d. Vice-Minister of the Ministry of Industry and Information Technology;
e. Vice-Minister of the Ministry of Supervision;
f. Vice-Minister of the Ministry of Finance;
g. Vice-Minister of the Ministry of Transport;
h. Deputy Director-General of the State-owned Assets Supervision and Administration Commission;
i. Vice-Director of the State Intellectual Property Office;
j. Vice-Director of the Legislative Affairs Office of the State Council;
k. Vice-President of the China Banking Regulatory Commission;
l. Vice-President of the China Securities Regulatory Commission;
m. Vice-President of the China Insurance Regulatory Commission;
n. Vice-President of the State Electricity Regulatory Commission.
 

Article 48 of the AML prohibits business operators from implementing notifiable concentrations, without first seeking clearance from MOFCOM.  Failure to notify MOFCOM of notifiable concentrations could result in the following sanctions: (a) an order to cease implementing the concentration; (b) an order to dispose the shares or assets within a stipulated period; (c)an order to transfer the (relevant) business within a stipulated period; (d) an order to adopt other necessary measures to reinstate the market situation before the concentration; or (e) a fine of not more than RMB500,000. 

On 13 June 2011, the Ministry of Commerce (MOFCOM) published draft rules which outline the investigation procedure, should business operators fail to notify MOFCOM of notifiable concentrations.  These draft rules are entitled "Provisional Measures on Investigating and Penalizing Violation of Notification Obligations for Concentrations between Business Operators" (Draft Rules).  MOFCOM is currently consulting on these Draft Rules; the public has 10 days to submit comments (i.e. by 23 June 2011). 

The following outlines are the salient provisions as set out in the Draft Rules:

• MOFCOM may investigate and impose remedies on notifiable concentrations which have not been reported to MOFCOM (notification obligation).
• A violation of this notification obligation means that business operators have implemented a notifiable concentration,without first notifying MOFCOM of this concentration. 
• MOFCOM may, by itself, investigate into notifiable concentrations which have not been reported.  Third parties may also report a suspected violation of the notification obligation to trigger an investigation (MOFCOM will keep the identifies of these third parties confidential).
• Business operators will be notified in writing when MOFCOM decides to commence an investigation into their transactions. Upon receipt of this written notice, business operators must submit relevant materials and documents within 15 days afterreceipt of the notice.  Relevant materials and documents include information to do with whether the transaction in question amounts to a concentration; whether the transaction triggers the notification thresholds pursuant to the AML; and whether the transaction has been implemented.
• If MOFCOM is of the view that business operators have violated the notification obligation and wishes to conduct a further investigation, MOFCOM will once again inform the business operators in writing.  MOFCOM will then commence a further investigation to determine whether the concentration has or may have the effect of restricting or eliminating competition.  Business operators subject to this further investigation must submit relevant materials and documents within 30 days after receipt of the written notice as described above.
• During the investigation process, MOFCOM may consult with stakeholders such as other government departments, trade associations and other business operators and individuals as required.
• During the investigation process, MOFCOM will possess full investigative powers (including carry out inspections at the premises of the business operators; compelling information from business operators and making copies of relevant documents) pursuant to Article 39 of the AML.

Comments

The Draft Rules are useful as they provide some clarity as to what happens if a business operator is being investigated for a failure to notify MOFCOM of a notifiable concentration.  It would be useful, though, if MOFCOM could clarify the following:

• We note that business operators could be found in breach of the notification obligation if they have "implemented" a notifiable concentration.  However the term "implement" has not been defined in the Draft Rules.  It would be useful to obtain some clarity about what this term means.  If this term is construed broadly, certain preparatory work (i.e. preparation for a concentration) might be construed as implementing a concentration.  On the other hand a narrow interpretation of this term would point to "closing" a concentration;
• In relation to a situation where a notifiable concentration is subject to a further investigation, pursuant to the Draft Rules, whether there would be a maximum statutory period in which MOFCOM would complete its review process; and
• the Draft Rules contain a provision which sets out the remedies which a business operator may face for a failure to notify MOFCOM of a notifiable concentration.  This provision states "MOFCOM shall order business operators to cease implementing the concentration; dispose shares or assets within a stipulated period; transfer the (relevant) business within a stipulated period; or reinstate the market situation before the concentration.  MOFCOM may also impose a fine of not more than RMB500,000."  This provision is a mirror of Article 48 of the AML, save for the term "shall" which has been omitted from Article 48 of the AML.  It is unclear as to the significance of the addition of this term "shall".  One view is that the addition of the term "shall" shows a stronger compulsion by MOFCOM to impose the above mentioned remedies.  It would be useful if MOFCOM could clarify the addition of the term "shall".

Overall, the publication of these Draft Rules shows MOFCOM's commitment to stepping up enforcement in relation to a failureto notify notifiable concentrations.  Business operators should be aware that a failure to seek antitrust clearance for notifiable concentrations could at best result in a delay in timetable in relation to their transactions (vis-à-vis MOFCOM investigating into the transaction); and at worst result in the sanctions as outlined above being imposed on them.
 

¹ Pursuant to Article 3 of the Provisions of State Council on Declaration Threshold for Concentration of Business Operators, where a concentration reaches the following turnover thresholds, the concentration must be cleared (from an antitrust law perspective) by MOFCOM: (a) during the previous fiscal year, the total global turnover of all business operators participating in the concentration exceeded RMB10 billion and at least two of these business operators each had a turnover of more than RMB400 million within China; or (b) during the previous fiscal year, the total turnover within China of all the business operators participating in the concentration exceeded RMB 2 billion and at least two of these business operators each had a turnover of more than RMB400 million within China.

Other than the main issues listed above, the Draft Rules also indicate that MOFCOM would take into account: (a) how upstream and downstream industries will be affected by proposed concentrations; (b) the extent to which the creation of strengthening of a single operator would eliminate or restrict competition; or when the concentration involves a handful of operators whether the creation or strengthening of the relevant operators would eliminate or restrict competition; and (c) where the operators participating in the concentration do not belong to the same relevant market, whether adjacent markets would be affected.

Comments

These Draft Rules are useful as they shed more light in relation to how MOFCOM will assess concentrations.  The provisions in the Draft Rules appear to be deliberately broad - so that MOFCOM would have flexibility to analyse each concentration based on the merits or facts of each case.  It would be useful if MOFCOM could explain in greater detail, what HHI thresholds, for instance, would deem a market as concentrated or not concentrated.  In addition, it would be useful to know the extent to which "failing firm" factors would be taken into account (including what is deemed to be a firm on the "brink of bankruptcy") – in terms of evaluating a concentration – both substance wise and procedurally.

According to Mr. Shang, from 1 August 2008 (when the Anti-Monopoly Law was enacted) till the end of May 2011, the Anti-Monopoly Bureau of MOFCOM cleared 240 merger control filings, among which 233 (97%) were approved without conditions, 1 rejected, and 6 were approved with conditions.  [Note: On 2 June 2011, MOFCOM announced that a transaction between two Russian potash producers was cleared with conditions, bringing the conditional clearance figure from 6 to 7 (see our article entitled The Russian Potash Deal - first conditional clearance of 2011)].

During the Symposium, Mr Shang also said that amongst these 240 cases, 119 cases (about 50%) were cleared before or by the end of the Phase I review period (30 calendar days); and 117 cases (about 49%) were cleared before or by the end of the Phase II review period (90 calendar days).  Only 4 cases entered the extended Phase II review period (which spans for a maximum of an additional 60 calendar days).

Some Historic Data

• By the end of June 2009, MOFCOM accepted 58 merger control filings, among which 46 were closed without conditions, 2 closed with conditions and 1 prohibited.
• By the end of June 2010, MOFCOM accepted about 150 merger control filings, among which 120 were closed without conditions, 5 closed with conditions and 1 prohibited.
   

1. Initiation of national security review

Pursuant  to the Notice on Establishing National Security Review Mechanism for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors released by the State Council (Notice), a national security review process may be triggered either upon voluntary request by the foreign investor involved or upon request by third parties.
 

• Voluntary application by participants of proposed transactions
  
  The Interim Rules provide that if the merger and acquisition by foreign investors of domestic enterprises which clearly fall under the national security review scope provided by the Notice, the foreign investor(s) (Applicant) should file the application for national security review at MOFCOM. If the merger and acquisition of domestic enterprises is conducted by more than two foreign investors, they can jointly file the application or select one of them to file the application. [Note: From the way this provision is phrased in the Interim Rules, it would appear that the authorities would prefer to be notified by the foreign participants of the merger or acquisition, should these participants feel that their proposed transactions could fall under the purview of the national security review regime.]
  
  The Applicant should submit relevant documents requested by MOFCOM (to be discussed in section 2).  After MOFCOM deems the application documents as complete and fulfills legal requirements, it will notify the Applicant that the application has been officially accepted in writing.
  
  After receiving "official acceptance", the Applicant is obliged to put the transaction on hold for 15 working days during which MOFCOM will determine whether the transaction should come under review pursuant to the national security review process.  If so, MOFCOM will notify the Applicant and also notify the ministerial joint committee (Joint Committee) within 5 working days. If MOFCOM did not notify the Applicant after 15 working days, the applicant may proceed to implement the transaction.
  
  The Interim Rules also provide that the Applicant can apply to conduct pre-filing consultation with MOFCOM about procedural issues before officially filing the national security review application.

• Application by third parties
  
  The review process may also be triggered by third party filings to the Joint Committee through MOFCOM.
  
  Pursuant to the Notice, third parties could include: relevant ministries of the State Council, nationwide industry associations, enterprises in the same industry (in relation to the proposed transaction) and enterprises in the upstream or downstream industries (in relation to the proposed transaction). These third parties should submit basic information to do with the transaction and details to do with how the proposed transaction may impact on national security. If MOFCOM is of the view that it is appropriate to conduct a national security review in relation to the proposed transaction, then MOFCOM will submit an application to Joint Committee within 5 working days.  The Joint Committee will then decide whether to commence a national security review process. MOFCOM will also request the foreign investor to apply for national security review if the Joint Committee deems necessary.

2. Required documents

Applicant(s) will be required to provide the following documents when filing the application for national security review:

(1) Application report

• an application report and a description of the transaction.  These documents must be executed by the legal representative or fully authorized representative of the applicant;

(2) Identification documents of the foreign investor(s):

• a notarized and certified foreign investor identification document or relevant incorporation certificates, bank reference letter etc; and
• identification documents of the legal representative, or power of attorney of the foreign investor, identification documents of the authorized representative;

(3) Background information of the foreign investor

• the introduction of the foreign investor and its affiliates (such as its actual controlling party and parties acting in concert); and
•  the statement regarding its relationship with the relevant governments;

(4) Background information of the domestic enterprise

• the introduction of the target domestic enterprise; and its
• articles of association;
• business license (copy);
• audited financial statements of the preceding year;
•  organizational chart of the company before and after the transaction;
• introduction of its subsidiaries and relevant business licenses (copy);

(5) Post-transaction documents

• shareholders' agreement of the foreign invested enterprise to be established after the M&A transaction; and its
• articles of association;
• joint venture contract or partnership agreement;
• a list of proposed senior executives(including directors, general managers or partners) to be appointed by the parties;

(6) Transaction documents for equity acquisitions (if applicable)

• share transfer agreement or subscription agreement;
• relevant shareholder resolution of the target domestic enterprise; and
• relevant asset assessment report;

(7) Transaction documents for asset acquisition (if applicable)

• the resolution issued by the competent asset owner approving the asset sale;
• asset purchase agreement (including list and introduction of the target assets);
• information to do with the relevant parties; and
• relevant asset assessment report;

(8) Introduction of control

• a description of the impact after completion of the foreign investor's voting power over the shareholders' meeting, board resolutions or partners' executive affairs;
• a description of condition that causes foreign investors to obtain actual control over management strategy, financial, employment and technology issues of domestic enterprise; and
• other relevant documents;

(9) Other documents requested by MOFCOM

3. Review decisions

The Notice did not list the types of the Joint Committee's review decisions. The Interim Rules categorized the review decisions into 3 types:
 

• No impact on national security
  
  If the Joint Committee decides that the transaction will not impact national security, the applicant can go ahead, and apply for foreign investors M&A review and other M&A approvals according to various foreign investment regulations;
   
• Potential impact on national security
  
  If the Joint Committee decides that the transaction may impact national security. The applicant can not apply for foreign investors M&A review or other M&A approvals, and shall put the implementation on hold. The applicant may amend the transaction plan, revise the application documents and re-submit the security review application; and
   
• Actual or potential severe impact on national security
  
  If the Joint Committee decides that the transaction has already impacted or may impact national security severely, the transaction will be prohibited. Measures will be taken to eliminate the impact on national security caused by the transaction. The measures include transfer of shares or assets.

Within 5 working days after receiving the Joint Committee's written decision, MOFCOM will notice the applicant about the decision in writing.

Comments

The Interim Rules sets out in detail how MOFCOM will deal with national security review applications.  We note that these Interim Rules are only valid for approximately 5 months – this is a signal that MOFCOM and the other authorities will "test" this system and procedure during this period and may adjust the procedure afterwards.  We also note that MOFCOM has announced that it is seeking the publics' suggestions and comments until April 10 2011, and may revise the Interim Rules after the expiration.

Besides, the Interim Rules clearly provide that if the local commerce administrative agencies notice that a M&A transaction clearly belongs to the national security review scope during the foreign invested enterprise M&A review procedure, the local commerce administrative agencies shall suspend the review procedure, request the foreign investor(s) to file national security review with MOFCOM, and report to MOFCOM about the situation. This reporting mechanism will help MOFCOM to better supervise the transactions which are not voluntarily filed by foreign investor.

¹See our article entitled "National Security Review Mechanism Formally Established in China".

In China, pre-merger notification is required when the entities participating in the merger possess a certain amount of turnover. Specifically, pre-merger notification is mandatory when, during the previous fiscal year:

a the total global turnover of all business operators participating in the concentration exceeded 10 billion renminbi, and at least two of these business operators each had a turnover of more than 400 million renminbi within China; or

b the total turnover within China of all the business operators exceeded 2 billion renminbi, and at least two of these operators each had a turnover of more than 400 million renminbi within China.

The Anti-Monopoly Law (AML) is the primary antitrust legislation which governs merger control. Since the AML was enacted in August 2008, a number of regulations and guidelines relating to  mergers, have been promulgated. The regulations and guidelines listed below, came into effect in 2009:

a Market Definition Guidelines issued by the Anti-Monopoly Commission of the State Council (effective on 1 January 2009);

b Rules for Calculating Turnover concerning Concentration Notification of Financial Operators (effective on 15 July 2009);

c Working Guidance for Anti-Monopoly Review on Concentration of Business Operators (effective on 5 January 2009);^[1]

d Guidance on the Documentation of the Notification of Concentration of Business Operators (5 January 2009); ^[2]

e Measures for the Undertaking Concentration Declaration (released on 21 November 2009, effective on 1 January 2010); and^[3]

f Measures for Examination of Concentration of Business of Operators (released on 24 November 2009, effective on 1 January 2010).^[4]

II YEAR IN REVIEW

In 2009, we understand that Mofcom received approximately 87 merger review filings. In the same year, we understand that Mofcom made decisions on 67 of the filings. Among these 67 decisions, 62 mergers were approved without conditions; four mergers had conditions imposed; and one merger was not cleared.

As can be seen from above, the vast majority of merger filings were cleared without conditions. The four mergers that were approved with conditions along with the merger that was not approved have sparked considerable discussion and interest. The following are brief descriptions of these five merger cases.

i Merger that was not approved

The merger which was not approved was Coca-Cola Company’s (Coke) proposed acquisition of China Huiyuan Juice Group Limited (Huiyuan). In this case, Huiyuan’s market share in the Chinese juice market was 10.3 per cent. Coke’s market share in the same market was 9.7 per cent. Therefore, post-acquisition, the merged entity’s market share would be just under 20 per cent. Due to this relatively low combined market share figure, commentators therefore assumed that the proposed-acquisition would be cleared smoothly. However, Mofcom did not approve of the proposed acquisition. The main reason cited was because Mofcom was of the view that Coke would have the ability to leverage its dominant position in the carbonated soft drink market into the juice market.

According to Mofcom, this leveraging would have the effect of restricting or eliminating competition from other juice supply entities, and would eventually harm the interests of beverage consumers.

ii Mergers that were approved with conditions.

The following four mergers were approved with conditions:

Acquisition of Lucite International Group Limited (Lucite) by Mitsubishi Rayon Co., Ltd. (Mitsubishi)

Mitsubishi is a leading manufacturer of monomers and polymers, based on methyl methacrylate (MMA) and acrylonitrile (AN) complexes. Lucite is the world’s leading supplier of MMA, accounting for approximately 24 per cent of the global acrylic monomer market. The merged entity, Mitsubishi Rayon possessed approximately 64 per cent of the MMA market in China. Mofcom imposed a variety of conditions on this acquisition, including a partial divestiture of the MMA output of Lucite China and restrictions on expansion in China in respect of the merged entity over the next five years.

Acquisition of Delphi Corp (Delphi) by General Motors Company (GM)

Delphi is a supplier of automobile components. General Motors is a vehicle or automobile manufacturer. This was an acquisition between two vertical entities. The conditions stipulated by Mofcom were behavioural conditions. For instance, Mofcom stipulated that after the acquisition was completed, both Delphi and GM must guarantee that Delphi and its controlling affiliates shall continue to supply products to Chinese vehicle manufacturers without any discrimination. These behavioural conditions are aimed at eliminating and mitigating anti-competitive adverse effects on other entities in the automobile components and vehicle or automobile manufacturing markets in China.

Acquisition of Wyeth Corp (Wyeth) by Pfizer Inc (Pfizer)

Both Pfizer Inc and Wyeth Corp supply a range of pharmaceutical products in the human health and animal health sector. Mofcom stipulated that Pfizer had to divest its swine mycoplasma pneumonia vaccine business in China.

Acquisition of SANYO Electric (Sanyo) by Panasonic Corporation (Panasonic)

Panasonic and Sanyo are Japanese conglomerates with diversified businesses and operations worldwide. Mofcom identified competition issues in three specific product markets: (1) rechargeable coin-shape lithium batteries; (2) nickel-metal hydride batteries for daily use; and (3) nickel-metal hydride batteries for vehicle use. Both Sanyo and Panasonic were required to divest their businesses (to different extents) in respect of the categories in (1) to (3).

The merger control decisions listed above show that Mofcom is a very active competition authority and would not hesitate to impose conditions (structural or behavioural conditions, or both) or to deny clearance to a merger, when the need arises. Companies who wish to merge or acquire in China should therefore should plan ahead and put in place a well-thought-out merger control strategy.

In practice, we note that Mofcom consults widely with the relevant stakeholders in respect of each merger filing. Relevant stakeholders could include other government authorities, industry associations, competitors and entities in the upstream and downstream industries. We understand that Mofcom undertakes these consultations by questionnaire, by way of phone interviews and sometimes even through visiting and interviewing these stakeholders face-to-face.

III THE MERGER CONTROL REGIME

i Waiting periods and time frames

There are broadly two review phases in which a merger filing would have to go through with Mofcom. First, there is a pre-acceptance phase. Second, there is a formal review phase.

Pre-acceptance phase

When entities submit a merger filing or notification to Mofcom, a ‘pre-acceptance’ case handler within Mofcom would determine if Mofcom is able to formally accept the filing. This case handler would review the filing for completeness and may also seek clarifications or ask for more details in respect of the filing, if certain aspects of the filing are unclear or need to be supplemented. From our experience, this pre-acceptance period generally takes between two and six weeks. I n other cases (for instance in the Coke/Huiyuan and Mitsubishi/Lucite cases) this phase may even ‘stretch’ to two or three months. We understand that during this pre-acceptance phase, the entities listed above were repeatedly asked by Mofcom to submit supplementary information in respect of their filings.

Formal review phase

Pursuant to the AML, there are two phases within the formal review phase: Phase 1, the preliminary review period and Phase 2, the further review period. Phase 1 is known as the preliminary review period and lasts 30 calendar days. During this phase, Mofcom will attempt to review the merger filing and make a decision as to whether the filing should be cleared. If merging entities do not hear from Mofcom upon the expiry of these 3 0 days, then the merger or acquisition is by default cleared or approved.

Phase 2 is known as the further review period and lasts 90 calendar days. I f Mofcom has made a decision that a merger filing warrants further review, Mofcom will inform the parties (in writing) before or by the expiry of Phase 1 that the review period is extended into Phase 2.

Furthermore, Mofcom may extend the Phase 2 period by another 60 calendar days at the most, provided that:

a the applicant agrees to extend the time limit for the review;

b the documents submitted by the applicant are inaccurate and require further verification; or

c the circumstances surrounding the filing have significantly changed after notification by the applicant.

It is important to note that if Mofcom fails to make a decision upon the expiry of each set period of time as stated above, the parties may execute the transaction.

The following table summarises the various waiting periods as described above and possible outcomes of the review (i.e., approved, approved with conditions or prohibited).

ii Parties’ ability to accelerate the review procedure

Most mergers are time-sensitive. Most merging entities generally wish for the merger review period and procedures to be as swift as possible. I n order to assist Mofcom in clearing merger filings smoothly and efficiently, we would recommend the following approach: first, articulate why your merger is time-sensitive (e.g., is one entity a failing firm?); second, ensure that your merger filing report is complete (according to the Mofcom requirements) and accurate; and third, if Mofcom asks any supplementary questions or asks for clarifications, respond to these further questions swiftly.

iii Third-party access to the file and rights to challenge mergers

Third parties do not possess a statutory right to access merger control files, nor do they possess a statutory right to challenge mergers in the process of review. However, in its review process, Mofcom may seek opinions from third parties (including government agencies, industry associations and other entities) in respect of the proposed acquisition and third parties may voice their opinions through these consultations.

In addition, pursuant to Articles 7 and 8 of Mofcom’s Draft Measures for Inspecting Concentration of Business Operators, third parties may be involved in the merger control review process if Mofcom decides to conduct hearings. Participants in these hearings may include: entities involved in the filing; competitors; representatives of upstream and downstream entities (and other related entities); experts; representatives of industry associations; representatives of relevant government authorities; and consumers. Third parties may therefore express their opinions on the proposed merger or acquisition through these hearings.

iv Resolution of authorities’ competition concerns, appeals and judicial review

Pursuant to Article 29 of the AML, Mofcom has the right to impose conditions in respect of mergers, in order to alleviate the negative impact of a merger on competition. This gives Mofcom wide discretion to impose a variety of conditions, including structural and behavioural conditions or both. Further, pursuant to Article 11 of Mofcom’s Draft Measures for Inspecting Concentration of Business Operators, either the entities involved in the merger or Mofcom may propose conditions.

Pursuant to Article 53 of the AML, entities that are not satisfied with a Mofcom decision in respect of merger control, may seek a review of the decision (i.e., appeal).

We understand that this review process and decision will be undertaken by the Treaty and Law Department of Mofcom.

Entities who are dissatisfied with the decision of the Treaty and Law Department of Mofcom may then seek a further review of the Treaty and Law Department’s decision in the courts (i.e., judicial review).

Entities may only seek a review of Mofcom’s decisions based on an error of law (including because administrative procedures are in violation of the law, administrative discretionary power has been abused or the result of the merger control review is unjust).

v Effect of regulatory review

Mofcom is the sole authority formally in charge of reviewing mergers. Therefore, it is not obligated by law to consult with or seek the opinions of other authorities or regulators.

However, we are aware that Mofcom does consult with other government agencieson certain mergers. For instance, Mofcom may consult with the State Administration of Radio, Film and Television (SARFT) and obtain the SARFT’s opinions in respect of a merger within the broadcasting industry. Such consultation procedures will take time and this is a factor that entities have to consider when submitting a merger filing. Mofcom may consider that such consultations are important and a merger filing may therefore last into Phase 2 if Mofcom is awaiting responses from other government agencies.

IV OTHER STRATEGIC CONSIDERATIONS

i How to coordinate with other jurisdictions

We are not aware of any formal agreements signed between Mofcom and the competition authorities of other jurisdictions in respect of sharing information or otherwise coordinating with each other (in the context of multi-jurisdictional merger filings). We note also that China has not yet joined the International Competition Network.

However, we understand that Mofcom does regularly consult with the competition authorities from the more experienced jurisdictions such as the United States and European Union. The competition authorities from these jurisdictions also conduct capacity building or technical assistance programmes for Mofcom officials.

In practice (in the context of multi-jurisdictional filings), we note that Mofcom will monitor the progress of merger control reviews in other jurisdictions very closely. Mofcom may also ask the entities involved in the proposed merger or acquisition to supply information in respect of their filings in other jurisdictions.

ii How to deal with special situations – financial distress and insolvency, hostile transactions, minority ownership interests, etc.

Financial distress and insolvency

Previously, foreign entities that wished to purchase domestic entities in financial distress or insolvency could apply to Mofcom for an exemption (in respect of notification or review). Despite the fact that there are no statutory exemptions (pursuant to the AML or in related regulations and rules) in respect of acquiring entities in financial distress or insolvency, we are of the view that Mofcom will take this factor into consideration when undertaking the merger review. This is, in particular, in terms of allocating a time-frame for the review.

Hostile transactions

There are no provisions within the AML or in its related regulations or rules that address the manner in which a hostile transaction will be reviewed. We are of the view that under such circumstances, the target entity should nevertheless submit its views to Mofcom for consideration.

Minority ownership interests

There are no provisions within the AML or in its related regulations and rules that address acquiring minority ownership interests. However, the conduct of acquiring minority interests in another entity may also be a notifiable transaction (depending on whether such conduct is construed by Mofcom, as acquiring ‘control’ of the target company).

V OUTLOOK & CONCLUSIONS

i Pending legislation

Currently, the measures listed are in draft form:

a Tentative Measures for Investigation and Handling of Concentration of Business Operators That Are Not Legally Notified (Draft); Cf Article 54(2) of the now-repealed Acquisition of Domestic Enterprises by Foreign Investors Provisions.

b Tentative Measures for Investigation and Handling of Concentration of Business Operators Not Satisfying Notification Thresholds But Involving Alleged Monopoly Acts (Draft); and

c Tentative Measures for Collection of Evidences on Concentration of Business Operators Not Satisfying Notification Thresholds But Involving Alleged Monopoly Acts (Draft).

ii Unresolved issues

In our view, it would be useful for the merger control regime if Mofcom could clarify matters pertaining to the following issues:

a the factors that Mofcom would consider when determining whether a joint venture is a notifiable transaction;

b the factors that Mofcom would consider when determining whether acquiring minority shares in an entity is a notifiable transaction; and

c whether the resale of goods to China should be taken into consideration when considering an entity’s turnover in China.

In addition, it would be helpful if Mofcom could issue public statements (or give a summary of issues considered) in relation to some of the mergers that have been cleared.

This would be helpful in terms of building jurisprudence and increasing transparency in relation to the merger clearance process.

 The following are some salient features of these recently enacted divestiture regulations:

• the objective of the regulations are to ensure that any divestiture or assets or business pursuant to the merger control regime is conducted smoothly (Article1);
• business operators who are required to divest assets pursuant to the merger control regime (known as “divestiture obligors”) would have to divest their assets within a time limit stipulated within a merger control decision by MOFCOM (including finding a purchaser and enter into the relevant sales agreements) (Article 3);
• divestiture obligors may appoint a “supervision trustee” and a “divestiture trustee” to assist in the divestiture process. The former will supervise the divestiture process and the latter would assist with locating a purchaser as well as assist with the actual sale process (Article 4);
• supervision trustees and divestiture trustees must
  • be equipped with the resources and capabilities necessary for conducting trust businesses; and
  •  not possess substantial interests in any of the business operators participating in the merger under scrutiny.

In addition, supervision trustees and divestiture trustees may be the same natural person or legal entity (Article 5); and

• purchasers of divested business must satisfy the following requirements;
  • they must not possess substantial interests in any of the business operators participating in the merger under scrutiny;
  • they must be equipped with the necessary resources and capabilities and must be willing to maintain and develop the business to be divested; and
  •  the purchase of the business to be divested must not result in eliminating or restricting competition (Article 8).

It is timely that MOFCOM has enacted these divestiture regulations. These regulations provide some sort of structure from which business operators can expect to divest their assets pursuant to a merger control decision issued by MOFCOM. In our view, these regulations are consistent with the divestiture regulations in the more experienced antitrust jurisdictions such as the European Union.

In practice, it is important to work closely with MOFCOM when a business has been told to divest pursuant to a merger control decision. Regular consultations with MOFCOM will ensure that the divestiture process goes smoothly. In our experience, it takes approximately 6 months for a business to find a suitable purchaser for the divested business and to reach the relevant agreements for the sale. It is also noteworthy that MOFCOM has stipulated that divested businesses should be transferred to the purchaser within 3 months after the execution of the sales and other agreements, although this time limit may be extended with MOFCOM’s consent.

• From 2008 to June 2010, MOFCOM accepted 140 merger review applications for review. Out of these 140 merger review applications, MOFCOM has completed review of approximately 90% of the cases.
• 95% of these merger reviewed were approved unconditionally. In the European Union (EU) and in the United States (US), on average only 93% of mergers are approved unconditionally.
• Thus far, only 5 mergers have been approved with conditions and only 1 merger was rejected (Coca-Cola’s proposed acquisition of Huiyuan).
• The merger control review process in China is divided into 3 stages. The first stage of review lasts no more than 30 days; the second stage of review spans for a further 30 to 90 days; and the third stage of review spans for a maximum of 60 days after the second stage. The entire merger control review process is not to exceed a total of 180 days.
• Out of all the mergers reviewed, more than half of the mergers were cleared within the first stage; the remainder of the mergers were cleared within the second and third stages.
• Shang Ming noted that the proportion of mergers entering the second stage of review was somewhat higher than that in the US or the EU. Shang Ming commented that at times, merger reviews enter the second stage of review not due to antitrust issues but due to process issues (e.g. MOFCOM undertaking public consultations etc).
• 62% of the merger applications received by MOFCOM are horizontal mergers; 14% of the merger applications received by MOFCOM are vertical mergers; and the remainder of the merger applications received by MOFCOM are conglomerate mergers.(2)
• A majority of the cases reviewed by MOFCOM involved business operators in the manufacturing industry. In addition, three-quarters of mergers accepted for review by MOFCOM involved public listed business operators.
• Shang Ming noted that some commentators believe that Chinese State Owned Enterprises (SOEs) obtain “special treatment” from MOFCOM pursuant to merger clearances. Shang Ming emphasised that this was not the case. All business operators, including SOEs, privately-owned companies and foreign companies are treated equally by MOFCOM.
• MOFCOM has received more merger clearance applications which involve foreign companies (as opposed to merger clearance applications which involve domestic companies only). Shang Ming said that this could be because the “financial strength” of these multinational foreign companies trigger the turnover notification thresholds more easily. In addition, Shang Ming also noted that since the global financial crisis, foreign multinational companies have been quite active acquirers.

It is timely for MOFCOM to conduct a stock-take of the merger control process in China, since its inception in 2008. It is interesting that a significant number of merger applications received by MOFCOM spill into the second stage of review. Shang Ming’s explanation that some of these “second stage review” merger applications do not necessary involve complex antitrust issues, but rather “process” issues, is also interesting.

In light of the above, companies that are interested in mergers or acquisitions that meet the turnover thresholds pursuant to the AML should ensure that they factor in the notification and review periods into their planning processes.

(1) The AML was enacted on 1 August 2008.

(2) The term “conglomerate mergers” refers to mergers involving businesses that operate in different product markets (i.e. they are neither “vertical” nor “horizontal” mergers).

Negative influences on the market due to Coke’s existing dominant position in the carbonated drink market

MOFCOM believed that after the completion of the Transaction, Coca-Cola would have had the ability to leverage its dominant position in the carbonated drink market in the juice drink market.

The ability to leverage is where an operator has a dominant position in a certain market and by taking advantages of its current dominant position, it is also able to obtain a new dominant position in a similar product market through tie-ins or bundle sales, imposing exclusive trading conditions, or other methods.

As Coca-Cola may have a dominant position in the carbonated drink market, MOFCOM believed that after the Transaction, Coca-Cola may (i) tie or bundle in Coca Cola’s juice drinks by utilizing its customers’ preferences in its carbonated drink, or tie its carbonated drink in as a means of promotion when selling juice drink; (ii) by offering discounts or refunds, encourage carbonated drink retailers to purchase a large number of its juice drinks, or limit their purchase and distribution of juice drinks manufactured by other competitors; (iii) increase sales volumes of its juice drink and supplant other juice drink products by taking advantage of its current sales channels, for example, its in-store refrigeration units installed at down-stream retailers.

Dominant market position in a certain market may be leveraged in adjacent or other closely related markets, which has already raised competition concerns by authorities in other jurisdictions. For instance, according to the decision made by the Australia Competition and Consumer Commission (ACCC) of the acquisition of Berri Limited (Berri) by Coco-Cola Amatil Limited’s (CCA) on October 8, 2003, ACCC believed that CCA would have the ability and incentive to leverage its market power in CSD (carbonated soft drinks) to increase distribution of Berri’s FB (chilled and ambient fruit juice and fruit drinks) product to the exclusion of rivals in the non-grocery trade channels.

Coke’s ability to impede market entry by controlling brands

Through review, MOFCOM believed that the brand is a key factor that influences effective competition in the drink market, that is, among other factors which may influence competition, such as capital and technology, the brand is considered one of the most important as opposed to other industries where technology may be more important. New entrants may not successfully gain market share in that it is difficult for them to obtain consumers’ recognition of their brands, even though they own certain technologies, facilities and capital. Coca-Cola may also restrain new market entrants by using its dominant position in the carbonated drink market as well as the leverage effect.

Accordingly, MOFCOM believed that after completion of the Transaction, Coca-Cola would have significantly stronger power to control the juice market by controlling two famous juice brands: “Meizhiyuan” and “Huiyuan”, as well as using its dominant position in the carbonated drink market. Therefore, the Transaction would significantly increase obstacles for potential competitors to enter the juice drink market from the prospective of branding.

The negative influences of the proposed concentration over small and medium operators and for the competition within the industry

MOFCOM believed that the Transaction would reduce survivability of domestic small and medium juice manufacturing enterprises, inhibit the ability of domestic enterprises to compete in the juice drink market, and harm the effective competition structure in the China juice drink market.

MOFCOM may have also believed that in the juice drink market, Coca-Cola and Huiyuan are direct competitors and therefore after the completion of the Transaction, Huiyuan, as an important and competent competitor, will no longer exist, which may lead to an increase of concentration. In addition, after the Transaction, Coca-Cola may soon gain a new dominant position by better utilizing Huiyuan’s current purchasing channels for raw materials, distribution channels of products, manufacturing equipment, market share, brand effects, and other advantages, as well as the leverage effects resulting from its dominant position in the carbonated drink market. Therefore, it could be concluded that the Transaction may negatively impact small and medium operators and may have a bad influence on the competition structure of juice drink industry and its further development.
 

A. Ease of Approving Holding Companies

On March 6th 2009, MOFCOM issued the Notice on Delegating the Approval Authority for Foreign Invested Holding Companies to streamline the establishment of foreign investment holding companies.

 This notice provides:

 1. Proposed holding companies with a registered capital of USD 100,000,000 or less will be examined and approved by the competent MOFCOM counterparts at the provincial or vice-provincial city level. Previously, the establishment of a holding company required MOFCOM level approval regardless of scale.

 2. Any amendments to established holding companies (i.e. such as name change, revisions to business scope) can be approved by MOFCOM provincial level counterparts except for cases where a single capital injection increases its value by over USD 100,000,000 or where shareholders of holding companies change.

 3. Despite the positive developments, MOFCOM also reinforces in the Notice that holding companies cannot invest in areas that are restricted or forbidden to foreign investment, or in industries that are subject to macro-control by the government. Further, if required by relevant industry rules, investments by holding companies will still need approval from the industry authorities even if approved at the local MOFCOM level.

B. Delegation of Approval Authority for FIVCEs and FIVCE Management Firms

MOFCOM further issued, on March 5 the Notice on Approving Foreign Invested Venture Capital Enterprises and Foreign Invested Venture Capital Management Enterprises (the “No. 9 Notice”) which simplifies the approval process for FIVCEs and FIVCE Management Firms.

The legal basis for setting up FIVCEs and FIVCE Management Firms are the Management Rules on Foreign Invested Venture Capital Emperies (the “FIVCE Rules”) promulgated by MOFCOM, the Ministry of Science and Technology, the State Administration for Commerce and Industry, the State Tax Administration, and the State Administration on Foreign Exchange on January 30, 2003. According to the FIVCE Rules, foreign investors are permitted to set up a FIVCE to invest in unlisted high-tech enterprises, provide management services to such enterprises and are also able to enjoy capital gains from such investments.

Pursuant to the FIVCE Rules, the establishment of a FIVCE adopts a multi tier approval process regardless of scale. A FIVCE requires preliminary examination at the MOFCOM provincial level with final approval from the central MOFCOM with the consent of the Ministry of Science and Technology. On the other hand the establishment of a FIVCE Management Firm only requires MOFCOM provincial level counterpart approval.

The No. 9 Notice simplifies the approval process in the following regards:

1. Proposed FIVCEs and FIVCE Management Firms with registered capital of no more than 100 million USD can be approved by MOFCOM counterparts at the provincial level (1), vice-provincial city level, or national economic development zone level. It is important to note that FIVCE Management Firms which were previously approved at the provincial level should now obtain approval from central MOFCOM in cases where its registered capital exceeds USD 100,000,000. Accordingly, the new policy is that establishment of a FIVCE can be approved locally except if the registered capital exceeds USD 100,000,000.

2. The provincial MOFCOM counterpart is required to complete the approval process and decide upon approval within 30 days after receiving the complete application documents. It is noteworthy that under FIVCE Rules, due to the two tier approval level regime, the mandatory approval timeframe is 60 days (15 days for preliminary review at the provincial level and 45 days for final approval by MOFCOM). Furthermore, following the delegation of approval authority in respect of FIVCEs, the No. 9 Notice requires that when establishing a FIVCE, the provincial approval authority shall request the opinion from the science and technology administration of the same level (i.e. the Ministry of Science and Technology provincial counterpart).

3. The basic rule has always been for amendments to the corporate structure for a FIVCE or FIVCE Management Firm to be approved by the original approval authority. The No.9 Notice changes this by allowing FIVCE or FIVCE Management Firms originally approved by MOFCOM to have subsequent commercial changes approved by MOFCOM's provincial counterparts except for capital increases where the increase exceeds USD 100,000,000 or the change of “requisite investors (2)” in the FIVCE.

It should be borne in mind that although the No. 9 Notice simplifies the approval process and shortens the approval timeframe considerably the substantial requirements provided in the FIVCE Rules will still need to be strictly followed in many cases. These requirements include the restrictions on the business scope of a FIVCE, notably a FIVCE being prohibited from (i) obtaining loans to finance venture capital investments, (ii) investing in areas prohibited to foreign investment, (iii) directly or indirectly investing in the real estate market, (iv) directly or indirectly investing in publicly traded stocks or bonds, except for shares of the invested enterprises held by the FIVCE which are publicly traded after listing.)

Summary

The devolution of approval competency for holding companies, FIVCEs and FIVCE Management Firms will simplify and speed up the approval process for foreign investors as well as lower the work burden on MOFCOM. In addition, the new policy will simplify the operations of existing holding companies, FIVCEs and FIVCE Management Firms in that many will be able to bypass central MOFCOM approval for operational actions such as capital increases less than USD 100,000,000.
Although, there is no apparent negative impact upon foreign investors in these notices, it should be also noted that MOFCOM and other approvals still remain in place under specific circumstances. Foreign investors will need to carefully check which approvals at which level will be required in order to have a valid establishment and which restrictions remain in place.
 

(1) Vice-provincial cities, as an administrative division in China, are not treated as a province from an administrative perspective, but are distinct from a financial perspective.

(2) According to the FIVCE Rules, one shareholder of the proposed FIVCE must be a requisite investor i.e. a investor that meets the following requirements or thresholds: (i) the business of the requisite investor is venture investment; (ii) the capital under its management is not less than USD 100 million in the last three years prior to the application and at least USD 50 million of which has been used for venture investment; (iii) the investor shall have at least three professional management personnel with not less than three years experience in venture investment business; (iv) the requisite investors shall not have been prohibited by the judicial authorities or other relevant regulatory authorities from engaging in venture investment or investment and consultancy business or punished due to any fraud; (v) the amount of capital contribution subscribed to and paid in by the requisite investors shall not be less than 30% of the total subscribed capital and 30% of the total paid in capital of the FIVCE respectively.
 

2. Pursuant to the Notice, MOFCOM will adopt a filing system for the establishment of new branches by FIEs. The Notice clarifies that establishment of a branch by a FIE does not require MOFCOM or local counterpart approval unless specific regulations state otherwise. This clarifies a previously unresolved issue in that MOFCOM local counterparts had varying practices in such regard from region to region (some local MOFCOM counterparts required approval for FIEs to set up a branch engaged trading). The Notice implies that if the FIE’s business scope relevant to a restricted area has been approved, then no additional approval from MOFCOM is required to set up a branch for the approved business. Furthermore, the Notice regulates that if a FIE intends to set up a branch abroad, then this should be approved by the provincial MOFCOM with the consent of the Chinese embassy’s commercial department in the country where such branch is to be located.

B. Ease of Approving Holding Companies

On March 6th 2009, MOFCOM also issued the Notice on Delegating the Approval Authority for Foreign Invested Holding Companies to streamline the establishment of foreign investment holding companies.

This notice provides:

1. Proposed holding companies with a registered capital of USD 100,000,000 or less will be examined and approved by the competent MOFCOM counterparts at the provincial or vice-provincial city level. Previously, the establishment of a holding company required MOFCOM level approval regardless of scale.

2. Any amendments to established holding companies (i.e. such as name change, revisions to business scope, normal changes to capital structure) can be approved by lower level MOFCOM counterparts except for cases where a single capital injection increases its value by over USD 100,000,000.

3. Despite the positive developments, MOFCOM also reinforces in the Notice that holding companies cannot invest in areas that are restricted or forbidden to foreign investment. Further, if required by relevant industry rules, investments by holding companies will still need approval from the industry authorities even if approved at the local MOFCOM level.

Summary
The devolution of approval competency for most projects will simplify and speed up the approval process for foreign investors as well as lower the work burden of MOFCOM. In addition, the new policy will make the operations of existing FIEs easier in that many will be able to now bypass central MOFCOM approval for operational actions such as capital increases.
Although, there is no apparent negative impact upon foreign investors in such notices it should be also noted that MOFCOM and other approvals still remain in place under specific circumstances. Foreign investors will need to carefully check which approvals at which level will be required in order to have a valid establishment.

[1] Vice-provincial cities, as an administrative division in China, are not treated as a province from an administrative perspective, but are distinct from a financial perspective.
[2] According to a notice issued by National Planning Commission (the predecessor of National Development and Reform Commission), central government reliant projects include the FIEs using state subsidies, FIEs investing in infrastructure, etc. But this notice was issued in 1999 based on the old Industry Category for Foreign Investment in 1997 which has been revised largely afterwards, thus may be out of date.
 

Before the issuance of such a Circular, the above-mentioned question has for a very long time confused not only foreign investors, its lawyers, and other consultants, but also some local officials of SAFE partly due to the reason that SAFE did not clarify this question by issuing an official and universally-applicable rule. As a result the answer to this question has to depend, to large extent, on the local regulatory practice. Not surprisingly, in practice, some local offices of SAFE held a view that a FIE should not be allowed to exchange the foreign currency from its capital account into RMB for purposes of re-investing in China on the grounds that the foreign currency deposited in such account had been specially approved to satisfy the defined project as described in the business scope. In the meantime, some others officials held different views and allowed the FIE to settle the foreign exchange into RMB to satisfy the needs of re-investing in China. This is particularly the case where a local government is thirsty for foreign investment and it may be driven to take a more flexible policy.

Now, with the promulgation of the Circular, the door to direct re-investment by FIE(s) using the RMB settled from its foreign exchange capital account in China is closed. If a FIE happens to come upon a good investment opportunity, it will have to use its accumulated RMB profits or income or borrow RMB from domestic banks.

As is known in recent years, international “hot” money has unnerved the Chinese government which has thus taken a series of measures to cope with the issue. Without doubt the new rule is intended to strengthen the administration of foreign exchange flow and curb the inflow of hot money. However while it may contribute to the strengthening of its foreign exchange administration and the stability of its economic growth, it may also add the cost of making re-investment by foreign investors through their FIE(s) in some cases more difficult from a commercial perspective.
 

Conditions to be Considered - the regulations introduce factors for the authorities considerations such as whether an import will unfavorably influence the PRC domestic industry’s development, adverse affect upon public morality or environment.

Validity Period - the amended Article 9 states that the validity period for the Proposal for Technology Import License will be set within the range of one to three years. As the previous law did not set limits it is not clear what this restriction will mean in practice.

Procedural Changes – the new regulations require on-line registration with a MOFCOM website before an applicant can collect a Technology Import License. More importantly, contracts which include royalty payments require the technology importer/exporter to make a recordal within 30 days after the base figure for the royalty has been determined. This requirement appears to be an on-going requirement for subsequent years.

Requirements in respect of free technology transfers have been relaxed. Under current law the technology importer or exporter should re-register any amendment to a free technology import or export contract. The June 2008 amendments simplify this by requiring the technology importer or exporter to comply with an amendment recordal procedure rather than re-registering. However, the current practice of the vast majority of companies in China – i.e. doing nothing – is simpler still. However, a failure to follow up properly will make taking legal action against a breaching importer more difficult still.