Part I of this article appeared in the March 2008 issue of The Metropolitan Corporate Counsel. It dealt with the change in Chinese industrial policies toward foreign investment such as the shift away from measuring quantitatively the total amount of investment toward more selectively targeting certain vital industries that affect strategic segments of the Chinese economy.
The Merger-Control Antitrust Rules Regulating Foreign Investment
Sometimes, even if an acquisition does not take place in China, it may still come within the Chinese antitrust legal regime. For example, in the case of an acquisition outside China, if the party to the acquisition (either the acquirer or the acquired party) will directly or indirectly hold equity ownership in more than 15 enterprises in China in the same or similar industry as a result of the acquisition, the contemplated acquisition must be reported to the Chinese government for a pre-merger antitrust review.
Before the Chinese Anti-Monopoly Law takes effect this August, the current merger-control antitrust rules are contained in Decree No. 10 and they apply to "offshore acquisitions," (i.e., the transaction takes place outside mainland China) as well as "onshore acquisitions" involving foreign investment. The parties to a concerned merger or acquisition shall submit the merger or acquisition proposal to the Chinese government if the contemplated transaction hits the thresholds stipulated in the relevant regulation.
The Ministry of Commerce and the State Administration for Industry and Commerce may, upon the request of the relevant competitors, the relevant functional departments or industry associations, subject a certain transaction to the merger-control antitrust filing if they think that the contemplated acquisition will involve a "very large market share or seriously affect market competition."
In the recent French Groupe SEB's acquisition of the leading Chinese cookware manufacturer, Supor Company, it is the competitors who requested the Ministry of Commerce to hold a hearing to review whether the transaction would have a negative impact on competition in the relevant market. For this case, the Ministry of Commerce launched the first Chinese merger-control antitrust hearing and investigation.
In 2007 the Ministry of Commerce issued new pre-merger antitrust filing guidelines, which require more detailed documentation and information from the applicants, set out a more transparent timeframe for the Ministry of Commerce to conduct the antitrust review, create an informal pre-filing consultation mechanism to enhance the transparency and predictability of the pre-merger filing process, and detail the approach to keeping filed information confidential. For example, they make clear that it shall be the party who initiates the concerned merger or acquisition who performs the pre-merger filing, but the filing can also be done by the party to be merged with or acquired. In the latter case, the parties may jointly or separately file the pre-merger filing. A pre-merger filing shall be made prior to the public announcement of the transaction or with the filing with the competent antitrust authority of the country where the parties are located.
The Employment Contract Law
Beginning in 2008, China has a new law - the Employment Contract Law. There are several significant changes brought about by this new law, which can be summarized as follows.
In contrast with the old law under which an employee can ask to sign an open-term employment contract only if he/she has been employed for 10 consecutive years by the same employer and the employer agrees to renew the employment contract, the new law imposes the obligation on an employer to sign an open-ended employment contract with its employee if the employee has completed two fixed-term employment contracts (regardless of the length of the contracts) with the same employer (unless the employee has serious misconduct or cannot physically be competent to carry out the job responsibilities according to the relevant provisions of the Employment Contract Law).
While the old law did not oblige an employer to pay severance pay to an employee when his/her contract expires, the new law requires that an employer pay severance pay to his employee at the time of the expiration of an employment contract, unless the concerned employee does not agree to extend the employment contract when the employer offers such contract extension on the condition that the terms of the contract will not be weakened.
Unlike the old law, which provides no detailed rules for non-compete restrictions, the new law explicitly states that non-compete restrictions shall not exceed two years following employment termination, and may only apply to senior management, technical personnel and employees with a confidentiality obligation. In exchange for non-compete covenants by the employee, an employer must make financial compensation to the employee. Differing from the old regulations on non-compete issues, the new law makes it clear that such compensation must be paid in monthly installments during the post-termination non-compete period.
The new law adopted a democratic procedural rule relating to an employer's adoption or amendment of its rules and codes of conduct directly related to employees' interest - such as remuneration, working hours, vacation, safety and health, insurance and welfare, training and discipline. Specifically speaking, before adoption of such rules and codes of conduct, an employer must complete the following three steps:
Step 1: Discussion . The employer shall discuss its draft rules at the "employee representative congress" or a meeting of all employees (i.e., 100 percent of the employees of an employer), and the employees may raise proposals to and comments on the draft;
Step 2: Negotiation . The employer shall negotiate with the labor union or the employee representatives to decide upon its rules; and
Step 3: Public announcement or notification otherwise . The employer shall publicly announce (e.g., by holding a meeting of all the employees) to all of its employees the newly determined rules, or otherwise inform all of the employees individually of the same.
If an employer fails to follow these procedures, the government may order it to rectify its failure to act, and the employer shall also indemnify the employees in case it causes damage to employees. In the implementation of the rules and codes of conduct, the labor union or employees are entitled to request amendments if they deem certain rules improper.
The New Corporate Income Tax Law
As of 2008 China has a new corporate income tax law ("CIT Law"). It is the first unified tax law regulating both domestic companies and companies owned by foreign investors.
Under the new CIT Law, foreign-invested enterprises will enjoy a lower tax rate at 25 percent compared to 33 percent under the old law, but will no longer be entitled to those tax preferential treatments (such as the 15 percent tax rate for those incorporated in the five special economic zones, and the "2-year exemption and 3-year half rate" for manufacturing-type companies whose corporate term is no less than 10 years) unless they are in those areas encouraged by the Chinese government (such as new or high-tech industries, environment-friendly areas, etc.) Foreign investors will have to pay withholding income tax in China at a 20 percent tax rate for the dividends received from their investee companies in China; they were exempt from such tax under the old law. The tax-free treatment offered to a company's transfer of shares within a "group" for the purpose of "group restructuring" is revoked, and the capital gains generated by share transfer of an investee company in China among affiliates of a foreign investor will be subject to Chinese tax.
The New Partnership Law
China has revised its Partnership Law. Unlike the old Partnership Law, the newly revised Partnership Law allows limited liability partnerships; in addition to natural persons, any entities are eligible to become partners. The revised Law also confirms partnership enterprises' pass-through tax treatment, namely, the income from production and operations and other income of the partnership enterprises are exempted from enterprise income tax and only subject to each partner's income tax.
The passage of the revised Partnership Law will boost the private equity industry in China. But, foreign investment in a partnership in China is still not legally feasible due to the lack of specific regulations.
The Anti-Monopoly Law Will Take Effect In August 2008
There is an ongoing lawsuit in China brought by a Chinese battery producer, Sichuan Dexian Technology Co., against the Japanese giant Sony for allegedly engaging in unfair competition by using codes in batteries installed in its digital cameras that prevent the use of non-coded batteries. Because the lawsuit was initiated before the Chinese Anti-Monopoly Law becomes effective, Sichuan alleged that Sony violated the Chinese unfair-competition law. After the Anti-Monopoly Law becomes effective this August, similar cases may be litigated in Chinese courts based on such allegations as abuse of dominant market position.
The Anti-Monopoly Law will regulate (1) monopoly agreements that eliminate or restrict competition; (2) a business operator's abuse of its dominant market position; and (3) business concentration.
Therefore, anti-monopoly-law issues must be added to the checklist of every foreign investor who plans to have business operations in China.
With the above discussion, I have tried to illustrate the elements that a foreign investor must take into consideration when it structures a China deal. But, what I did not spend time discussing in the above text is that it is equally important to have creativity when doing China deals. Let's assume that a foreign investor wants to become a shareholder of an existing FIE involving state-owned assets. If the foreign investor is to buy equity ownership of a Chinese target through share transfer, the law requires that it go through the equity exchange market, whereupon the share transfer is subject to a bidding process if there is more than one party indicating its interest in the traded shares. To avoid a mandatory bidding process, which may lead to an unpredictably high price, the foreign investor may consider increasing the registered capital of the Chinese target by injecting an additional amount of capital, which will not trigger the requirement of going through the equity exchange market procedures. Additionally, another consideration is that proper documentation of the various mechanisms invented by lawyers is necessary and requires very sophisticated understanding of the Chinese regulations.
Keeping cautious and trying to be creative are the two keys to your China deals.
Published April 1, 2008.