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This article is taken from GTDT Practice Guide: China M&A. Click here for the full guide.
Factors regarding using shares as consideration
When contemplating whether to purchase or sell shares in a company, one of the hot topics for discussion between the parties can be the consideration structure. Although cash can be the most straightforward form of consideration, sometimes the purchaser might prefer shares as consideration if the purchaser does not have sufficient free cash to fund the acquisition or wants to save free cash for other purposes, such as working capital. The purchaser might also find the facility and financing arrangement to be too expensive or time-consuming or might like to take advantage of merger relief from tax perspectives. Sometimes, the seller, on the other hand, might also prefer shares as consideration if it wants to retain certain interest or control over the target company to be sold or would like a certain tax advantage, such as deferred income tax.
Despite all the above potential advantages of using shares as consideration, the parties also need to further assess the disadvantages before making a final decision. For example, the acquiring company will need to assess whether it is necessary to amend its articles of association and obtain internal approval for the share transfer or issuance, whereas the seller might need to conduct necessary due diligence over the acquiring company to assess the adequacy of share consideration, which will be even more complex in the context that a price adjustment mechanism has been introduced. Another important concern regarding share consideration that is worth careful attention is the potential regulatory requirements, which is particularly true in a cross-border merger and acquisition (M&A) transaction in the People’s Republic of China (China).
Overview of PRC laws regarding cross-border share swaps
Prior to the issuance of Provisions on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (issued on 8 August 2006 and amended on 22 June 2009, the M&A Provisions), there were no PRC laws or regulations specifically applicable to foreign investors using overseas equity interests to invest in domestic enterprises. The cross-border share swap concept was first introduced under the M&A Provisions, which specifically allow the use of shares of overseas listing companies or overseas special purpose vehicles (SPVs) as capital contributions for domestic companies. Under the regime of the M&A Provisions, such cross-border share swaps need to meet the following requirements.
Qualifications for shares of overseas company as consideration[3]
M&A advisory report
The domestic company participating in the cross-border share swap transaction or its shareholders shall hire an intermediary institution registered in China to act as a consultant (M&A Consultant). Such M&A Consultant is required to conduct due diligence and issue an M&A advisory report expressing clear professional opinions on the aforementioned criteria item by item. The M&A advisory report shall be submitted to MOFCOM for approval as one of the application materials.
Foreign investors and the domestic company participating in a cross-border share swap transaction shall submit application materials including the information of such overseas company and its equity interests, M&A advisory reports, financial reports, etc., for approval by MOFCOM. After obtaining such approval by MOFCOM, the domestic company shall also seek approval for outbound investment in order to hold the shares of the overseas company. In addition to the above, the domestic company also needs to obtain approvals by or clearance with various other Chinese regulatory administrations. A typical road map of the approval procedure includes:
Although China’s A-share listed companies have made frequent overseas M&As in recent years, there have been few cases of overseas M&As consummated through a cross-border share swap. One of the key reasons is the strict regulations in China restricting the extensive implementation of cross-border share swaps. Compared with other approval or record-filing requirements, MOFCOM approval for cross-border share swap acquisition transactions is probably the most difficult one to obtain in practice, and as a result there are few cases of successful cross-border share swaps under the M&A Provisions.
According to the Measures for the Administration of Strategic Investment in Listed Companies by Foreign Investors (2015 Amendment) (Strategic Investment Measures), foreign investors may make a scale of medium- and longer-term strategic merger investment (strategic investment) in A-share listed companies upon the approval of MOFCOM. Foreign investors obtaining a share of A-share listed companies through a cross-border share swap would fall into the above scope of strategic investment and therefore would be subject to this approval.
In addition to the general requirements on share swaps under the M&A Provisions, a cross-border share swap that constitutes strategic investment shall also satisfy certain additional requirements under the Strategic Investment Measures, including, but not limited to, the following.
MOFCOM promulgated the most recent revised draft of the Strategic Investment Measures for public comment on 18 June 2020 (2020 Revised Draft), which contemplated relaxing certain of the above-mentioned requirements set forth in the currently effective Strategic Investment Measures, including, but not limited to, the following.
Further, the 2020 Revised Draft contemplated requesting that the overseas company of which the shares will be used as consideration shall be a listed company only if the strategic investment is conducted by means of transfer under agreement. In other words, should the 2020 Revised Draft be adopted in its current form, when the foreign investor intends to acquire shares of an A-share listed company by means of private placement or tender offer in consideration of shares of an overseas company, such overseas company no longer needs to be a listed company.
More importantly, the 2020 Revised Draft contemplated clarifying that strategic investment no longer requires pre-approval from MOFCOM or its local counterparts to keep consistency with the new Foreign Investment Law. Although the Strategic Investment Measures (2015 Amendment) have not yet been abolished or revised, our case study indicates that the competent authorities have already adopted such an interpretation approach in practice.
At the time the M&A Provisions were promulgated in 2006 and amended in 2009, the then effective laws governing foreign investment were the Law on Chinese-Foreign Equity Joint Ventures (adopted in 1979), the Law on Foreign-Capital Enterprises (adopted in 1986) and the Law on Sino-Foreign Contractual Joint Ventures (adopted in 1988) (collectively, the Old FIE Law). The Old FIE Laws, supplemented by a series of subordinate legislation, established a relatively comprehensive examination and approval system for foreign investment. In addition to other potential specific approval requirements (eg, the merger control review, the national security review, etc), the Old FIE Laws imposed general approval requirements targeting only foreign investment (ie, project-based approval from NDRC or its local counterparts and an enterprise-type approval from MOFCOM or its local counterparts).
The Old FIE Laws have played an institutional role for decades and witnessed a surge of foreign investment into China. MOFCOM, in an effort to reform foreign investment regulation, introduced a new record-filing system for those foreign investment outside of the ‘negative list’, first in 2013 as a trial programme in the Shanghai Pilot Free Trade Zone and later on a nationwide basis in 2016. Since then and prior to 1 January 2020, all foreign investment was subject to scrutiny by MOFCOM – approval for investment expressly listed in the negative list or record filing for investment outside the negative list.
The National People’s Congress adopted the Foreign Investment Law on 15 March 2019, which became effective on 1 January 2020 and repealed the Old FIE Laws concurrently. The Foreign Investment Law replaces the previous approval/record-filing system with a uniform reporting system, and MOFCOM now assumes a monitoring role by receiving foreign investment information through such a system rather than directly supervising foreign investment via the approval/record-filing process. The Foreign Investment Law has also established a ‘national treatment’ regime whereby foreign investors and domestic investors should be treated equally, subject only to exceptions as provided in the negative list.
Neither the M&A Provisions nor the Strategic Investment Measures have yet been formally amended or abolished; hence, uncertainty remains on the implementation of the MOFCOM approval requirements under these two regulations. However, neither the transborder share swap nor the foreign investor’s strategic investment in A-share listed companies itself is expressly listed in the negative list; hence, foreign investors have a strong argument that MOFCOM’s pre-approval requirement under the M&A Provisions regarding transborder share swaps or under the Strategic Investment Measures regarding strategic investment no longer applies. When answering certain enquiries in a public message board on its official website regarding how to apply the M&A Provisions and the Strategic Investment Measures, respectively, after the Foreign Investment Law came into effect, MOFCOM non-officially replied that it no longer assumed the approval or record-filing authorities for the establishment and change of foreign-invested enterprises, and the contents under the M&A Provisions or the Strategic Investment Measures contradicting the Foreign Investment Law, which are not clearly listed, however, should cease to be implemented.[4]
Case study I: THY’s acquisition of CNCE Luxembourg and AHT’s acquisition of Hiwinglux and IEE
As disclosed in the transaction report dated 6 December 2018,[5] Qingdao Tianhua Institute Of Chemistry Engineering Company Limited (Stock Code: 600579.SH, which has subsequently changed its name to KraussMaffei Company Limited since 9 September 2019) (THY), an A-share listed company with China National Chemical Corporation (ChemChina) as its controlling shareholder, intended to acquire 100 per cent equity interests in China National Chemical Equipment (Luxembourg) S.à. r.l. (CNCE Luxembourg), a Luxembourg company, from CNCE Global Holdings (Hong Kong) Co., Limited (CNCE Global). The consideration for such transaction was issuance of shares of THY. This transaction was closed in April 2019. Prior to the aforementioned transaction, THY had no foreign shareholders. After the completion of such transaction, THY becomes the sole shareholder of CNCE Luxembourg, and CNCE Global becomes a major shareholder of THY, holding 52.2 per cent of shares.
This transaction constituted a strategic investment by a foreign investor acquiring shares in an A-share listed company and therefore was subject to, among others, MOFCOM’s approval under the Strategic Investment Measures. According to the Strategic Investment Measures, the foreign investor shall hold more than 10 per cent shares in the A-share listed target, where in this case CNCE Global would hold 52.2 per cent shares of THY post-closing. In addition, the shares issued by THY to CNCE Global as transaction consideration would be subject to a lock-up period of three years.
Furthermore, this transaction also constituted a cross-border share swap under the M&A Provisions, which required approval from MOFCOM. As introduced, under the M&A Provisions, unless the overseas company is an SPV established for the purpose of overseas listing, it shall be a publicly listed company in a location with a sophisticated stock exchange trading system, and its shares shall be listed and traded on lawfully established overseas public stock exchange markets with a stable trading price in the past one year. In this case, the overseas company CNCE Luxembourg is neither within the definition of an SPV nor a listed company under the M&A Provisions. However, according to the transaction report, the requirements under the M&A Provisions were satisfied based on the following reasonings:.
According to the transaction report and other disclosures subsequently made by THY, THY has obtained approvals from SASAC, NDRC (in respect of ODI), MOFCOM (in respect of ODI and strategic investment by foreign investor acquiring shares in an A-share listed company) and CSRC with regard to this proposed transaction.
An interesting takeaway from this case is that when MOFCOM is reviewing such cross-border share swaps, it will tend to look closer at the essence of the transaction. In fact, this is not the first case in which foreign investors have used overseas non-listed equity assets to subscribe for non-publicly issued shares of A-share listed companies. As disclosed in the transaction report dated 11 October 2016,[6] Aerospace Hi-Tech Holding Group Co., Ltd (Stock Code: 000901.SZ) (AHT) intended to acquire (i) 100 per cent equity interests in Hiwinglux S.A. (Hiwinglux, incorporated in Luxembourg) from Eashine International Co., Limited (Eashine, incorporated in Hong Kong) and (ii) 97 per cent equity interests in IEE International Electronics & Engineering S.A. (IEE, incorporated in Luxembourg) from Easunlux S.A. (Easunlux, incorporated in Luxembourg). The consideration for acquisition of Hiwinglux was issuance of new shares of AHT, and the consideration for acquisition of IEE was a combination of issuance of shares of AHT and cash. After completion of such transaction, Eashine became a shareholder of AHT, holding 1.47 per cent of its shares, and Easunlux held 6.21 per cent of shares in AHT.
The aforementioned transaction constituted a cross-border share swap. Different from the requirement under the M&A Provisions, neither Hiwinglux nor IEE was a publicly listed overseas company or an SPV established for the purpose of being listed abroad. According to the transaction report, such transaction had its peculiarities and justification.
AHT’s acquisition of Hiwinglux and IEE was closed in November 2016. AHT successfully obtained approvals from SASAC, NDRC (in respect of ODI), MOFCOM (in respect of ODI and strategic investment by foreign investor acquiring shares in an A-share listed company) and CSRC with regard to this proposed transaction.
In summary, these two cases are similar in nature, although the reasonings given by the professional advisers in their respective transaction reports are slightly different. In these two cross-border share swap cases, the counterparties and the targets are under common control of the same state-owned enterprise; therefore, the transactions are, in essence, considered as an internal reorganisation and integration of state-owned assets. However, because of a lack of public precedents, it is unclear whether non-state-owned enterprises would have a similar chance of convincing MOFCOM to justify their proposed cross-border share swap transactions by arguing an internal reorganisation as well.
Case study II: ENN NG’s acquisition of ENN Energy
As disclosed in the transaction report dated 14 May 2020,[7] prior to the transaction, ENN Natural Gas Co., Ltd (Stock Code: 600803.SH) (ENN NG) was an A-share listed company with one of its major shareholders (holding 5 per cent or more shares) being a foreign investor. ENN NG intended to acquire a certain number of shares of ENN Energy Holdings Limited (2688.HK) (a company incorporated under the laws of the Cayman Islands with its shares listed on the Hong Kon Stock Exchange, ENN Energy) previously held by ENN Group International Investment Limited (a company incorporated under the laws of the British Virgin Islands, ENN Group). The consideration for the above-mentioned acquisition is a combination of asset swap, share swap (through directional issuance of new shares or private placement) and cash. After the transaction, ENN Group will acquire a certain number of shares of ENN NG, and ENN NG will acquire a certain number of shares of ENN Energy. The transaction was closed in September 2020.
According to the disclosure in the transaction report, on one hand, the proposed transaction constituted a strategic investment by foreign investors and therefore was subject to, among others, MOFCOM’s approval under the Strategic Investment Measures and, on the other hand, the proposed transaction satisfied the relevant requirements for strategic investments and ENN Group satisfied the relevant requirements for foreign investors, and ENN Group expected no substantial obstacle in obtaining such approval. ENN NG obtained approval from the China Securities Regulatory Commission, NDRC (in respect of ODI), MOFCOM (in respect of ODI) and SAMR (in respect of merger control), respectively, in connection with the proposed transaction. However, when it made an announcement of the completion of the deal in September 2020, ENN NG listed all the necessary regulatory approvals that it had obtained in connection with the transaction except for MOFCOM’s approval regarding strategic investment. Instead, ENN NG disclosed in the aforesaid announcement that it will further complete the relevant registration with SAMR and report the relevant information of foreign investment to MOFCOM.
Further, probably because ENN NG was a foreign-invested onshore company prior to the transaction, neither the transaction report nor the announcement made by ENN NG mentioned the M&A Provisions.
What observers might find particularly interesting in this case is ENN NG’s understanding of the MOFCOM approval requirement. Apparently, ENN NG understood when it first disclosed the proposed transaction that the currently effective Strategic Investment Measures should be complied with as they had not been repealed or amended, although the proposed transaction seems to fall into the scope of an internal reorganisation as with the two cases in case study I. However, it seemed to ultimately turn to the Foreign Investment Law, which has the higher legislation hierarchy, and kept silent on the analysis of the conflict of laws, even if the Foreign Investment Law had not taken into effect upon completion of the proposed transaction until more than three months later.
Case study III: Shanghai RAAS’s acquisition of GDS
As disclosed in the transaction report dated 26 December 2019,[8] prior to the transaction, Shanghai RAAS Blood Products Co., Ltd (Stock Code: 002252.SZ) (Shanghai RAAS) was an A-share listed company with one of its major shareholders (holding 5 per cent or more shares) being a foreign investor. Shanghai RAAS intended to acquire a certain number of shares of Grifols Diagnostic Solutions, Inc. (a company incorporated under the laws of the United States, GDS) previously held by Grifols, S.A. (a company incorporated under the laws of Spain, Grifols). The consideration for the above-mentioned acquisition is directional issuance of new shares by Shanghai RAAS or private placement. After the transaction, Grifols will acquire a certain number of shares of Shanghai RAAS, and Shanghai RAAS will acquire a certain number of shares of GDS. The transaction was closed in March 2021. Unlike the cases in case study I and case study II, this transaction was not an internal reorganisation.
According to the disclosure in the transaction report, the transaction constituted a strategic investment by foreign investors and therefore was subject to, among others, MOFCOM’s approval under the Strategic Investment Measures. However, when it made an announcement of the completion of the deal in March 2021, Shanghai RAAS listed all necessary regulatory approvals that it had obtained in connection with the transaction except for MOFCOM’s approval regarding strategic investment.
The transaction report also expressly mentioned that as Shanghai RAAS was a foreign-invested onshore company prior to the transaction, the transaction did not constitute a cross-border share swap as prescribed in the M&A Provisions and therefore was not subject to MOFCOM’s approval for a cross-border share swap thereunder.
Unlike the case in case study II, the transaction report for this transaction was disclosed only several days before the Foreign Investment Law came into effect, when Shanghai RAAS still took a conservative approach of interpretation of the then effective Strategic Investment Measures. This transaction was closed after the Foreign Investment Law took effect, and Shanghai RAAS ultimately became silent on the interpretation of the currently effective Strategic Investment Measures.
For decades, PRC laws and regulations consistently asked for, among others, MOFCOM’s approval for cross-border share swaps in which case a foreign investor acquires certain shares of a non-foreign-invested onshore company in consideration of certain shares of another overseas company held by such foreign investor. Nevertheless, unlike other regulatory requirements, such as ODI filings, merger control filing and CSRC’s approval, it had been very difficult, although not impracticable at all, to obtain MOFCOM’s aforesaid approval in practice, which indicates that foreign investors should be rather cautious of taking a shar e swap approach when considering the deal structure in cross-border M&A transactions. However, the aforesaid regulatory barrier has been substantially lifted by the new Foreign Investment Law, except for contemplated transactions falling into the negative list. Certain ambiguity remains because of the conflict of currently effective laws and regulations, and we expect that the M&A Provisions and the Strategic Investment Measures will be amended to bring them in line with the Foreign Investment Law in the near future.
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