On August 8, 2006, the Ministry of Commerce (MOFCOM), together with the State-Owned Assets Supervision and Administration Commission (SASAC), the State Administration of Taxation (SAT), the State Administration for Industry and Commerce (SAIC), the China Securities Regulatory Commission (CSRC) and the State Administration of Foreign Exchange (SAFE), promulgated the amended Provisions on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (the M&A Rules), which are intended to further regulate the M&A activities of Chinese companies by foreign investors. The regulations took effect as of September 8, 2006. The former Provisional Regulations on Foreign Investors' Merger and Acquisition of Domestic Enterprises was repealed by the new M&A Rules.

Compared with the previous provisions, the M&A Rules introduce the following new provisions that are worth a reminder for all foreign businesspeople intending to enter the Chinese market.

M&A by share swaps

The M&A Rules introduce for the first time M&A by share swaps. A shareholder of an overseas publicly listed company or an offshore company may use its shares or the newly issued shares to purchase the shares or newly issued shares of a domestic company (Chinese target company). The conditions set out for both the acquiring party and the Chinese target company are:

(i) Legally held by shareholders and legally transferable;

(ii) Without ownership dispute, pledge or any other property restrictions;

(iii) Shares of the offshore company are listed and traded in a public and legitimate securities exchange market (excluding the over-the-counter market); and

(iv) Share price of the offshore company is stable for the preceding 12 months.

In addition, in an M&A deal between a Chinese target company and the foreign acquiring party, an independent transaction advisor registered in China (M&A advisor) should be engaged. The M&A advisor shall conduct a due diligence investigation in respect of the truthfulness of the application documents of the M&A deal, financial standing of the acquirer, and whether the requirements as set out in the M&A Rules are satisfied. The M&A advisor will usually be a professional service firm, such as a law, accounting or consulting firm with a good reputation and capability to investigate and analyze the financial status of the overseas company and the legal system of the country or region where the overseas company is registered and/or listed.

Government review of sensitive M&A deals

The M&A Rules incorporate a reporting and review mechanism on sensitive M&A deals, for example if a foreign acquiring party wishes to take control over a Chinese target company which is in a key industry, or has or may have influence on national economic security, or will result in the transfer of control over a Chinese company owning a well-known Chinese trademark. Even though the trading parties in such a deal do not report to the MOFCOM for review, the MOFCOM, together with relevant authorities, may decide at its discretion to initiate such a review and demand termination of the transaction if it determines that material harm will be done to national economic security.

Regulating ‘round-trip investment' and special purpose vehicles (SPVs)

The M&A Rules include new provisions to further regulate "round-trip" investment and offshore companies directly or indirectly owned or controlled by Chinese nationals, which are defined as SPVs in the new M&A Rules. It is now a popular practice for a China-based private company to establish an SPV and then use the SPV to reinvest back in China as a "foreign investor" to hold the assets and business inside China, in an operation usually called "round-trip investment." The M&A Rules provide that the parties to an M&A deal shall disclose any affiliated relationship between the acquiring party and the Chinese target company. If both parties are under the same controller, they shall disclose such control and explain whether the appraisal result reflects the fair market value. The post M&A deal company in such a case shall not be deemed as a foreign-invested enterprise (FIE), unless the acquiring party has also increased the registered capital and contributed the increased registered capital for no less than 25 percent of the target company. The new rules introduced to further regulate SPVs include:

- Approval is required for incorporation of an SPV by a Chinese nationality or Chinese legal person;

- The overseas listing of an SPV must obtain approval from the CSRC;

- Additional documents are required for submission to the MOFCOM if an SPV is the acquiring party of an M&A deal;

- Additional initial approval from the MOFCOM is required if the M&A deal conducted between an SPV and the Chinese target company is a share swap; and

- Thirty days after the listing, the FIE must report to the MOFCOM on the plan to return the proceeds of the offshore offering to the People's Republic of China.

Sabrina Zhang is Regional Partner of Dezan Shira & Associates--

www.dezshira.com