Initially published in the February edition of the China-Britain Business Review.
The new laws will impose burdens on business but that is unavoidable, write Niamh Grogan, partner in EU and Competition, SJ Berwin, Susan Ning, Head of International Trade, King & Wood, and Matthew Townsend, trainee solicitor, SJ Berwin.
For the last six months, investors in China have been subject to a new source of regulation which is changing the way in which they go about pursuing mergers and acquisitions in the People's Republic. The rules, which were intended to establish China as a regulatory capital similar in stature to Brussels and Washington DC, have been criticised for incorporating vague clauses and unnecessarily wide administrative powers.
While these fears have been only partially allayed by the publication of the first merger review decision in November 2008 and the provision of further official guidance in early January 2009, 'foreign' (non- Chinese) businesses nevertheless face the reality of complying with the new regime.
Bearing in mind that further implementing regulations are expected in the future, this article lays out the best available answers to the main questions investors will wish to ask about the new rules.
1. How could the new laws affect your transaction?
The Anti Monopoly Law ("AML") came into force on 1st August 2008 and the Provisions of the State Council on Notification Thresholds of Concentrations of Undertakings ("the Regulations") on 3rd August 2008.
These rules, which replaced regulations promulgated in 2006, require businesses to notify the Chinese Ministry of Commerce ("Mofcom") in advance where there is an acquisition of control or decisive influence by one business of another (known as a "concentration"), which meets the notification thresholds.
Businesses, which are planning a merger or acquisition in which there is a Chinese element, should ensure that the completion timetable for the transaction incorporates the period required to gain approval from the authorities.
Such a period, which, in certain circumstances, could last for as long as 180 working days between notification and clearance, will clearly have cost implications for the parties. Of course, businesses should also consider the possibility that the transaction will not be cleared, in which case the transaction cannot go ahead.
Similarly, when considering notifications, Mofcom may decide to allow the concentration but impose restrictive conditions — as it did in its review of InBev's acquisition of Anheuser-Busch (Announcement No.95 of the PRC Ministry of Commerce, 18th November 2008). In this instance the combined entity was prohibited from increasing its existing stakes in several Chinese breweries.
Businesses which fail to notify may face a fine, and possibly forced divestment of the assets transferred.
2. Jurisdiction: will your merger or acquisition fall within the relevant territory?
The AML applies both to transactions taking place inside and outside China. The sole test for jurisdiction under Article 2 is whether the transaction has the effect of eliminating or restricting competition in the Chinese market.
This provision raises the possibility that transactions involving non-Chinese investors, taking place outside of Chinese territory, may still be subject to the law if the thresholds for turnover within the Chinese market are met.
That means that not only businesses which operate within the Chinese geographic area but also those which own or operate assets or subsidiaries located within China or which make extensive sales within China, should be aware that they might need to make a notification.
3. Will your transaction meet the thresholds for review?
Under the regulations, a notification must be made if a merger or acquisition meets one of the following two thresholds:
- combined global turnover of the undertakings is Yn10bn (approx £1bn) and at least two of the undertakings each have Yn400m (approx £40m) turnover within the PRC; or
- combined Chinese turnover of the undertakings is Yn2bn and at least two of the undertakings each have Yn400m turnover within the PRC.
This test is significant for foreign businesses operating in China for several reasons:
i. undertakings which have markets in several jurisdictions may, on completing a global transaction, find that they meet the notification requirements in China alone, without meeting those in the EU or America even if their presence in these markets is equally significant.
This is because the "local nexus" thresholds of Yn400m are lower than those in many other developed competition regimes.
Companies should therefore be wary of assuming that because their operations are too small to engage European and American merger control, they will also avoid it in China;
ii. as the review thresholds are higher than those employed in China before the AML came into force, businesses conducting "notifiable" transactions may be caught by the law and therefore potentially be subject to a more tailored and thorough investigation than would have been the case when regulators faced a larger caseload; and
iii. companies involved in transactions which do not meet the thresholds set out in the AML may nevertheless have to undergo administrative review. This is because the AML grants the Authority the right to conduct an investigation solely on the basis that the concentration is one which may eliminate or restrict competition.
Businesses which otherwise meet the notification thresholds may fall within one of the exceptions provided for in the AML: those which are simply undergoing internal restructuring, for example, are not required to notify.
4. Will your transaction be ruled unlawful?
The law currently allows the Authority to consider a wide range of factors when considering whether a transaction is anti-competitive. The test, under Article 28 of the AML, is whether the proposed concentration of business operators eliminates or restricts competition or may eliminate or restrict competition. In applying the test the Authority will examine the following:
i. the market share in the relevant market of the undertakings concerned and their ability to control the market;
ii. the degree of concentration of the relevant market;
iii. the effect of the transaction on market access and technological progress; and
iv. the effect of the transaction on consumers and other undertakings. In addition to these factors, the Authority will be able to have regard to such general considerations as:
v. the effect of the transaction on national economical development; and
vi. any other factors the anti monopoly authorities consider necessary to consider.
Investors should therefore be aware of the increased risk of their merger or acquisition being rejected if they operate in a sector which is unpopular with government authorities or is otherwise under public scrutiny in China.
Businesses should also take note of growing evidence that the Authority, as expected, is taking a strong line in the early enforcement of the law in order to "make examples" of early infringers.
That said, investors will, if they are able to make their case persuasively, have an opportunity to influence the Regulator's decision.
Under Article 28 of the AML, businesses are entitled to make representations that the positive effects of the transaction will outweigh the negative. Investors should bear in mind, at an early stage of notification, that they may need to instruct experts to make their case for them.
5. Will your transaction be rejected for reasons of national security?
Article 31 of the AML provides for a national security review when non-Chinese businesses merge with or acquire Chinese companies, or by other means become involved in a concentration. It is clear that this represents a separate level of review operating over and above the normal competition assessment.
The specific provisions governing the review are not contained within the AML and the scope of the national security exception is not clear.
Investors should be aware of the extra risk associated with the national security review, a risk which will vary depending on the size of the business, the sensitivity of the industry involved and the timing of the transaction.
6. Which documents will your business be required to produce?
Businesses will not need to produce significantly different documents to those required under the old regime. Article 23 of the AML lays out a list of documents that must be supplied as part of the notification process. These include:
i. summary of notification;
ii. explanation of the concentration's effect on competition on the relevant market of the concentration;
iii. agreement of concentration;
iv. the financial reports and accounting reports of the proceeding accounting year of the undertakings concerned, audited by a certified public accountant; and
v. other documents or materials stipulated by the anti monopoly authorities.
Mofcom requires a standard application form to be filled in for all transactions. Investors should also pay attention to recent guidance given by Mofcom on documentation requirements, and on how the agency will define product markets for more detailed information when preparing the notification document.
7. What delays should your business expect the review to require?
The anti monopoly authorities are obligated under Article 25 of the AML to review the documents and materials submitted within 30 days. If, however, they reach a decision that further examination is needed then they may continue the review process for a further 90 days.
Although the issue has not been officially clarified we understand that these periods refer to "working" rather than "calendar" days. A further extension of 60 (working) days can be added in exceptional circumstances (for example with the consent of both parties to a transaction).
The time limit for review under the AML is not significantly different to that under the old regime.
Moreover, the process is very similar to the EC procedure which allows for a 25 working days phase I scrutiny stage and 90 working days phase II stage. Parties to multinational deals which require EC review in addition to notification in China may find that the addition of a filing requirement in China does not significantly lengthen the timetable for completion.
Businesses which will face notification requirements in China alone and suspect that issues could be raised should allow for such a potential delay. Such a period can be minimised with effective planning — for example by notifying the authorities at the earliest possible time after a binding agreement is made (or a sufficient intention to enter an agreement has been reached or announced).
If parties see the delay associated with "phase II" scrutiny as unacceptable they may consider drafting the contract in such a way as to allow the parties to withdraw from the deal in such an event.
8. What are the penalties for noncompliance?
Before the AML came into effect, the M&A Regulations and the 2007 Guidance did not expressly provide for any fines or sanctions in case of failure to notify a controllable transaction to the merger control authorities or for carrying out the transaction before clearance of the notification.
The AML, however, expressly provides for such sanctions and thereby gives the law more "teeth" than its predecessors. If investors implement a transaction without having obtained prior approval, the Authority is authorised to suspend the transaction, order the parties to dispose of the shares and/or assets transferred, and impose a fine of up to Yn500,000.
The Bureau of Antitrust Investigation of Mofcom has established six divisions, including a special division to supervise undertakings that have failed to notify a notifiable transaction. As we have already indicated, the Authorities are expected to enforce the new rules emphatically.
Conclusion
So what does all this mean for businesses that may at some point find their businesses fall within the legislation?
First, increased costs. Preparing submissions and notifications is bound to add to costs. Businesses will find themselves having to conform to strictly enforced rules requiring the instruction of experts and the factoring of time delays into their transactions.
Second, uncertainty and risk for businesses attempting transactions in the short term. This is because new guidance, including rules governing turnover calculations, public hearings, the applicants' rights and obligations, and many other important matters, are still in the pipeline.
Third, uncertainty arising from the regulator's ability to dismiss transactions on a wide variety of grounds, and, as demonstrated in the InBev/Anheuser- Busch review, to impose conditions on transactions.
And, fourth, increased vigilance and toughness on the part of the authorities — again potentially increasing the cost of compliance.
While it is hoped that the AML will, in the long term, increase the legal certainty for investors into China, despite the gradual appearance of further regulations and guidance, the risk associated with doing business in China may have increased. Nevertheless, businesses cannot afford to ignore the AML which has become another element of doing business in China.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.