By Linjun (Lawrence) Guo

After three decades of rapid growth, China has become the second largest economy in terms of GDP. However, economic development has come at a heavy price, with China facing certain structural problems, and serious social and economic issues such as an ever widening gap between the rich and the poor, a need for new economic driving forces in the wake of a major export slowdown, and excessive infrastructure investments. The new central government has launched some important social and economic measures to tackle many of these key issues, and to push the economy forward towards a more sustainable development. We summarize in this short essay several significant legal developments in mergers and acquisitions and foreign direct investment in China.

 

 

A. LAUNCH OF SHANGHAI (PILOT) FREE TRADE ZONE BY THE STATE COUNCIL

 

 

 

On 29 September 2013, the Chinese government formally established the China (Shanghai) Pilot Free Trade Zone (the “FTZ”) in Shanghai. Pursuant to a collection of rules and regulations issued by the Standing Committee of the National People's Congress, the State Council and the State Administration of Industry and Commerce, the following policies have been implemented in the FTZ:
 

• Shanghai Municipal People’s Government issued the Negative List for foreign investment on September 29, 2013. With the exception of industries listed in the Negative List, examination and approval for foreign investment projects involving any otherwise permitted industries are exempt from foreign investment approval, requiring instead to be filed for record with the relevant governmental authorities.

 

• Additional investment fields have been opened up for foreign investors. In the FTZ, foreign investment in service sectors enjoy liberalized policies. For instance, foreign-funded professional health and medical insurance institutions, foreign-funded credit investigation companies, Sino-foreign equity joint ventures for talent intermediary services, Sino-foreign contractual education and training institutions and other service industries may now be established by foreign investors. Foreign investors may also establish wholly foreign-owned enterprises engaged in international ship management, entertainment venues and medical institutions.

A policy drive of the State Council behind the backdrop of the FTZ is to test a drastic regulatory reform of streamlining and liberalizing regulatory approval requirements in China. Traditionally, such approval requirements have been numerous and burdensome on enterprises. If this experiment proves successful, it is possible that the State Council may adopt the regulatory reform (including the Negative List rule) in other provinces and localities in the future. However, this pilot program is still in its infancy, and there is a long way to go before we will know the result.

B. REFORM OF EQUITY CAPITAL CONTRIBUTION RULES FOR COMPANY INCORPORATION

The equity capital contribution rules under the Company Law have been extensively liberalized by the top Chinese legislative branch. On December 28, 2013, the Standing Committee of the National People's Congress issued the amended Company Law of the People's Republic of China (the “Company Law”). These changes have been further implemented by the State Council and the competent company registration authority.

The main changes of the Company Law are as follows:

 

 

• Minimum company equity capital contribution requirements for incorporation of a company have been removed;

 

 

 

• Actual subscribed capital contributions into the company no longer need to be registered with the registration authority;

 

• The stipulation about the percentage of the equity capital of a company to be made in cash has been removed;

 

• The time period during which the shareholders shall fully pay in their equity capital has been removed. Now, the shareholders may record in the company's articles of association their independently agreed respective amounts of subscribed capital contributions, the method and period of contribution, etc.

 

Additionally, these changes now also apply to foreign-invested enterprises in China through a Notice issued by the Ministry of Commerce dated June 17, 2014. Pursuant to that Notice, Chinese legal requirements or restrictions applied to foreign-invested companies in respect of initial capital contribution, the percentage of the equity capital which must be contributed in cash, the contribution period and the minimum amount of the equity capital have also been removed. It’s no longer necessary to examine the actual contribution of the subscribed registered capital. However, the limit on the ratio between the registered capital and the total investment of a foreign-invested enterprise still applies.

However, there are still 27 special industries in which the previous registration capital contribution and verification requirements still apply. These include, for instances, commercial banks, securities houses, insurance, insurance brokerage, financial assets management companies, trust companies, finance lease, auto finance, consumer finance companies, and joint stock companies incorporated by public placements.

In addition, the State Council also decided to abolish the annual "enterprise inspection system" previously applied to all enterprises in China for many years, and instead has adopted an annual report disclosure system. This will greatly reduce the information collection and disclosure burden of PRC enterprises.
 

C. REFORM OF CHINESE SECURITIES LAW

 

The Chinese securities regulatory authority, China Securities Regulatory Commission (the “CSRC”), imposed a moratorium on initial public offerings (the “IPOs”) in October 2012 subject to further reforms by the Chinese authorities. The CSRC issued the Opinions on Further Promoting the Reform of the System of Initial Public Offerings on November 30, 2013, aiming at reforming the system of the IPOs. The reforms include making underwriters and controlling shareholders responsible for false statements in a prospectus. After a suspension of more than a year, CSRC reopened the IPO market at the beginning of 2014.

The State Council has initiated several important guiding policies in the securities market which are yet to be implemented by the CSRC:
 

• The approval requirement for a significant assets purchase, disposal or restructuring by a listed company will be removed, and such transactions will be subject to less stringent advance vetting by the CSRC. It is foreseen that the CSRC will implement these changes in the second half of 2014. However, a backdoor listing in the form of assets restructuring will be still examined by the CSRC as rigorously as a normal IPO project.

 

• The IPO approval system which has been enforced for two decades is to be abolished and replaced by an IPO registration system in the next few years. The CSRC will likely take a gradual approach in implementing this fundamental reform over the next few years.

D. CHINESE GOVERNMENT STRENGTHENED ENFORCEMENT OF ADMINISTRATIVE REGULATIONS

Chinese authorities strengthened investigation and punishment of commercial corruption, giving and receiving bribes, and monopolistic behaviour starting from 2012. Last year, GlaxoSmithKline (the “GSK”), a UK based drug maker was put under investigation in China for suspicion of accepting cash rake-offs and paying bribes to officials and doctors to boost sales and prices of its drugs in China. Some senior executives from GlaxoSmithKline (China) Investment Co., Ltd. were investigated for suspected bribery and tax-related violations.

Additionally, in January 2013, National Development and Reform Commission (the “NDRC”) penalized Samsung, LG and four Taiwanese firms, Chi Mei Optoelectronics, AU Optronics, Chunghwa Picture Tubes and HannStar Display, with fines totalling RMB 350 million for fixing the prices of LCD screens during the period from 2001 to 2006.

This indicates that all market players in China, regardless of foreign invested companies or domestic enterprises, must pay closer attention to compliance to reduce risks, especially for foreign investors. Companies may take actions such as enhancing internal training, strengthening internal reporting systems, and adopting internal compliance audits and investigations to effectively cope with compliance risks.

This also means that a purchaser in an M&A transaction must investigate and assess the compliance-related risks and contingent liabilities with much more prudence and care. A purchaser should aim to learn to the greatest extent possible any historical non-compliance business activities in the target before seeking price adjustment or other pre- or post-closing remedial measures. In some cases if a non-compliance activity is severe enough, the purchaser may need to consider abandoning the deal.

E. SIGNIFICANT CHANGESOF POLICIES AND REGULATIONS REGARDING OUTBOUND INVESTMENT APPROVAL

The Chinese central government has also liberalized the outbound investment approval requirement in the recent past. The State Council issued the Catalogue of Investment Projects Subject to Government Verification and Approval (2013 Version) (the “Catalogue”) in November 2013. Pursuant to the Catalogue, outbound investment projects in which the amount of Chinese investment reaches or exceeds USD one billion, or which involves sensitive countries and regions or sensitive industries, shall be subject to additional verification and approval by the NDRC. Other than the foregoing projects, overseas investment projects by an enterprise directly administered under the Chinese central government, and projects invested by a provincial-level or local enterprise with a proposed investment amount of more than USD 300 million but less than USD one billion must be reported to NDRC to complete a record-filing procedure.

NDRC has already issued rules to implement the foregoing change in April 2014. The Ministry of Commerce of China (MOFCOM) is likely to amend its rules with respect to outbound investment approval later in 2014.

 

 

This policy and legal change will greatly reduce approval barriers for Chinese investors going abroad, and facilitate Chinese outbound investment transactions. 

 

 

 

Mr. Linjun (Lawrence) Guo is a Beijing-based partner with Global Law Office and admitted to the bars of the PRC and New York State, U.S.A. He specializes in mergers and acquisitions, foreign direct investment, private equity, capital markets, compliance and general corporate.（E-mail: lawrence.guo@glo.com.cn）