Today I will discuss about the effectiveness of the transfer Agreement, in fact sometimes this topic can be a little confusing. One of the main feature of the rules governing equity transfer concerns when an equity transfer agreement (in an “equity” acquisition) is deemed to be effective. Under PRC law, an equity transfer agreement is effective only when it is approved by Chinese authorities (in this sense see Art. 20 of the
Several Regulation on the Change in Equity Interest of Investor in Foreign Investment Enterprise
, 1997, available at the following website:
http://www.lehmanlaw.com/resource-centre/laws-and-regulations/foreign-investment/provisional-regulations-on-the-change-of-equity-interests-among-investors-in-foreign-investment-enterprises-1997.html
) and not when it is executed by parties. It should also be stressed that a sale and purchase agreement in respect of a transaction falling within the scope of the M&A Regulations 2006 has to be governed by the PRC law. This is stated in art. 22 of the M&A Regulations 2006 (a significant departure from existing PRC legal principle, in fact under the General Principle of Civil Law 1997, parties to a foreign-related contract are free to choose the law governing the contract).
It must be underlined, even where a foreign law is chosen to govern the equity transfer agreement, the law governing the transfer of the equity interest will be PRC law. PRC law is the
lex loci situs
as the subject matter of the transfer is a PRC enterprise. In this particular aspect, PRC law is a non-choice and insulated from party autonomy.
Usually after the acquisition of the target company, the next step is to merge it with the buyer’s company (i.e. the acquiring company) though this is not always the rule. A merger can be implemented in one of two ways:
1) Merger by absorption: a company adsorbs another company as a result of which the first company survives, and the adsorbed company is dissolved and ceases to exist. It is important to note that the date of establishment of the post-merger company is the same as the surviving company.
2) Merger by new establishment: Two or more companies merge to form a new company, and the merging companies are dissolved and cease to exist. In this case, the date of establishment of the post-merger company is the date on which it is issued its new business license (in this sense Art. 15 of the so called “FIE M&A Regulations 1999”
http://www.fdi.gov.cn/pub/FDI_EN/Laws/GeneralLawsandRegulations/MinisterialRulings/P020060620325132654936.pdf
).
Inevitably in a merger, the surviving or newly established company succeeds the claims and assumes the debts of each party to the merger (in this sense, Art. 175 of the Company Law 2006, available at:
http://www.lehmanlaw.com/resource-centre/laws-and-regulations/company/the-company-law-of-the-peoples-republic-of-china.html
).
In the merger of two or more companies limited by shares, the registered capital of the post-merger company is the aggregate registered capital of the pre-merger companies. The investor in the pre-merger companies can also agree among themselves their share equity percentages in the post-merger company subject to any State-owned assets valuation requirement. Whereas the post-merger company is a limited liability company, the position is the same as in the case of a merger between two companies limited by shares. Differently, when a merger of a limited liability company with a company limited by shares results in a company limited by share, the registered capital of the post-merger company is the aggregate of: (i) the amount resulting from dividing the net asset value of the limited liability company by the net asset value per share of the company limited by share, and (ii) the aggregate share amount of the company limited by shares (in this sense, Art 11, FIE M&A Regulations 1999, which is available at:
http://www.fdi.gov.cn/pub/FDI_EN/Laws/GeneralLawsandRegulations/MinisterialRulings/P020060620325132654936.pdf
).
It is necessary to stress that a domestic enterprise (DE) refers to a non-foreign invested enterprise. The merger of a foreign invested enterprise and a DE creates a foreign invested enterprise (i.e. a FIE) with a total amount of investment that is the aggregate of the pre-merger foreign investment enterprise’s total amount of investment and the enterprise asset value of the domestic company as recorded in its audited financial statements, as domestic companies do not have a total amount of investment. Therefore, its registered capital will be the aggregate of the registered capital of the pre-merger entities. It is worth remembering that the ratio of registered capital to total amount of investment has to comply with the debt-equity ratio rules applicable to foreign invested enterprises, but a special dispensation can be granted where rules cannot be applied (in this sense, Art. 18 of the FIE M&A Regulations 2001).
Next time I will spend some words on another important theme, namely ‘subscription of new equity and max permitted debt-to-equity-ratios, which represents another nevralgic point concerning the structuring of these transactions.
– CRISTIANO RIZZI