| On February 3, 2011, the PRC State Council (the “State Council”) promulgated the Circular on Establishing the Security Review System for Merger and Acquisition of Domestic Enterprises by Foreign Investors (the “SR Circular”) . On March 4, following up the SR Circular, the Ministry of Commerce (the “MOFCOM”) issued the Interim Provisions for the Issues Concerning the Implementation of the Security Review System for Merger and Acquisition of Domestic Enterprises by Foreign Investors (the “Interim SR Rules”) . After a trial implementation period of about six months of the Interim SR Rules on the security review system, the MOFCOM have formulated the Provisions for the Implementation of the Security Review System for Merger and Acquisition of Domestic Enterprises by Foreign Investors (the “SR Rules”) , which was promulgated on August 25, 2011, and shall take effect as of September 1, 2011. Thus China has established its own national security review mechanisms for Merger and Acquisition (“M&A”).
I. Definition and categories of M&A of domestic enterprises by foreign investors
According to the scope of M&A defined by the SR Circular, there are four scenarios that can be considered as M&A of domestic enterprises by foreign investors:
a. When a foreign investor purchases the equities of a domestic non-foreign-invested enterprise or subscribes to the capital increase of the domestic non-foreign-invested enterprises to alter it into a foreign-invested enterprise;
b. When a foreign investor purchases the equities of the Chinese shareholder of a domestic foreign-invested enterprise or subscribes to the capital increase of the domestic foreign-invested enterprise;
c. When a foreign investor establishes foreign-invested enterprises and purchases the assets of a domestic enterprise through the foreign-invested enterprises and operates the assets according to the agreements signed, or when a foreign investor purchases the shares of the domestic enterprise through the foreign-invested enterprises.
d. When a foreign investor directly purchases the assets of a domestic enterprise and utilizes the assets to invest and establish a foreign-invested enterprise to operate the assets.
II. The scope of security review
The scope of security review includes two aspects: A. the M&A by foreign investors of domestic military-industrial and military related enterprises, neighboring enterprises of key and sensitive military facilities and other units concerning national security; B. the M&A by foreign investors of such domestic enterprisers as major farm products, energy and resources, infrastructures, transportation services, key technologies and major equipment manufacturing related to the national security.
The enterprises that fall under the B category shall only be reviewed in cases where the actual control right may be gained by foreign investors. “Actual control” means that the foreign investor becomes the controlling shareholder or actual controller of a domestic enterprise through M&A, including the following scenarios：a. The total shares held by one foreign investor, its controlling parent company and subsidiary account for more than 50% after M&A; b. The total shares of several foreign investors account for more than 50% after M&A; c. The voting power of the foreign investor has major influence on the decision making process of the board of shareholders or the board of directors, even though the foreign investor’s shares account for less than 50% after M&A; and d. Other situations that may cause the actual control right to operation, decision making, finance, personnel and technology, etc. of a domestic enterprise to be transferred to a foreign investor.
As a result of the vague wording of the stipulation, it is unclear as to which specific industry shall be reviewed under the SR Circular. However, there is an unofficial list which contains 57 industries for security review that has been circulated within the legal community. The MOFCOM has neither published the list on its website nor has it denied its existence. Perhaps MOFCOM considers that a vague and obscure position leaves it more with flexibility to decide whether or not to apply the list of industries to particular transactions, or to modify the list in the future.
III. The Joint Conference mechanism and the content of security review
A system of ministerial joint conference (the “Joint Conference”) was established to conduct security review of M&A, under the leadership of the State Council, and with the involvements of the National Development and Reform Commission (the “NDRC”), the MOFCOM, and other pertinent departments.
The security review shall take into account the following aspects of the M&A :
a. its effect on the national security, including the production capacity of domestic goods, domestic service capacity and related equipments and facilities regarding the needs of national defense;
b. its effect on the stability of national economy;
c. its effect on the basic living order within the society; and
d. its effect on the research and development capacity of key technologies related to the national security.
IV. The procedures for security review
1. Pre-filing Consultation
Before filing a formal application with the MOFCOM for M&A security review, the applicant may file a consultation request with the MOFCOM regarding procedural issues related to its merger with or acquisition of a domestic enterprise and communicate relevant information in advance. The pre-filing consultation is not a necessary procedure for submitting a formal application, and the consultation does not have a legal and binding effect and shall not be treated as the basis for submitting a formal application.
2. Filing an application for security review
The security review procedure can be initiated under three circumstances:
a. Where the M&A falls under the scope of security review as specified in the SR Circular, the foreign investor shall file an application for M&A security review with the MOFCOM.
b. Where local departments in charge of commerce have received an M&A application which is subject to the M&A security review but the applicant has not filed an application for M&A security review with the MOFCOM, such local departments shall suspend the processing of application and shall require the applicant to file an application for M&A security review with the MOFCOM in writing within 5 working days and shall report the relevant information to the MOFCOM at the same time.
c. Where a foreign investor mergers with or acquires a domestic enterprise, and where relevant departments under the State Council, national industry associations, enterprises in the same industry, or upstream or downstream enterprises believe that a security review needs to be conducted of such M&A, they may make proposals for an M&A security review to the MOFCOM and submit explanations with regard to the circumstances in question, and the MOFCOM may request interested parties to submit relevant explanations. Where the transaction is subject to M&A security review, the MOFCOM shall submit its recommendations to the Joint Conference within 5 working days. Where the Joint Conference believes that the M&A security review is indeed necessary, the MOFCOM shall, based on the decision of the Joint Conference, require the foreign investor to file an application for M&A security review.
3. Submission of documents
In accordance with the SR Rules, the applicant shall submit the following documents when filing a formal application for M&A security review with the MOFCOM:
a. An application letter and form for M&A security review and a description of the transaction signed by the legal representative or the authorized representative of the applicant;
b. The foreign investors’ identity certificates or certificates of registration, as well as credit certifications, notarized or authenticated in accordance with law; the legal representative’s identity certificate or the foreign investors’ authorization of power issued to their authorized representatives, and the authorized representative’s identity certificate;
c. A description of the foreign investors and their affiliates (including their actual controlling persons and persons acting in concert), and their relationship with the relevant national governments;
d. A description, as well as the articles of association, business license (photocopy), audited financial statements of the previous year, and the pre- and post- M&A organization charts of the domestic enterprise to be merged or acquired, as well as a description and the business license(s) (photocopy) of enterprises in which it has invested;
e. The contract, articles of association, as well as list of the board members to be appointed by the parties, and the general manager, partners, and other senior managerial personnel of the proposed post- M&A foreign-invested enterprise;
f. In cases of stock-based M&A, the stock transfer agreement or the agreement on the foreign investor’s subscription to the capital increase of the domestic enterprise, the domestic enterprise’s shareholders’ resolutions and resolutions from a general shareholders’ meeting, as well as relevant asset evaluation reports;
g. In cases of asset-based M&A, the resolutions consenting to the sale of the assets by the domestic enterprise’s governing authority or holder(s) of assets, asset sales agreement (including a list of the target assets and their status), information on all parties to the agreement(s), as well as relevant asset evaluation reports;
h. Explanation of the impact that the voting rights to be enjoyed by the foreign investor after the M&A will have on the implementation of shareholders meetings resolutions, board resolutions, and partnership affairs, as well as explanations of other circumstances that will result in a transfer of actual control of matters such as operational decision-making, finance, personnel and technology to foreign investors or their domestic or overseas affiliates, as well as agreements and documents relating to the aforementioned circumstances;
i. Other documents as required by the MOFCOM.
4. Acceptance of the application by MOFCOM
Where a transaction is subject to M&A security review, the MOFCOM shall notify the applicant in writing within 15 business days after the submission of the application. During the 15-business-day period commencing from written notification to the applicant of the receipt of its application, the Applicant shall not carry out the M&A transaction, and the local department in charge of commerce shall not approve the M&A review transaction. After 15 business days, if the MOFCOM has not notified the applicant in writing, the applicant may complete the relevant procedures in accordance with relevant state laws and regulations.
5. The security review
a. The MOFOM shall submit the transaction to the Joint Conference for review within 5 business days after issuing the notice to the applicant requesting security review.
b. The Joint Conference asks from relevant departments for advice within 5 working days upon receiving the application of the MOFCOM for security review.
c. The relevant departments should raise written opinion within 20 working days upon receiving the letter of written request for advice.
d. Special review shall not be conducted, provided that relevant departments all hold that M&A doesn’t affect the national security, and the Joint Conference shall be responsible to raise the review opinion within 5 working days upon receiving all written advice and notify the MOFCOM in writing.
e. If some department deems that M&A may affect the national security, the Joint Conference should start the procedures for the special review within 5 working days, after which the Joint Conference organizes security evaluation of M&A and conduct security review of M&A, based on the conclusion of the security evaluation. If consensus can be reached within the Joint Conference, the Conference will present the conclusion of the security review; otherwise when there is major disagreement within the Joint Conference, the Conference shall report to the State Council for a final decision. The Joint Conference shall complete the special review within 60 working days as of the starting date of the procedures for the special review, or in cases where there is major disagreement, report to the State Council for decision, with the MOFCOM notified of the review opinion in writing.
f. Within 5 business days following its receipt of the written review opinion of the Joint Conference, the MOFCOM shall provide written notification of the review opinion to the applicant (or the party concerned) and to the local department in charge of commerce and responsible for administration of M&A transactions.
g. Where an applicant amends the filing documents, cancels the M&A transaction or supplements, amends materials as required by the Joint Conference after the MOFCOM submitted the transaction to the Joint Conference for review, the applicant shall submit relevant documents to the Joint Conference. The Joint Conference shall, within 5 business days after receipt of the application report and relevant documents, submit such report and documents to the Joint Conference.
V. Legal result of the security review
a. With respect to a transaction that will not have an impact on national security, the applicant may complete the M&A transaction formalities with the relevant administrative department with corresponding administrative authority.
b. With respect to a transaction that may have an impact on national security and has not been carried out, the applicant shall terminate the transaction. The applicant shall not apply for or complete the M&A transaction without first making adjustments to the M&A transaction, amending the filing documents and undergoing review again.
c. Where the M&A has already produced or may produce a serious impact on national security, based on the review opinion of the Joint Conference, the MOFCOM shall, along with relevant departments, terminate the transaction, or take measures such as transferring the equity or assets in question or other effective measures to eliminate the impact of such M&A on national security.
VI. Other rules
With regard to the M&A of domestic enterprises undertaken by foreign investors, the authorities should judge whether such transaction is subject to the security review based on the essential content and actual impact of the transaction. Foreign investors shall not avoid M&A security review through any means, including but not limited to commissioned shareholdings, trusts, multi-level investments, leases, loans, contractual control, and overseas transactions.
In cases where an application for M&A of a domestic enterprise by a foreign investor was not submitted to the Joint Conference for review or the Joint Conference, having reviewed a submission, has determined that a proposed M&A would not have an impact on national security, but thereafter, due to changed circumstances, such as modification of the merger, change of business activities or acquisition transaction or amendment of the relevant agreements or documents or other changes (including alteration of overseas actual controlling person), such M&A transaction becomes subject to security review as stipulated in the SR Circular, the parties concerned shall cease the transaction and activities, and the foreign investor shall file an application for M&A security review with the MOFCOM.
China’s national security review mechanisms for M&A exclude the merger and acquisition of the domestic financial institution by foreign investors.