On Aug. 8, 2006, the People's Republic of China ("PRC")'s  Ministry of Foreign Commerce ("MOC") issued new regulations ("Revised Provisions") on M&A transactions in China. [2] These new regulations would simultaneously ease and impede foreign acquisitions by allowing all stock purchases, but also requiring government approval of most M&A transactions involving offshore entities. [3] The Revised Provisions went into effect on Sept. 8, 2006, replacing the interim provisions issued in 2003. [4]

This piece will first focus on two main areas of rule-making: share exchanges involving off-shore entities (whether foreign or domestically controlled) and domestic Chinese companies, and the additional regulatory approval requirements for foreign purchases of Chinese companies.  The piece will then discuss the possible effects on foreign purchases of Chinese entities and possible motivations behind the law.

III. Share Exchanges

For the first time, foreign buyers will have authorization to "pay for stakes in Chinese companies in shares instead of in cash." [5] This new option will give foreign buyers increased flexibility and will bring China in line with international practice. [6]

However, in order to take advantage of these rules, the parties must satisfy a number of conditions including:

• the acquirer's shares must be tradable on an overseas stock exchange;
• the offshore company's trading price must be "stable" for one year preceding the transaction;
• the shareholders of the target company must be the legal owner of the shares, which must also be legally transferable;
• the shares of both the acquirer and target must be unencumbered. [7]

IV. Increased Regulatory Scrutiny

While the new regulations increase business' flexibility in how they pay for their purchases, they also raise new regulatory hurdles to approval.  For most transactions involving offshore restructurings, firms must obtain prior approval from the MOC. [8] The regulations "confer broad new powers to block investments in key industries if they are deemed to be a danger to China's economic security," "alter control of a key Chinese brand," or involve a firm with more than 2,000 employees. [9]

As always, "the devil [will] be in the detail[s] and the implementation of the regulations." [10] Some investors are concerned that the rules "put the onus on the buyer and seller to declare if the deal might affect . . . economic security." [11] Moreover, the rules "are pretty vague about what you've got to report, what's influencing economic security," says John Grobowski, co-managing partner of Baker & McKenzie's Shanghai office. [12] He continued, "[t]his puts a pretty heavy burden on the parties involved in the transaction to make those kind of determinations." [13]

"Furthermore, if an M&A transaction is completed without the required MOFCOM review and approval, the Revised M&A Provisions authorize MOFCOM to either rescind the M&A transaction or retroactively amend the agreed contractual terms and conditions of the M&A transaction." [14] Thus, if the companies miscalculate, and determine, inaccurately, that the deal does not require review by the Chinese government, it can have very serious consequences.  Therefore, companies will likely be very cautious in determining whether to request government review.  While the review process is not especially time consuming, requiring a decision within thirty days, the government has not yet indicated the level of scrutiny that will be applied. [15] Thus, firms should be very careful when considering purchases of companies that might trigger this review process.

V. Effects on the Foreign M&A Markets

According to The Financial Times, "It is tempting to conclude that one of the world's toughest markets for mergers and acquisitions is getting tougher." [16] While, as noted above, the regulations strengthen the regulatory scrutiny, they simultaneously ease some parts of the process.  "The approval process will be more streamlined", and all relevant ministries are on board. [17] The old regulations, on the other hand, gave power to a ministry which seemed "unaware of its new responsibilities." [18]

However, experts doubt the new rules will "have a big impact on M&A because big takeovers are already subject to strict vetting." [19] The most important factor will be how the regulations are applied as the blocking provisions are subject to wide interpretation. [20]

VI. Motives Behind New Regulations

Leaders claim that China, the developing world's biggest recipient of foreign investment, isn't closing off its economy. [21] Rather, their motivation stems from the "government's growing preoccupation with helping the expanding universe of Chinese companies and pressing domestic issues such as poverty and wealth disparities." [22] However, "because the new restrictions are part of a broader policy shift -- rather than some temporary interest in penalizing foreign businesses -- it's a potentially scarier development for foreign companies." [23]

There also seems to be an element of domestic politics in play. "Increasingly savvy domestic companies -- some of whom have been stymied in their efforts to expand overseas -- are seizing the moment to push for moves they hope will strengthen them against outside competitors." [24] "'As local Chinese companies become more competitive, they are becoming more sophisticated in using whatever means are available to them to maintain their position,' says Henry Wang, a lawyer with DLA Piper Rudnick Gray Cary in Shanghai. 'They are using a combination of the media and government help.'"  As Chinese companies become more sophisticated, they appear to be emulating their American counterparts, taking advantage of the ability to lobby the government to produce positive results.

VII. Conclusion

While the new regulations simplify some areas of the M&A market, by allowing all stock mergers, they also create new barriers to entry into the Chinese market.  However, once companies adopt to, and understand how the new rules will affect business, the rush into China will probably resume at an even greater pace.

[1] David Lee, A Warning to Foreign Companies Entering Sensitive U.S. Markets, Journal of the Business Law Society, Sept. 18, 2006, http://iblsjournal.typepad.com/illinois_business_law_soc/2006/09/a_warning_to_fo.html (last viewed Oct. 17, 2006).

[2] DLA Piper Rudnick Gray Cary, Revisions to 2003 M&A Regulations, (Aug. 9, 2006) (Unpublished report on file with author) [hereinafter Revisions].

[3] Id.

[4] Id.

[5] Eadie Chen and Langi Chiang, New Rules Could Be Boon and Bane for Chinese M&A, Reuters, Aug. 9, 2006, available at http://today.reuters.com/news/articlebusiness.aspx?type=ousiv&storyID=2006-08-09T103951Z_01_PEK26055_RTRIDST_0_BUSINESSPRO-ECONOMY-CHINA-ACQUISITIONS-DC.XML&from=business .

[6] Id.

[7] Supra note 2, Revisions.

[8] Id.

[9] Supra note 5, New Rules.

[10] Id.

[11] Id.

[12] Id.

[13] Id.

[14] Supra note 2, Revisions.

[15] Id.

[16] Chinese Deals, The Financial Times, Aug. 10, 2006, available at http://www.ft.com/cms/s/cfa81d08-285d-11db-a2c1-0000779e2340.html.

[17] Id.

[18] Id.

[19] Supra note 5, New Rules.

[20] Supra note 16, Chinese Deals.

[21] Andrew Batson and Mei Fong, In Strategic Shift, China Hits Foreign Investors With New Hurdles, Wall St. J., Aug. 30, 2006, at A1.

[22] Id.

[23] Id.

[24] Id.

[25] Id.