Kim Bohyoung，Huang Lina, Li Aihua 公司业务部 金杜律师事务所
1. Divestment of Foreign Investors
Due to the global adjustment of business strategy and a growing trend towards interest in community, a number of foreign investors no longer take China as their production base. Those having established labour-intensive industries in China are gradually reducing existing business and are shifting to capital-intensive and technology-intensive industries. As a result, some foreign-invested enterprises (FIEs) have acted quickly to exit the Chinese market.
Foreign investors mainly take either form of equity transfer or asset transfer. In the former scenario, foreign investors transfer all the equity held by them in an FIE (the “Target”) to the buyer. In the latter, foreign investors sell the assets, usually properties, land use rights, equipment, etc. of the Target before liquidating the company.
2. Equity Transfer vs. Asset Transfer
For the foreign shareholders as the seller, these two approaches differ in the following aspects:
| Item | Equity transfer | Asset transfer before liquidation |
| Parties | – Buyer and Seller | – Buyer and the Target |
| Subject matter | – Equity in the Target | – Assets of the Target |
| Formalities | – It is required to go through formalities with market regulation authorities for the equity change. | – If any property is involved, it is required to change the owner of the property and the land use right with the real estate authority. |
| Pricing basis | – Valuation of the Target as a whole | – Appraisal and pricing for the assets of the Target |
| Employees | – The seller is not legally responsible for employee settlement and the buyer generally retains most of the employees. In practice, however, employee settlement may still be an onerous issue. | – The buyer is not obligated to employ the employees of the Target. To ensure smooth progress of liquidation, in practice, the seller generally needs to have its employees settled prior to the liquidation. |
| Tax costs | – Low tax costs. In general, the buyer is required to pay stamp tax and the seller is required to pay enterprise income tax and stamp tax. | – High tax costs. In general, the buyer is required to pay deed tax and stamp tax, and the seller is required to pay VAT, land value increment tax, enterprise income tax, local additional tax, stamp tax, etc. |
| Legal risks | – Except as otherwise provided under the equity transfer agreement, the seller may entirely escape from the risks relating to the Target. | – The seller has to bear the financial risks relating to the contingent liabilities, contingent penalties or liabilities of the Target. |
| Duration | – 2-3 months | – 1-2 months for asset transfer and 1-2 years for liquidation |
Equity transfer is simpler and more efficient and thus is widely adopted by the exiting foreign investors only if there is proper buyer.
3. Equity Transfer Procedures
In practice, the procedures for equity transfer are as follows:
| No. | Actions | Taken by |
| 1 | Both sides reach an initial agreement and sign a letter of intent for equity transfer. | Seller and Buyer |
| 2 | Depending on specific circumstances, conduct assets appraisal of the Target and legal, financial and tax due diligence | Buyer |
| 3 | Enter into the equity transfer agreement | Seller, Buyer (and Target) |
| 4 | Liquidate the assets, creditor’s rights and debts pursuant to the equity transfer agreement and carry out other pre-closing activities required | Seller, Buyer, and Target |
| 5 | In order to close the transaction, the parties go through relevant formalities relating to administrative procedures, asset transfer and transfer of business management right in accordance with the agreement. | Seller, Buyer, and Target |
The administrative procedures for equity transfer vary greatly depending on whether the buyer is a domestic or overseas enterprise.
- Buyer as a domestic enterprise
- Buyer as an overseas enterprise
Where the buyer is an overseas enterprise, it may be exempted from the formalities of foreign trade deregistration and foreign exchange registration and the equity transfer price may be paid on the day of industrial and commercial registration.
4. Issues to Be Considered
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- Registration before payment
As required by the administrative authorities, a domestic enterprise as a buyer should first complete the procedures such as industrial and commercial registration of changes and tax declaration before paying the equity transfer price to an overseas enterprise. Consequently, overseas shareholders will not receive such price until one or two months after the industrial and commercial registration of changes or even later. As such, overseas shareholders have to bear higher risk in payment collection during the equity transfer.
To reduce the risk, overseas shareholders as the seller may adopt the following approaches:
- Open an escrow account, and require the buyer to transfer the equity transfer price to the escrow account first. The amount will then be transferred to the seller after all formalities are completed;
- Pledge the equity of the Target after industrial and commercial registration of changes;
- Request the buyer to issue a performance guarantee;
- Collect payment through a new or existing onshore account (it may be practically difficult to do so);
- Request payment through buyer’s overseas affiliated account (the process may be complicated); or
- Take control of the important qualification certificates, material contracts, company seal, etc. of the Target and hand over such materials and the business management right to the buyer on the date of payment by the buyer.
- Employee settlement
In equity transfer transactions, the Target is not required to pay financial compensation to its employees under existing laws and regulations. However, in practical situations, some employees may require financial compensation to the Target and to recalculate their length of service. Generally, the buyer may also request the seller to procure the Target to terminate employment relations with some employees before closing of the deal. If the Target fails to reach agreement with its employees, it may lead to labour disputes and even class action, thus affecting the closing of the project.
In this regard, both sides should first determine which employees to be retained, how to settle the remaining employees, and how to calculate and who to pay their financial compensation. An appropriate personnel designated will advise the employees of the plan in due time before carrying out the plan. In this course, relevant information should be kept in strict confidence.
- Loans from overseas shareholders
The target held by the withdrawing overseas shareholders is usually unable to repay the loans from overseas shareholders, and the buyer does not want to the situation the target still holds any debts from the original shareholder after closing. As such, it is one of the main issues the parties face during the transaction how to resolve the loan from the original shareholders.
Loans from overseas shareholders, i.e. foreign debts, are usually settled through debt-equity swap, debt forgiveness and prepayment, which are compared in the table below for reference.
| Approach | Merits | Demerits |
| 1. Debt-equity swap |
– If the Target cannot afford to repay the debt, a debt-equity swap may avoid tax losses that would have otherwise been incurred with debt forgiveness. |
– Procedures are complicated as multiple authorities, including industry and commerce, commercial and foreign exchange administrations, are involved. – As the process is required to be completed before equity transfer, the closing of equity transfer may be delayed. |
| 2. Debt forgiveness | – Procedures are simple and follow-up report suffices. Thus, it will not affect the progress of the transaction. | – The approach is of no special demerits legally. Tax implications are the main considerations. |
| 3. Prepayment | – Cross-border payment of the equity transfer price is conditioned upon the completion of industrial and commercial registration of change and commercial, tax, and foreign exchange registrations. In practice, quota limitations on foreign exchange for capital accounts may cause delay in the actual payment of foreign exchange, and thus the seller will not receive the amount transferred until a long time after completion of equity transfer. But the repayment of shareholders’ loans is not conditioned upon the above procedures, so the parties can negotiate a flexible timeline for such repayment, for example, the buyer can prepay the loan on the date of industrial and commercial registration of change. | – Prepayment is allowed only when the loan is marked as prepayment acceptable at the time of foreign debt registration. It is required to confirm in advance whether the Target satisfies the above requirement. |
Foreign debts are subject to foreign exchange regulations, and the seller and the buyer cannot decide on the payment method on their own. Therefore, in addition to compliance with laws and regulations, the parties should determine which approach will be adopted after taking into consideration of the practical operation requirements of the local foreign exchange authority.
The above is a brief introduction to the form, procedures, and issues to be considered during divestment of foreign investors. We’d like to share more with you on foreign-related transactions in upcoming articles.
Disclaimer
* KWM Korea CloudOffice does not provide legal advice in relation to, or practise, Korean law in any form. This article is for general information purposes only and does not constitute advice.