Foreign Investment Law Impact M&A in China

Foreign Investment Law Impact M&A in China

On March 15, China’s National People’s Congress closed out the Two Sessions meetings by passing the “Foreign Investment Law of the People’s Republic of China” (the “Foreign Investment Law”). The said law will come into effect from January 1, 2020.

The Foreign Investment Law will govern the activities of all foreign investors (including those from Hong Kong, Macau, and Taiwan), which also pertains to wholly foreign-owned enterprises (WFOEs) and Sino-foreign joint ventures (JVs).

What’s new about the Foreign Investment Law?

The Foreign Investment Law contains a several provisions that pledge to give foreign investors a level playing field with their domestic counterparts.

Article 22 protects IP and commercial secrets, and also clearly forbids government officials from using administrative measures to pursue forced technology transfers. If a government official does not comply with Article 22, Article 39 holds them criminally liable.

To ensure pre-establishment national treatment will be used, the Negative List will be used in managing the foreign investment. The restrictions on foreign investment are defined comprehensively.

Article 20 promises legal procedures and “fair and reasonable compensation” for expropriations and requisitions.

Article 35 states that some investments could be subject to national security reviews, and decisions made from such reviews are final.

What is impacted by Foreign Mergers and Acquisitions (M&A)?

Before the Foreign Investment Law, the key regulation about Foreign M&A was the “Provisions on the Merger and Acquisition of Domestic Enterprises by Foreign Investors” (the “Order No. 10”) and “Interim Measures for the Recordation Administration of the Formation and Modification of Foreign-Funded Enterprises”. In order to execute the Foreign Investment Law, there are still some points that need to be clarified.

Is there related regulation for managing M&A with affiliated party?

Order No. 10, Article 11 states that a company, which is set up or controlled by a domestic enterprise or individual, should get approval from the Ministry of Commerce to merge the related domestic company. It established the basic approval system of managing M&A with a related party. After the revocation of the previous three laws, Order No. 10 needs to be quoted in a new regulation to continue this approval system.

Is an assets appraisal report mandatory in a Foreign M&A?

Order No. 10 states that the price of the M&A needs to be consistent with an assets appraisal report. The deals that are much lower than the price in the assets appraisal report are forbidden.

In the law, there is no definition of the price. It can be managed from tax and foreign exchange. There should be some new regulations launched to clarify this point.

Supervision of Variable Interest Entities (VIE) architecture

The VIE architecture is not defined clearly in current laws so the Foreign Investment Law is important to clarify if VIE is legal or not and how to supervise it.

VIE allows a foreign investor to control a domestic entity through agreements but not a direct investment. In China, there is a restriction on internet, media, education, etc. for foreign investment. Moreover, VIE is accepted by the U.S. Securities and Exchange Commission (U.S. SEC) and Hong Kong Exchange (HKEX). VIE has become an essential way for a domestic company to take an IPO overseas or for foreign investors to invest in a business in the Negative List.

Some Articles, which are negative for VIE that appeared in the draft,were deleted in the final launch version. However, there are no related Articles to clarify if the VIE is legal or illegal. Article 2.4 says, “Other ways of foreign investment not defined in law and regulations” keeps a door open to supervise VIE.

Even now, the VIE is still in a grey area. A new law or regulation should be defined to move VIE under Foreign Investment supervision.

Are equity contribution and stock mergers and acquisitions allowed?

Order No. 10 allows foreign investors to merge and acquire stocks of a domestic company by paying stocks of foreign companies or overseas special purpose shares. However, there are some conditions to be satisfied.

After the launch of the Foreign Investment Law, there has been no restriction of equity contribution, stock mergers, and acquisitions. However, Order No. 10 is still effective. The regulation needs to be clarified and amended.

To sum up, the key question is if Order No. 10 will be abolished or not because many Articles therein are covered by the Foreign Investment Law. Building a unified system of managing foreign investment is reasonable and feasible and may include abolishing Order No. 10 and launching new regulations to cover some of the Articles therein which are not covered by the Foreign Investment Law.

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