The ins and outs of M&As in China: Considerations when drafting contracts

By Dr. Ulrike Glück

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Foreign companies wanting to invest in China may either embark on a greenfield investment or acquire an existing Chinese company (M&A project). As is the case in other jurisdictions, China also has extensive laws and regulations governing acquisitions. The basic principles are identical. In M&A projects, the parties involved can opt for either a share deal or an asset deal.

Key features

Foreign investors must be aware of certain specific provisos that they should take into consideration when planning deals in China:

Unlike in Western countries, China has special regulations that only apply to the acquisition of domestic companies by foreign investors. These special regulations  not only influence the regulatory procedures for an acquisition, they also impact the range of possibilities available for the deal structure and the content of contract clauses.

As a matter of principle, foreign investment in China is subject to approval and is not possible in all industry sectors. The permissibility and form of foreign investment are subject to the Regulations on Foreign Investment Guidelines as well as the Guideline Catalogue of Foreign Investment Industries (Guideline Catalogue). The latest version of the Guideline Catalogue came into effect in 2015. An updated draft version was issued in December 2016 and is expected to be enacted soon.

The abovementioned regulations also allocate industrial sectors to the following four categories: encouraged, permitted, restricted and prohibited. The Guideline Catalogue also stipulates whether all the shares in a company in a particular industry sector may be held by foreign shareholders (wholly foreign-owned enterprises, or WFOEs), whether only joint ventures can be established, and whether only Chinese-majority shareholding is permitted. The restrictions stipulated in the Guideline Catalogue apply to both greenfield investments and M&A projects. If only joint ventures are allowed in a particular industry sector, it is not possible for foreign investors to acquire all the shares in a domestic Chinese company.

Access to the market has improved greatly over the last decade, but there are still restrictions in place in more sensitive sectors such as telecommunications, energy and primary education.

As mentioned previously, all foreign investment in China is subject to approval and registration. Partial reform in October 2016 reduced some of the red tape for greenfield investments made by foreign investors and for corporate changes to existing foreign invested enterprises (FIEs), including share transfers in FIEs that do not fall into the so-called Negative List. For projects such as these, approval procedures have been replaced by recording procedures. The Negative List corresponds with the restricted and prohibited categories under the Guideline Catalogue as well as projects in the Guideline Catalogue that are encouraged but are subject to shareholding ratio restrictions. Unfortunately, however, the reform did not apply to the acquisition of domestic companies by foreign investors. This remains subject to approval.

Importance of the investment vehicle

When acquiring shares or assets, foreign investors may select from three types of investment vehicles to make their purchase:

  • Option 1: a foreign company
  • Option 2: a foreign-invested holding company incorporated in China
  • Option 3: another FIE already established in China that is not a foreign-invested holding company, but rather a production and/or trading or service company

Legally speaking, foreign-invested holding companies established in China are also FIEs and both are legal entities under Chinese law. Despite this, however, foreign-invested holding companies are subject to the same special laws and regulations as foreign investors when acquiring domestic Chinese companies. Therefore, the restrictions laid down by the Guideline Catalogue must be taken into consideration even with Option 2. Further, both Option 1 and Option 2 are subject to the Provisions on Merger and Acquisition of Domestic Enterprises by Foreign Investors (M&A Provisions) which stipulate that both share deals and asset deals are subject to approval and registration by the Authorities of Commerce under the PRC Ministry of Commerce (MOFCOM). The M&A Provisions state that the provincial authorities of commerce are in charge, but the power to approve has in effect been largely delegated to the Authorities of Commerce at the city or district level. Likewise, the Administrations for Industry and Commerce (AIC), again at the city or district level, are in charge of registration.

According to the M&A Provisions, share purchase agreements and asset purchase agreements only become effective once approved. They are mandatorily subject to Chinese law.

Option 3 is more flexible and involves considerably less red tape. Share transfers do not  require approval from the Authority of Commerce; they just have to be registered with the competent AIC. Prior to June 2015, it was difficult for foreign investors to use any FIE other than a holding company as an investment vehicle. This is because existing FIEs could only use their own profits or cash flow to finance the acquisition, and these were often not sufficient for larger acquisitions. FIEs were not allowed to use their registered capital for equity investment. The use of loans was theoretically possible, but only in the form of M&A loans that, in practice, are only granted to domestic state-owned enterprises. Since 2014 in the Chinese free trade zones and June 2015 throughout China, the situation has improved due to the relaxation of the relevant foreign-exchange control regulations. Today, all FIEs may use their foreign-exchange registered capital or the RMB converted from their registered capital to make equity investments.

Less red tape is not the only advantage of Option 3: It also offers more flexibility for deal structuring and contractual agreements than Options 1 and 2.

Contract clauses

As is the case elsewhere, share-purchase or asset-purchase agreements in China also have to include the following minimum information: names and addresses of the parties to the contract, object of the agreement (the shares or assets to be transferred), purchase price and taxes, closing conditions, closing and closing date, covenants of the seller and the target between signing and closing, representations and warranties of the seller, liability for breach of contract, governing law and dispute resolution.

However, some clauses and structures that are standard or common in Western countries are less common in China. In Options 1 and 2, some of these clauses and structures are not even possible due to regulatory restrictions. This applies, in particular, to earn-out clauses as well as for clauses providing for a flexible purchase price or a purchase-price adjustment.

In general, purchase prices are subject to the agreement of the parties. An exception to this is if the seller is a state-owned enterprise, in which case the shares or assets constitute state-owned assets. They must be specifically appraised and the appraisal is then subject to approval by or registration with the state-owned Assets Supervision and Administration Commission. The purchase price may not be lower than 90% of the appraised value and the sale must be made by public tender through the Equity Change Center.

Acquisitions subject to the M&A Provisions must go through an approval procedure. In practice, many Authorities of Commerce insist that the contract states a fixed purchase price. Acquisitions by foreign investors must also be registered with the competent State Administration of Foreign Exchange (SAFE). Even if the approval authority is flexible, the purchase price must be fixed prior to registration with the SAFE. This poses difficulties for flexible purchase prices or purchase-price adjustments.

According to the M&A Provisions, the full purchase price for the shares or assets must be paid within three months of registering the transfer with the AIC. If approved by the Authority of Commerce, payment in installments is permitted, with the first installment constituting at least 60% of the total purchase price and paid within six months of registration. The remaining purchase price must be paid within one year of registration. Earn-out clauses usually cover a term of two to three years. Due to the abovementioned regulatory restrictions for projects subject to the M&A Provisions straightforward earn-out clauses are not possible. The parties concerned generally try to achieve the same result by means of consulting or service contracts.

Option 3 is the most flexible one. Since acquisitions through an FIE are not subject to the M&A Provisions, they are also not subject to the corresponding regulatory restraints. If shares in a domestic Chinese company are bought by an FIE, flexible purchase-price clauses and price adjustments as well as earn-out clauses are possible. An asset deal entails even less red tape because the asset transfer agreement need not be registered with Chinese authorities. Exemptions do exist however for assets such as real estate and intellectual property rights, whose transfer must be registered with the competent authorities. In order to take effect in rem. This would be the real estate authority for the transfer of real estate, the Intellectual Property Office for the transfer of patents, and the State Trademark Office for the transfer of trademarks.


Foreign investors seeking to acquire domestic Chinese companies should be aware of certain Chinese regulatory characteristics. Using the most appropriate investment vehicle is essential for governmental procedures and flexibility in structuring deals. Using an existing FIE as the buyer can significantly reduce red tape and increase flexibility for contractual agreements.

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