Chinese First Antitrust Law to Take Effect in August: Impact on Foreign Investors Who May Engage In Mergers and Acquisitions in China

Chunsheng Lu is an associate with the firm in Philadelphia where he focuses his practice on general corporate governance, mergers and acquisitions, security, and China related commercial transactions. Mr. Lu was recently invited by China Ministry of Commerce, World Trade Organization Committee, to attend a meeting on China Antitrust Law (to be effective August 1, 2008) execution and enforcement rules. This article was prepared immediately after Mr. Lu’s attendance of the meeting in Beijing, China.

This summer, for most of the foreign individuals, the upcoming 2008 Olympic Games might be the most exciting event in China; for the foreign companies or investors, however, the new China Antitrust Law (the “Law”) may be more important than the Olympics Games.

Background

The Law was enacted on August 30, 2007, approximately 15 years after various attempts and efforts by the Chinese government in establishing a comprehensive antitrust legal framework, and it will become effective on August 1, 2008. The Law consists of 8 chapters and 57 articles in total. Similar with most antitrust laws in other jurisdictions such as the United States and EU, the Law addresses the traditional antitrust issues, including trade cartels, restrictive trade agreements, monopoly power, market concentration through mergers and acquisitions. Unlike many other antitrust laws, the Law also contains a chapter specifically addressing the monopolistic actions by the administrative bodies. This article focuses on the Law’s regulatory structure with regard to mergers and acquisitions that involve one or multiple foreign party(ies) (“Foreign M&A”) and may result in the market concentration.

Concentration of Undertakings

The provisions in the Law regarding the review and approval on Foreign M&A are mostly set forth in Chapter 4 (the Concentration of Undertakings). The term “Concentration” is defined as: (i) mergers between undertakings; (ii) acquisition of control over other undertakings by way of equity or assets acquisition; (iii) acquisition of control over other undertakings by contract or other means. Concentrations that reach a certain threshold level are required to notify the Antitrust Enforcement Authority (an agency newly set up under the State Council pursuant to the Law) (the “AEA”) and cannot be consummated without the AEA’s prior approval. The Law itself does not provide the threshold standards (the “Standards”); rather, it states that the State Council will promulgate the Standards. Further, the Law does not define the term “control” as used in the above definition of “Concentration.”

In March 2008, the State Council of China released for public comment a draft Standards for reviews of concentration. The draft Standards defines “control” as acquiring 50% or more of the equity or assets with voting rights, or becoming the owner of the largest portion of equity or assets with voting rights, or majority voting rights which may actually dominates other undertakings or determine the election of half or more of the members of the board of directors of other undertakings. Most significantly, the draft Standards specifies the threshold standards triggering the notification requirement. According to the draft Standards, the notification is required whenever: (i) the worldwide sales revenue during the previous fiscal year of the companies involved in the concentration exceeds RMB 9 billion and two or more of the companies involved had sales revenue in China during the previous fiscal year exceeds RMB 300 million, (ii) the sales revenue in China during the previous fiscal year of the companies involved in the concentration exceeds RMB 1.7 billion and two or more of the companies involved had sales revenue in China during the previous fiscal year exceeds RMB 300 million, or (iii) the concentration will result in a market share of one party over 25% in the relevant market within China (the “25% Market Share Threshold”).

It is notable that under the Regulations for Merger with and Acquisition of Domestic Enterprise by Foreign Investors (No. 10 Decree), jointly issued by 6 Chinese government ministries including Ministry of Commerce (“MOFCOM”), State-Owned Assets Supervision and Administration Commission of the State Council, General Taxation Bureau, State Administration of Industry and Commerce, China Security Regulatory Commission and State Administration of Foreign Exchange on August 8, 2006, the threshold standards for the antitrust review are different from those of the draft Standards. The No. 10 Decree sets forth the threshold standards as follows: (i) any party’s current year turnover exceeds RMB 1.5 billion, (ii) the number of enterprises in the relevant domestic industries accumulatively acquired by the foreign investor and its affiliated parties exceeds 10 in one year, (iii) the market share of any party of the M&A has reached 20% in China market, or (iv) the market share of the acquiring party after the transaction will reach 25% or more in China market. Any transaction meeting one of the above 4 threshold standards cannot be proceeded without first providing the notification to MOFCOM along with the other requisite documentation.

During the Chinese Antitrust Law meeting, the author raised the question as to which threshold standards should be binding after the Law and the Standards become effective and Mr. Shang Ming, Director of the Antitrust Office, Ministry of Commerce, indicated that the Standards, not the No. 10 Decree, should be binding. Further, Mr. Ming and Mr. Xiaoguang Zhao, Director of Law and Order Department, State Council of China, both indicated that the draft Standards would be subject to some important changes and would be issued by the State Council around August 1, 2008. Among others, the most important changes to the draft Standards, which have not been announced to the public, yet, include the deletion of the 25% Market Share Threshold because of the practical difficulty with regard to the evaluation of the market share.

Required Documentation for Notification

Pursuant to the Law, the acquirer or all of the merger parties (in a situation of a merger) should submit the notification to the AEA and the notification shall include the following: (i) the timing of the anticipated transaction, the involved parties’ names, domiciles, and their business scopes; (ii) a description of the effects of concentration on the competition status in the relevant market; (iii) the concentration agreement or other written arrangement (such as a stock purchase agreement or an asset purchase agreement); and (iv) a financial accounting report of the undertakings for the previous accounting year, which shall be audited by an independent accounting firm. In addition, the Law has a catch-all provision which allows the AEA to request “other documents and information” as it deems necessary.

Review Procedure and Timing

The Law provides that within 30 days from the date of receipt of the complete notification materials from the involved party, the AEA shall make an initial decision as to whether to conduct a further review. If the parties to the transaction do not receive any further review notice upon expiration of the 30 day period, the transaction is deemed to be approved. Where the AEA determines to proceed with the further review, it shall notify the parties of such determination in writing and complete the further review within 90 days from the date of such determination. The Law also provides three situations under which the AEA can extend the 90 day review period, but such extension cannot exceed 60 days: (i) where the parties agree to extend the review period, (ii) where the documents submitted are inaccurate and require further verification, or (iii) where the circumstances have significantly changed after the notification by the parties.

Factors Considered in the Review Process

The Law directs the AEA to consider the following factors in determining whether the concentration exists:

Market share and the ability to control the market;
Concentration degree of the relevant market;
Possibility of eliminating or restricting competition;
Effect on market access and technology advancement;
Effect on consumers and other relevant undertakings;
Effect on the development of the national economy; and
Other factors.

Based on the above factors, the AEA shall make a decision as to whether to allow the concentration. Even if the AEA concludes that the concentration has the effect of eliminating or restricting competition, the concentration can still be permitted if it can be proven that the positive effects of such concentration significantly outweighs the negative effects or if the allowance of the concentration serves the public interest.

Remedies

The remedies for the damages caused by the concentrations in violation of the Law include: (i) an imposition of an administrative fine up to RMB 500,000; (ii) injunction of execution or consummation of the concentration; or (iii) order to dispose shares or assets, to transfer certain business, or to adopt any other necessary measures to revert the market competition condition back to the condition before the transaction.

National Security Check

In addition to the concentration examination, where national security is involved in the case of acquisition of domestic enterprise by foreign capital or the participation by foreign capital in the concentration of undertakings by other means, a national security review will also be conducted in accordance with the relevant laws and regulations. The Law does not address whether the AEA or other government agencies shall have the power of such review. Further, it is not clear whether such national security review is subject to the time limitation as above discussed.

Conclusion

In spite of some uncertainties and ambiguities existing in the Law, it is applause-worthy that China has taken such a significant step forward in constructing its first comprehensive antitrust law. With the Law set to become effective August 1, 2008, it is imperative for the companies doing business in China to familiarize themselves with the Law to avoid the possible violation of the Law with regard to monopolistic conducts and restrictive trade agreements. For those companies intending to merge with or acquire Chinese companies, the thorough understanding of the Law and the Standards is necessary to consummate a transaction smoothly and legally.