- Tentative Provisions on Relevant Issues Concerning Implementation of the Security Review System of Foreign Mergers and Acquisitions of Domestic Enterprises
- April 8, 2011 | Authors: John V. Grobowski; Yiqiang Li; Wendy Yan
- Law Firm: Faegre Baker Daniels - Shanghai Office
Quickly following the lead of China's State Council, the Ministry of Commerce (MOFCOM) has issued temporary rules clarifying important procedural issues related to the council's Notice on the Establishment of a Security Review System for Foreign Mergers and Acquisitions of Domestic Enterprises (M&A Security Review Notice), which was published on February 3, 2011. The M&A Security Review Notice, summarized in the March 2011 issue of China Law Update, requires a security review when foreign investors take control of a domestic enterprise in any of a number of broadly defined sectors that involve "national security." MOFCOM released the Tentative Provisions on Relevant Issues Concerning Implementation of the Security Review System of Foreign Mergers and Acquisitions of Domestic Enterprises (Security Review Implementation Provisions) on March 4, 2011, in an attempt to clarify who must file a security review application, when such applications must be filed, and how.
The Security Review Implementation Provisions are scheduled to expire in less than six months, on August 31, 2011. Because these provisions were released so quickly, MOFCOM officials have said the agency will follow and assess their implementation, improving them based on comments from the public. MOFCOM is expected to release a more complete version before expiration of the tentative provisions.
Security Review Application
Under China's existing legal regime, MOFCOM or its provincial or local offices must approve every merger or acquisition involving a domestic enterprise and a foreign investor, regardless of the industrial sector and national security implications. That approval review focuses primarily on the sector and business scope of the foreign investment. The transaction cannot proceed without such approval.
The M&A Security Review Notice adds another layer of review for transactions in sectors that involve national security. Pursuant to the Security Review Implementation Provisions, a foreign investor contemplating a merger with, or an acquisition of, a domestic enterprise that is subject to the M&A Security Review Notice should file an application for security review with MOFCOM. Though not explicitly stated in the Security Review Implementation Provisions, it seems logical that the foreign investor must file the security review application before submitting an application for approval review to MOFCOM or its provincial or local offices.
Two or more foreign investors participating in the same transaction may jointly file a security review application, or they may designate one investor to file the application. The investor who submits the application is referred to as the applicant.
If a proposed transaction is subject to security review but the foreign investor fails to file a security review application, MOFCOM offices are directed to suspend the approval review process and require the foreign investor to submit a security review application in writing to MOFCOM. Provincial, and local MOFCOM offices are also required to report the proposed transaction to MOFCOM.
Application Documents Required for Security Review
The Security Review Implementation Provisions stipulate that the following documents are required for a security review:
- An application letter and a statement of the proposed transaction, both signed by the legal representative or authorized representative of the applicant
- Identity certificate or registration certificate and certificate of good standing of the foreign investor or investors, all of which have been notarized and authenticated
- Identity document of the foreign investor's legal representative or a power of attorney granting authority to the authorized representative, and the identity document of the authorized representative
- Basic statement regarding the foreign investor or investors and affiliated enterprises (including the de facto controller and persons acting in concert) covering, among other things, the relationship between the foreign investor(s) and the governments of relevant countries
- Corporate documents of the target domestic enterprise, including articles of association, business license, audited financial statements, and organizational chart before and after the transaction, as well as a summary statement about the enterprises in which the target domestic enterprise is invested
- Relevant transaction documents:
For an equity transfer or agreement to increase a capital subscription, the shareholder resolution, transaction agreement, and an asset appraisal report of the target enterprise are required
For an asset transfer, the shareholder or board resolution in connection with the asset transfer, transaction agreement, and an asset appraisal report are required
- Documents regarding the post-transaction influence the foreign investor or investors will have on the target company, such as a statement showing the voting rights of the foreign investors and a statement on the transfer of control rights from domestic investors to foreign investors
MOFCOM's Acceptance of a Security Review Application and Suspension of MOFCOM's Approval Review
After receiving a security review application, MOFCOM has 15 working days to review the application and decide whether the proposed transaction must undergo security review. If a security review is deemed necessary, MOFCOM is required to notify the applicant in writing within this 15-day period and then, within the next five working days, forward the application to the Joint Ministerial Panel established by the State Council in the M&A Security Review Notice. During the 20 working days allowed for that preliminary and general security review, MOFCOM offices are required to suspend their ordinary approval review of the proposed transaction, and the applicant must not proceed with the transaction. The Joint Ministerial Panel, which is led by MOFCOM and the National Development and Reform Commission (NDRC), then has 30 working days to conduct its first, or "general," review, as specified in the M&A Security Review Notice.
If MOFCOM decides a security review is not necessary, it will not issue a written notice to the applicant. Thus, if the applicant does not receive a written notice from MOFCOM within 15 working days of MOFCOM's acceptance of a security review application, it may apply for approval review with the appropriate MOFCOM office.
As provided in the State Council's M&A Security Review Notice, a transaction that potentially affects national security is first given a "general review" by the Joint Ministerial Panel, which solicits the opinions of relevant government agencies. If the proposed transaction does not pass this general review (that is, if the panel decides there is reason to be concerned about the deal's impact on national security), the Joint Ministerial Panel will undertake a "special review."
As noted in the March issue of China Law Update, if all those agencies hold the view that the deal under review does not have any impact on national security, a special review will not be initiated. The Joint Ministerial Panel should make a final review conclusion based on the comments of agencies that were consulted, and notify MOFCOM of its decision within five working days of collecting the agencies' comments.
If any agency thinks the deal under review may have an impact on national security, the Joint Ministerial Panel should initiate a special review within five working days of receiving the agency's written comments. For the special review, the panel will coordinate a security assessment of the proposed deal, and then review the transaction based on the results of that assessment. If there is great divergence in security review opinions, the panel should submit a report to the State Council for rendering of a final decision. The panel is required to complete its special review within 60 working days.
Once the panel has completed the entire review process, it notifies MOFCOM of its decisions in writing. MOFCOM then issues the review decisions in writing to its provincial or local offices as well as the applicant. The Security Review Implementation Provisions clarify this process:
- If the proposed deal is deemed not to have an impact on national security, the applicant may proceed with the ordinary approval review process with the appropriate MOFCOM office.
- If the proposed transaction is deemed to have a potential impact on national security, the applicant must make adjustments to the proposed transaction and modify its application documents accordingly. Though the Security Review Implementation Provisions are not clear on this process, MOFCOM will presumably tell the applicant what adjustments are necessary. The deal must then undergo security review once again.
- If the Joint Ministerial Panel decides the proposed transaction would have a significant impact on national security, MOFCOM should, based on the panel's results and together with other relevant agencies, order termination of the transaction, or require the foreign investor to take effective measures, such as an equity transfer or asset transfer, to eliminate the impact.
- If MOFCOM has determined that a proposed transaction does not require security review, or if the Joint Ministerial Panel decides after general review that the transaction does not have an impact on national security, and later adjustments to the deal make it subject to security review, the parties must immediately suspend the deal, and the foreign investor must submit a security review application.
The Security Review Implementation Provisions also clarify what should happen if an applicant modifies its application documents or withdraws a transaction after MOFCOM has forwarded a security review application to the Joint Ministerial Panel for review. In that event, the applicant should submit an application for the modification or withdrawal to MOFCOM. MOFCOM is then required to forward the modification or withdrawal application to the panel within five working days.
Relevant departments of the State Council, relevant national industrial associations, enterprises in the same industry as the domestic enterprise to be acquired, and upstream or downstream enterprises may suggest a security review to MOFCOM by submitting statements about the transaction, including basic information and the impact of the transaction on national security. MOFCOM will forward such suggestions to the Joint Ministerial Panel within five working days if a security review is necessary. Upon confirmation from the panel that a review should be conducted, MOFCOM will require the applicant to submit a security review application.
The Security Review Implementation Provisions to some extent provide procedural transparency and certainty in how MOFCOM should process security review applications. Still, a number of issues remain unclear ¿ for example, the department of MOFCOM to which a security review application should be submitted. In addition, given the broad definition of sectors subject to security review in the State Council's M&A Security Review Notice, foreign investors may lack sufficient guidance in determining whether a contemplated transaction is subject to security review.
Moreover, unlike MOFCOM's merger control decisions, where the agency is obliged to publicly announce a decision to block or impose restrictive conditions on a transaction, MOFCOM is not obliged by either the M&A Security Review Notice or the Security Review Implementation Provisions to let the public know the results of the review process. This lack of disclosure may present some difficulty for foreign investors in learning how security reviews are processed, and in helping them assess and predict results of the review process and the impact on their own investments. On the other hand, we also expect that authorities will learn from experience and become increasingly sophisticated in handling security reviews.
There is also some concern that provincial and local governments might refrain from reporting transactions that potentially involve national security to MOFCOM since doing so would cede control over the transaction to the central government. In such cases, the central government might block or alter deals that local or provincial government officials deem beneficial to the local or regional economy. It has been reported that MOFCOM is aware of this potential problem and will pay attention to it.
As MOFCOM is soliciting public comments (from March 10 to April 10) on the Security Review Implementation Provisions, the rules may be subject to further revision. China Law Update will closely monitor any new developments.