Inside M&A - July/August 2009

Contents

Mergers and Acquisitions in China: Restrictions on Choice of

Governing Law

China Issues Draft Regulations on Anti-Price-Monopoly for

Comments

Chinese Government Issues Finalized Guidelines on Relevant

Market Definition

Mergers and Acquisitions in China: Restrictions on Choice of

Governing Law

McDermott Will & Emery has a strategic alliance

with

MWE China Law Offices, a separate law firm based

in Shanghai. This article was authored by MWE China Law Offices

lawyer David Dai.

As a country with a civil law tradition, the People's

Republic of China has enacted its own written contract law that in

large part adopted the UNIDROIT General Principles of International

Commercial Contracts (an instrument reflecting the general

principles of the international commercial contract law). However,

in the area of Chinese contract law (for the purpose of this

article, Chinese contract law refers to the contract law of

mainland China, exclusive of Hong Kong, Macau or Taiwan), China has

also kept some unique Chinese characteristics along with certain

areas of uncertainty due to the limited experience of its

comparatively young market economy and judicial system. Therefore,

while the content of Chinese contract law is generally within the

normal expectations of most non-Chinese parties, there remain

certain special rules and areas of ambiguity.

As a result, foreign investors in mainland China often prefer to

choose another legal system for reasons of familiarity and greater

certainty. Unfortunately, their choice of governing law may be

limited by their own negotiating strength in commercial

transactions, as well as by various statutory restrictions under

Chinese law. This article attempts to conduct a practical analysis

of these statutory restrictions and their effects on the choice of

law, with respect to mergers and acquisitions in China, and related

implications that may arise from an uninformed choice of governing

law.

General Principles on the Choice of Law Under Chinese Contract

Laws

Chinese law tends to respect the will of parties to a

"foreign-related" contract in choosing a non-Chinese

governing law, subject to the statutory restrictions imposed by

Chinese laws and regulations (Article 145 of the General Principles

of the Civil Law of the People's Republic of China and Article

126 of the Chinese Contract Law).

Whether a contract is foreign-related, therefore, becomes a

precondition for the parties thereof to exercise the right of

choice. In other words, contracts without foreign elements are

governed by Chinese law. According to the judicial interpretations

of the Supreme People's Court (Article 178 of the Judicial

Interpretation of the Supreme People's Court on the Application

of the General Principles of Civil Laws of the People's

Republic of China), to qualify as a foreign-related contract, the

contract must meet one of the following conditions:

At least one of the parties to the contract is

"foreign." For legal entities, this means that the place

of incorporation must be outside mainland China; for individuals,

citizenship must be non-Chinese.

The subject matter of the contract is outside mainland

China.

The formation, modification or termination of contractual rights

and obligations occurs outside mainland China.

The first two of the above items (foreign parties and subject

matter) are comparatively straightforward, but uncertainty still

exists as to the practical meaning of the third item (contractual

rights and obligations outside mainland China). In particular, the

mere fact that a contract was signed outside mainland China may

not, in itself, be sufficient for the contract to be deemed as

foreign related by the Chinese courts.

Chinese law further imposes the following mandatory restrictions

on foreign-related contracts in the choice of non-Chinese law as

the governing law (Articles 6 to 8 of the Regulations Regarding the

Application of Laws for Foreign-Related Civil and Commercial

Disputes dated July 23, 2007, issued by the Supreme People's

Court).

Certain specific categories of contract must be governed by

Chinese law, including most foreign-investment related

contracts.

The application of foreign law will be deemed invalid where it

conflicts with the "public interests of the People's

Republic of China."

Foreign law will not be applied if the relevant choice of law

represents an attempt by the parties to seek to avoid the

application of mandatory provisions or prohibitions of the Chinese

laws and regulations.

Contracts Governed by Chinese Law

While allowing parties to a foreign-related contract to select

non-Chinese law as the applicable law for resolution of a

contractual dispute, Chinese contract law also expressly provides

that Chinese law must apply to Chinese-foreign equity joint venture

(EJV) contracts, Chinese-foreign contractual joint venture (CJV)

contracts, and contracts for Chinese-foreign joint exploration and

development of natural resources that are performed in mainland

China.

Moreover, according to the regulations issued by the Supreme

People's Court in 2007, the performance of the following

additional foreign M&A-related contracts in mainland China must

be governed by Chinese laws:

Equity-interest transfer contracts of foreign-invested

enterprises (FIEs)

Contract-management contracts of EJVs and CJVs in China by

foreign individuals, legal persons or other organizations (known

collectively as "foreigners")

Contracts for the equity purchase of non-FIEs by foreigners

Contracts for the subscription to increase registered capital of

non-FIEs in China

Contracts for the asset purchase of non-FIEs by foreigners

The above regulations are a judicial statement issued by the

Supreme People's Court with respect to judicial proceedings in

mainland China. Non-judicial organizations are not necessarily

bound by these regulations. Nevertheless, in practice, Chinese

authorities such as the Ministry of Commerce (MOFCOM), which are

charged with approving certain foreign M&A-related contracts,

tend to adhere to the regulations.

General Policies on Foreign M&A in China

The Provisions for Foreign Investors to Merge and Acquire

Domestic Enterprises (the M&A Rules), enacted in 2006 by MOFCOM

and five other ministerial government authorities, represented a

major development in China's regulation of foreign acquisitions

of China-based companies and signaled government intentions to

monitor and supervise such foreign M&A activities in China to

an even greater extent.

The M&A Rules set forth the general principles governing

M&A activities by foreign investors in China, including the

following statutory obligations of the parties to such M&A

transactions:

To abide by the laws, administrative regulations and rules of

China, comply with the principles of fairness, reasonableness,

compensation for equal value and good faith, and avoid causing

excessive centralization, excluding or limiting competition,

disturbing the social economic order, damaging the public

interests, or other actions resulting in any loss to state-owned

assets (Article 3 of the M&A Rules)

To satisfy the requirements of the laws, administrative

regulations and rules of China concerning the qualifications of

investors, and to comply with policies on industry, land,

environmental protection, etc. (Article 4 of the M&A

Rules)

To follow relevant provisions on the management of state-owned

assets, if the acquisition of a domestic enterprise involves the

transfer of state-owned property rights of the enterprise and

management of state-owned property rights of listed companies

(Article 5 of the M&A Rules)

To pay taxes under Chinese tax laws and accept the supervision

of tax authorities (Article 7 of the M&A Rules)

To abide by the laws and administrative regulations of China on

the administration of foreign exchange and to follow approval,

registry, archival filing and modification formalities of foreign

exchange control authorities (Article 8 of the M&A Rules)

In addition to the tightened regulation on M&A activities

that may result in either a concentration of control in a given

industry or control of companies in industries that are considered

"key" and "sensitive" in the Chinese economy,

the M&A Rules also stress the necessity of protecting national

economic security in the context of foreign acquisition of domestic

enterprises. Thus, the M&A Rules dictate that foreign investors

must comply with MOFCOM reporting requirements in connection with

acquisitions of domestic target companies engaged in key industrial

sectors that affect or may affect the security of the national

economy, or in connection with acquisitions of domestic target

companies holding well-known trademarks or traditional brands in

China (Article 12 of the M&A Rules).

To ensure compliance with the above statutory...