On February 3, 2011, the General Office of the PRC State Council issued the Notice Regarding the Establishment of National Security Review Mechanism for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (“国务院办公厅关于建立外国投资者并购境内企业安全审查制度的通知”) (the "Notice"), which will take effect 30 days after its promulgation. The Notice represents another major step that the Chinese government has taken in recent years in the area of regulating mergers and acquisitions (M&A) of domestic companies by foreign investors in China.
As early as 2003, China issued provisional rules governing acquisition of domestic companies by foreign investors, and on August 8, 2006, these provisional rules were amended into the Rules on the Merger and Acquisition of Domestic Enterprises by Foreign Investors ("M&A Rule") by the Ministry of Commerce ("MOFCOM") and five other agencies. The M&A Rule, for the first time, called for notification and review of a transaction that might have an impact on China’s "national economic security". Subsequent to the M&A Rule, the PRC Anti-Monopoly Law ("AML"), effective on August 1, 2008, mandates a broader "national security" review when a foreign investor participates in the concentration of business operators by merging or acquiring a domestic enterprise or by any other means where national security is involved. Following the AML, on April 6, 2010, the PRC State Council issued the Several Opinions on Further Improving the Work of Utilizing Foreign Investment, which directs the government to accelerate the establishment of a national security review mechanism on mergers and acquisitions of domestic companies by foreign investors.
2 Highlight of the Notice
The Notice sets up a ministry-level intra-agency joint meeting as the national security review committee. It also lays out the scope and content of national security review as well as the mechanism and the procedures for the review.
2.1 Scope of Review
National security review covers the following areas:
- national defense security, including foreign investors’ acquisition of military enterprises and military supporting enterprises, enterprises adjacent to important and sensitive military facilities and other entities relating to national defense security; and
- other national security areas, including foreign investors’ acquisition of enterprises involving important agricultural products, energy and resources, infrastructure, transport systems, key technology sectors and important equipment manufacturers which may have an impact on national security and foreign investors may acquire de facto control of such enterprises.
Under the Notice, the term "de facto control" refers to the following circumstances:
- a foreign investor and its parent company and subsidiaries hold in the aggregate more than 50% of total shares of a domestic company after acquisition;
- several foreign investors hold more than 50% of total shares of a domestic company after acquisition;
- a foreign investor holds less than 50% of total shares of a domestic company after acquisition, but the voting right of the foreign investor could have significant effect on the resolutions of the shareholder meeting or the resolutions of the board of directors; and
- other circumstances which may lead to a foreign investor’s de facto control of a domestic company, including its operational decisions, financing, personnel and technology.
Foreign investors’ M&A activities in relation to domestic enterprises include the following circumstances:
- share purchase, including a foreign investor (a) purchasing the shares of a non-foreign-invested enterprise in China or subscribing to its the capital increase to convert it into a foreign-invested enterprise; and (b) purchasing the shares from Chinese shareholders of a foreign invested enterprise or subscribing to its capital increase.
- asset purchase, including a foreign investor (a) establishing a foreign-invested enterprise to purchase assets of a domestic company and operate such assets, or purchasing shares of a domestic company through such foreign-invested enterprise; and (b) purchasing the assets of a domestic company directly to establish a foreign-invested enterprise with such assets.
2.2 Content of Review
The national security review committee will review, approve or block a transaction based on the following aspects:
- influence on national defense security, including influence on domestic manufacturing capabilities, services and related facilities and equipment required by national defense;
- influence on national economic stability;
- influence on basic social order; and
- influence on China’s ability to research and develop key technologies for national security.
2.3 Review Procedures
(a) Review Body
The foreign investment security review committee will be guided by the State Council and led by the National Development and Reform Commission and MOFCOM, which will conduct reviews together with other agencies on as needed basis.
Foreign investors shall make an application to MOFCOM when acquiring domestic companies. If the transaction falls into the scope of national security review, MOFCOM will submit the application to the committee for review within 5 working days. The Notice also permits the agencies of the State Council, national trade associations, competitors, suppliers and upstream and downstream enterprises to apply to MOFCOM for review of a transaction.
The review process starts with a "general review", and if a transaction fails to pass the general review, a "special review" will be required. If a transaction is deemed not have an impact on national security, the committee will send its review opinion to MOFCOM. Where a transaction is deemed to affect national security, a "special review" will be initiated by the committee and a security evaluation will be conducted and in the event of major disagreements, the committee will submit the transaction to the State Council for its final decision. After a final decision is made, MOFCOM will notify the applicant about the review result.
During national security review, the applicant may apply to MOFCOM to amend the transaction plan or cancel the transaction. Where the acquisition of domestic companies by foreign investors has had or may have a material impact on national security, the committee shall require MOFCOM, together with the relevant agencies, to terminate the transaction or transfer relevant equities/assets or take other effective measures to eliminate the transaction’s impact on national security.
As mentioned in the beginning of this article, the requirement for national security review is already stipulated in the AML, however, there were no concrete rules in place until the newly issued Notice. In addition to the requirement for national review in respect of M&A activities, foreign investment in China must comply with the Catalogue for the Guidance of Foreign Investment Industries and, if required, complete anti-trust review in accordance with the AML. However, compared to developed countries, China’s new requirement for national security review is not unique. For example, Australia has set up the Foreign Investment Review Board to review foreign investment projects, and the United States also has an intra-agency Committee on Foreign Investment in the United States, which reviews foreign investment in a US company that may result in foreign control or have an impact on national security.
While China’s national security review may add additional burden and costs on foreign investors as well as uncertainty for M&A transactions in China, the Notice also provides a timeline for the review process and some level of transparency on the review procedures.
The Notice describes the scope of review in a broad stroke and some of the products or sectors are not sufficiently described or defined and this may give the review committee a lot of discretion. For example, the term "important agricultural products" are not defined and thus it is difficult to ascertain what kinds of products are covered, whether agricultural products include agricultural products processing, etc.
With respect to content of review, the Notice does not specify the criteria for evaluating influence on national economic stability and influence on basic social order. As the national review gets tested in real-life cases, there will likely be questions raised on the review process and procedures. It is possible that further explanations or regulations will be issued by the State Council or relevant agencies to make the national review more workable in the future.
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