When foreign investors acquire a purely domestic Chinese company, a foreign investor might consider taking buy-back arrangement in order to avoid hidden or contingent liabilities. That is common practice in M&A transaction with western jurisdiction. However, such arrangement would not be workable under PRC legal scheme.
Buy-back arrangement means the buyer can request that the seller repurchase the equity interests originally sold to the buyer at a fixed price upon the occurrence of specified events, such as the company’s failure to meet certain milestones or material breaches of representations and warranties by the seller. But such arrangement would not, if challenged, be enforceable under PRC legal scheme.
After a foreign investor acquires Chinese entities or individuals’ equity interest from a purely domestic Chinese company, the target company will be converted into a foreign invested enterprise (“FIE”); then under buy-back arrangement, those Chinese entities or individuals will become the shareholders of the FIE again, which require the approval from the authority, as required by PRC laws. However, it is far from clear as to whether the authority approves such changes of shareholder on the ground of repurchase because there is no any clear guidance under the PRC law on how to deal with such a situation.
Also, the PRC laws in respect of the PRC Equity Joint Venture Law stipulates that unanimous approval of the board of directors should be required for matters such as mergers and acquisitions, and changes to the Articles of Association. Thus, in case of a joint venture, if the directors appointed by the “seller” refuse to approve the repurchase, it is an open question whether the foreign investor can enforce such a clause in the PRC court to obtain board approval.
In light of the foregoing, the foreign investor should be careful in dealing with buy-back arrangement because it would not be enforceable under PRC laws.
By Adam Li