Effects Of CFIUS Regulations On Minority Investments
By Meir Lewittes and Thomas Sauermilch
Recently enacted regulations issued by the U.S. Department of Treasury on behalf of the Committee on Foreign Investment in the United States (CFIUS) affect a wide variety of minority investments in transactions by foreign investors, including joint ventures and private investment in public equity (PIPE) transactions that have become more prevalent as traditional merger and acquisition transactions have dried up as a result of the crisis in the financial markets.
In addition to these new rules, which went into effect on December 22, 2008, the Treasury Department also released guidance on the various transactions that CFIUS has reviewed, and identified the factors used in determining whether such transactions presented national security concerns. Taken together, the new rules and the guidance provide practitioners with a practical roadmap on how to address the requirements of the Exon-Florio amendment to the Defense Production Act of 1950, as amended by the Foreign Investment and National Security Act of 2007 (FINSA), most importantly in non-takeover minority investments where an unsuspecting investor may unintentionally enter into a transaction subject to review and potential suspension by CFIUS. Under Exon-Florio, only transactions that could result in the control of a U.S. business by a foreign person are deemed “covered transactions” and subject to CFIUS review.
Covered Transactions and Control
The rules clarify that a foreign person may be deemed to control a joint venture which includes a U.S. business by virtue of the contractual rights of the foreign person in the joint venture, and that CFIUS will analyze the factors that determine control as they would in connection with a takeover or merger. The new regulations further clarify that control means “the power, direct or indirect, whether or not exercised, through the ownership of a majority or a dominant minority of the total outstanding voting interest in an entity, board representation, proxy voting, a special share, contractual arrangements, formal or informal arrangements to act in concert, or other means, to determine, direct, or decide important matters affecting an entity[.]”
Emphasizing that all relevant facts and circumstances are taken into account and that no single factor is determinative of control, the rules provide an expanded list of examples of “important matters” that affect an entity. Negative controls or “veto rights” over these matters, many of which are typical rights granted an investor or partner in a joint venture agreement, are deemed to indicate a level of control. These matters include the right to control the following:
- The sale, lease, mortgage, pledge or other transfer of any of the tangible or intangible principal assets of the entity, whether or not in the ordinary course of business
- The reorganization, merger or dissolution of the entity
- The closing, relocation or substantial alteration of the production, operational, or research and development facilities of the entity
- Major expenditures or investments, issuances of equity or debt, or dividend payments by the entity, or approval of the operating budget of the entity
- The selection of new business lines or ventures that the entity will pursue
- The entry into, termination or non-fulfillment by the entity of significant contracts
- The policies or procedures of the entity governing the treatment of non-public technical, financial or other proprietary information of the entity
- The appointment or dismissal of officers or senior managers
- The appointment or dismissal of employees with access to sensitive technology or classified U.S. government information
- The amendment of the articles of incorporation, constituent agreement or other organizational documents of the entity with respect to the foregoing items
Furthermore, if two joint venture partners hold equal interests in a U.S. business, and each partner has veto rights with respect to important matters affecting the U.S. business, each partner may be deemed to control the U.S. business.
But not all minority investor protections or veto rights rise to the level of control under the new rules. Certain rights that do not affect the strategic direction of the U.S. business or its day-to-day management are not deemed to provide the recipient of these rights with control over the U.S. business. Under the new rules, these non-control protections include the following:
- The power to prevent the sale or pledge of all or substantially all of the assets of an entity or a voluntary filing for bankruptcy or liquidation
- The power to prevent an entity from entering into contracts with majority investors or their affiliates
- The power to prevent an entity from guaranteeing the obligations of majority investors or their affiliates
- The power to purchase an additional interest in an entity to prevent the dilution of an investor’s pro rata interest in that entity in the event that the entity issues additional instruments conveying interests in the entity
- The power to prevent the change of existing legal rights or preferences of the particular class of stock held by minority investors, as provided in the relevant corporate documents governing such shares
- The power to prevent the amendment of the articles of incorporation, constituent agreement or other organizational documents of an entity with respect to the foregoing matters
Additionally, the rules clarify that when determining control where more than one foreign person has an ownership interest in an entity, CFIUS will consider factors such as the relationship among the foreign persons and any formal or informal arrangements to act in concert, whether the foreign persons are agencies or instrumentalities of a single foreign government, and whether a given foreign person and another person that has an ownership interest in the entity are both controlled by a single foreign government.
Private placement or private investment in public equity (PIPE) transactions, even if structured as investments in convertible non-voting securities or for less than 10 percent of the voting rights of the U.S. business, may be deemed to be covered transactions under the new rules. An investment in non-voting securities or other instruments that are convertible into voting securities may be a covered transaction regardless of the fact that at the time of investment the foreign person will not have such voting rights. In its analysis of the transaction, CFIUS will consider the imminence of the conversion, whether the ability to convert depends on factors within the control of the acquiring party, and whether the amount of voting interest and the rights that would be acquired upon conversion can be reasonably determined at the time of acquisition. Even if the securities are not immediately convertible, the fact that they may be converted at the option of the acquiring party may be taken into consideration by CFIUS in its assessment of the transaction. With some of the recent high-profile investments by foreign entities in the United States made through convertible securities such as convertible preferred stock, convertible debt instruments and warrants to purchase common stock, both foreign investors and U.S. companies must consider the conversion mechanisms in light of the CFIUS rules. Accordingly, if the negative control rights over “important matters” as set forth above are present in a convertible securities transaction, the investment may be deemed to give such investor control over the U.S. business as determined by CFIUS.
Similarly, even a transaction in which the foreign person acquires less than 10 percent of the voting interests of a U.S. business may still be a covered transaction. A “safe harbor” exists only for transactions in which the foreign person acquires 10 percent or less of the outstanding voting interest in a U.S. business and the transaction is solely for the purpose of passive investment. The rules expand the meaning of “solely for the purpose of passive investment” by providing that “[o]wnership interests are held or acquired solely for the purpose of passive investment if the person holding or acquiring such interests does not plan or intend to exercise control, does not possess or develop any purpose other than passive investment, and does not take any action inconsistent with holding or acquiring such interests solely for the purpose of passive investment.” Acquisitions that are of less than 10 percent of the voting interest of a U.S. business but are not solely for the purpose of passive investment, such as where the investor obtains control over important matters affecting the U.S. business, are subject to CFIUS review.
Finally, the rules clarify that although representation on the board of directors of a U.S. business is a factor that may indicate control, absent the foreign investor obtaining other veto rights over important matters affecting the U.S. business, such board representation alone will not cause the foreign investor to control the U.S. business, even if such investor acquires more than 10 percent of the voting interests of the U.S. business.
Foreign persons or entities seeking to make investments or acquisitions in the United States, and companies in the United States seeking foreign capital or foreign buyers must consider the implications of the structure and the nature of the party opposite them early on in the proposed transaction in order to make a determination as to whether a voluntary notice filing should be made. The new rules encourage parties to engage in pre-filing consultations in advance of filing the formal notice. Under the rules, CFIUS review of covered transactions must be completed within 30 days, except that CFIUS must conduct an additional investigation, which must be completed within 45 days, where the transaction threatens to impair U.S. national security, where the transaction involves a foreign-government controlled entity or foreign control over critical infrastructure, or where CFIUS recommends further investigations. Given the expanded information about the parties and the transaction the new rules require to be included in the notice, parties should budget additional time for the preparation of the filing and potential subsequent requests for additional information with respect to the notice.
Illinois Circuit Court Reinforces Seventh Circuit’s Limitation on Financial Advisors’ Liability Under Fairness Opinions
By Jeffrey L. Rothschild
Three recent decisions, taken together, offer valuable guidance to financial advisors for avoiding liability when issuing financial opinions.
In a recent notable case, an Illinois circuit court enforced language in the engagement letter limiting the financial advisor’s relationship, and thus liability, to its corporate client only. This decision follows two decisions by the U.S. Court of Appeals for the Seventh Circuit, affirming the principle that a financial advisor owes no duty to the stockholders of its corporate clients when issuing a fairness opinion, so long as such limitation on liability is explicitly stated in the contractual relationship.
Ron Young v. Goldman Sachs & Co.
In connection with the announcement in April 2008 of a merger agreement between Wm. Wrigley Jr. Company and Mars, Incorporated, Goldman Sachs issued a fairness opinion to the board of directors of Wrigley, stating that the consideration to be received by the stockholders of Wrigley in the proposed transaction was fair, from a financial point of view, to the stockholders of Wrigley. Goldman Sachs’s compensation for its services to Wrigley was approximately $46 million, the bulk of which was contingent upon the consummation of the merger.
In a putative class action filed against Goldman Sachs, purportedly on behalf of all Wrigley stockholders, the plaintiff alleged that Goldman Sachs had a conflict of interest, preventing it from issuing an unbiased fairness opinion. The complaint alleged causes of action for breach of contract, breach of fiduciary duty, and aiding and abetting breaches of fiduciary duty by Wrigley’s directors. currency exchange rates, interest rates, monetary policy or inflation...”
Goldman Sachs argued that the plaintiff stockholder lacked standing to assert his claims against Goldman Sachs, and filed a motion to dismiss. In granting the motion to dismiss on the grounds of standing, the court considered the language of the engagement letter between Goldman Sachs and Wrigley, the fairness opinion and the proxy materials submitted to the stockholders.
The court highlighted language from the engagement letter that stated Goldman Sachs’s intent that its advice was exclusively for the board of directors of Wrigley and not for any other third party. The court also drew attention to language in the engagement letter stating that Goldman Sachs was an independent contractor and owed duties solely to Wrigley, and specifically disclaiming any fiduciary duties owed to Wrigley’s stockholders.
Although the fairness opinion was submitted to the stockholders with the proxy materials, the introduction to the opinion and the opinion itself clearly stated that the opinion was for the “information and assistance of Wrigley’s board of directors” and that it was “not a recommendation as to how any [stockholder] should vote with respect to the adoption of the merger agreement.”
Based on the language in the engagement letter specifically limiting Goldman Sachs’s relationship to be between it and the Wrigley board of directors, and the notice to the stockholders in both the proxy and the fairness opinion that Goldman Sachs’s advice was not provided as a recommendation to the stockholders, the court held that the stockholders had no privity to or relationship with Goldman Sachs and dismissed the complaint for lack of standing.
This decision, citing to the recent decision of Edward T. Joyce, et al. v. Morgan Stanley & Co., Inc.538 F.3d 797 (7th Cir. 2008), is the latest decision supporting the principle that financial advisors may rely on the language contained in their engagement letter or fairness opinion to shield them from liability to the stockholders of their corporate clients. In The HA2003 Liquidating Trust v. Credit Suisse Securities (USA) LLC, 517 F.3d 454 (7th Cir. 2008), and Joyce, the Seventh Circuit considered the limitations on liability contained in engagement letters and fairness opinions, denying liability outside the scope defined by the parties.
Edward T. Joyce, et al. v. Morgan Stanley
In August 2008, the Seventh Circuit decided a case similar to Young, and similarly held that the financial advisor owed no fiduciary duties to the stockholders in relation to the issuance of a fairness opinion to the board of directors. In this case, Morgan Stanley issued a fairness opinion to the board of directors of 21st Century Telecom Group, Inc., in relation to its merger with RCN Corporation. When the stock of RCN sharply declined following the merger, the stockholders of 21st Century, who now held the devalued stock, sued Morgan Stanley, alleging that it owed a duty to advise the stockholders of 21st Century about hedging strategies.
In finding that Morgan Stanley owed no duty to the stockholders, the court examined the engagement letter between Morgan Stanley and 21st Century, and the fairness opinion. The court highlighted language in the engagement letter similar to the language the court later highlighted from the engagement letter in Young, specifically limiting Morgan Stanley’s relationship to 21st Century as an independent contractor, owing duties solely to 21st Century. Also similar to Young was the fairness opinion disclaiming any duty to the stockholders and explicitly stating that the fairness opinion did not represent an opinion or recommendation as to how the stockholders should vote at the stockholders’ meeting held in connection with the merger. Finally, the court drew attention to the conflict waiver clauses in the engagement letter and the fairness opinion, noting that the absence of any mention of the stockholders reinforced the conclusion that Morgan Stanley did not accept a duty toward the stockholders.
The HA2003 Liquidating Trust v. Credit Suisse
In February 2008, the Seventh Circuit, in contemplating financial advisors’ liability in connection to the issuance of fairness opinions, held in Credit Suisse that financial advisors’ responsibilities are set by contract. In this case, HA-LO Industries hired Credit Suisse to issue a fairness opinion in connection with its proposed purchase of Starbelly.com, Inc. HA-LO also retained an accounting firm as a business consultant to review HA-LO’s projected revenues from its acquisition of Starbelly.com. The accounting firm advised HA-LO that Starbelly.com was “unlikely to generate anywhere near the projected revenue stream.”
HA-LO’s CEO rejected the accounting firm’s conclusions, presenting HA-LO’s board of directors with only its own financial projections and not the evaluations of the accounting firm. Nor were the accounting firm’s evaluations furnished to Credit Suisse, and the engagement letter specified that Credit Suisse would rely solely on HA-LO’s financial projections. Pursuant to the terms of the engagement letter, Credit Suisse issued a fairness opinion stating that the consideration to be paid by HA-LO in the acquisition of Starbelly.com was fair, from a financial point of view, to HA-LO. In the fairness opinion, as indicated in the engagement letter, Credit Suisse specifically stated that it relied solely on HA-LO’s financial projections, which Credit Suisse had not independently verified.
After HA-LO filed for bankruptcy, the HA2003 Liquidating Trust (the Trust) formed in connection with the bankruptcy, brought an action against Credit Suisse under the terms of the engagement letter for gross negligence in issuing the fairness opinion. The Trust argued that Credit Suisse was grossly negligent by failing to review the accounting firm’s financial projections and instead relying solely on HA-LO’s financial projections, and failing to withdraw the fairness opinion or issue a second opinion upon the change in market conditions indicating a decline in the dot-com boom.
In finding that Credit Suisse had not been grossly negligent, the court held that Credit Suisse could not be held liable for following the exact terms of its contract with HA-LO. Under the terms of the engagement letter, Credit Suisse would use only HA-LO’s financial projections, and this reliance on HA-LO’s financial projections was reiterated by Credit Suisse in its fairness opinion. Furthermore, Credit Suisse was under no obligation to either retract or amend its fairness opinion upon acquiring new knowledge relevant to the opinion.
These three decisions, taken together, offer valuable guidance to financial advisors for avoiding liability when issuing financial opinions. First, Credit Suisse offers financial advisors some assurance that they may rely on the terms of their engagement letters and fairness opinions. Second, Joyce expands on Credit Suisse, shielding financial advisors from liability to the stockholders of their corporate clients, at least in the Seventh Circuit, where such limitation on liability is explicitly stated in the engagement letters and related fairness opinions. Finally, in Young, the Illinois circuit court, citing to the Seventh Circuit decision in Joyce, demonstrated its willingness to enforce the contractual limitations on liability, highlighting the importance of careful drafting in explicitly limiting liability in engagement letters and fairness opinions.
This article was originally published as a McDermott On the Subject.
Revised Notification Thresholds and Increased Penalties Under the Hart-Scott-Rodino Act
By Jon Dubrow, Joseph F. Winterscheid and Carla A.R. Hine
The Federal Trade Commission (FTC) recently announced revised thresholds for the Hart-Scott-Rodino (HSR) Antitrust Improvements Act of 1976 (HSR Act) and increased penalties for violations of the HSR Act and other laws enforced by the FTC. The FTC also announced the 2009 thresholds for determining whether parties trigger the prohibition against interlocking directors under Section 8 of the Clayton Act.
Notification Threshold Adjustments
Pursuant to the amendments passed by the U.S. Congress in 2000, the FTC published the revised thresholds for HSR pre-merger notifications in the Federal Register on January 13, 2009. These revised thresholds became effective on February 12, 2009. Any transaction completed and any HSR pre-merger notifications filed on or after February 12, 2009, must comply with these new thresholds.
As required, the FTC adjusted the notification thresholds based on the change in the gross national product (GNP) for the fiscal year ending September 30, 2008. Most notably, the base filing threshold of $50 million, which frequently determines whether a transaction requires filing of an HSR notification, will increase to $65.2 million following this revision. The changes also will affect other dollar-amount thresholds:
The alternative statutory size-of-transaction test, which captures all transactions valued above $200 million regardless of the “size-of-persons,” will be adjusted to $260.7 million.
The statutory size-of-person thresholds (applicable to transactions now valued at less than $260.7 million)
The adjustments affect parties contemplating HSR notifications in various ways. Parties may be relieved from the obligation to file a notification for transactions closed after February 12, 2009, that fall below the adjusted base threshold. For example, a transaction resulting in the acquiring person holding voting securities or assets valued at less than $65.2 million would not be reportable on or after the effective date. The adjustments will also affect various exemptions under the HSR rules. For example, acquisitions of foreign assets and voting securities of foreign issuers will now be exempt unless they generated U.S. sales in excess of $65.2 million.
Parties may also realize a benefit of lower notification filing fees for transactions that just cross current thresholds. Although filing fees for HSR-reportable transactions will remain unchanged, the applicable filing fee tiers will shift upward as a result of the GNP-indexing adjustments:
Transactions valued at or in excess of $65.2 million but less than $130.3 million require parties to pay a $45,000 filing fee.
Transactions valued at or in excess of $130.3 million but less than $651.7 million require parties to pay a $125,000 filing fee.
Transactions valued at or above $651.7 million require parties to pay a $280,000 filing fee.
Civil Penalty Adjustments
Pursuant to the Federal Civil Penalties Inflation Adjustment Act of 1990, the FTC published revised amounts for certain civil penalties for laws that the agency enforces in the Federal Register on January 9, 2009. The act requires the FTC to review these civil penalties at least once every four years and adjust them when the application of the percentage increase in the Consumer Price Index meets certain threshold levels. Among the revised civil penalties is an increase in penalties for violations under the HSR Act from $11,000 per day to $16,000 per day. Civil penalties for violations of the HSR Act were last adjusted in October 1996. The adjusted civil penalties became effective February 9, 2009.
Interlocking Directorate Thresholds Adjustment
On January 13, 2009, the FTC announced revised thresholds for interlocking directorates, which are effective immediately upon publication in the Federal Register. The FTC revises these thresholds annually based on the change in the level of GNP. Section 8 of the Clayton Act prohibits a person from serving as a director or officer of two competing corporations if certain thresholds are met. The prohibition against interlocking directors applies if each corporation has more than $10 million (as adjusted) in capital, surplus and undivided profits; however, the prohibition does not apply if either corporation has less than $1 million (as adjusted) in competitive sales. Pursuant to the recently revised thresholds, Section 8 of the Clayton Act applies to corporations with more than $26,161,000 in capital, surplus and undivided profits, while it does not apply where either corporation has less than $2,616,100 in competitive sales.
This article was originally published as a McDermott On the Subject.
Anti-Monopoly Pre-Merger Notification Filing Practice in China
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 lawyers Henry (Litong) Chen and Jacqueline Cai
In the past two years, there have been several major anti-monopoly merger filings with the Ministry of Commerce of China (MOFCOM), including pre-merger notifications filed under the new Anti-Monopoly Law (AML). The AML went into effect in August 2008 for the purpose of preventing and stopping monopolistic acts. Specifically, the AML prohibits certain types of horizontal and vertical agreements (Chapter 2), prohibits certain behaviors classified as abuse of dominant market position (Chapter 3), establishes a merger review scheme (Chapter 4) and prohibits abuse of government administrative powers restraining competition (Chapter 5).
MOFCOM’s expanded merger review powers under the AML underscore the need for advance planning with respect to Chinese pre-merger notification requirements in connection with any transaction that has significant effects on the Chinese market, irrespective of whether the parties to such transactions have physical operations in China.
Recent Pre-Merger Cases
Major transactions scrutinized under Chinese anti-monopoly laws in 2007 and 2008 include the following:
ArcelorMittal’s Acquisition of the Shares of China Oriental Group Company Limited
China Oriental, incorporated in Bermuda and listed on the Hong Kong Stock Exchange, is a controlling shareholder of Hebei Jinxi Iron and Steel Company Limited, a major manufacturer of H-shaped steel products in China. On November 9, 2007, ArcelorMittal entered into certain shareholders’ agreements to purchase the shares of China Oriental from its major shareholders. On December 12, 2007, ArcelorMittal filed the pre-merger anti-monopoly filing with MOFCOM. On May 13, 2008, an announcement at the Hong Kong Stock Exchange disclosed that both ArcelorMittal and China “are still awaiting anti-monopoly clearance, the Anti-Monopoly Condition has not been satisfied and the Shareholders’ Agreement has not become unconditional. Accordingly, it has ceased to be of any effect.” The mere fact of awaiting clearance does not necessarily mean ArcelorMittal did not pass antitrust review. However, the ArcelorMittal/China Oriental case is the first case that did not pass anti-monopoly clearance of MOFCOM on a de facto basis.
InBev N.V./S.A.’s $52 Billion Acquisition of Anheuser Busch
On July 13, 2008, InBev announced its of Anheuser Busch. The acquisition, filed with the Anti-Monopoly Bureau (AMB) of MOFCOM on September 10, 2008, was the first major transaction notified to the AMB under the new AML. AMB officially accepted the filing on October 27, 2008. On November 18, 2008, MOFCOM released the 2008 No. 95 Announcement to declare the approval of the acquisition, subject to four restrictive conditions. The four restrictive conditions were as follows:
Anheuser Busch’s current 27 percent shareholding percentage in Tsingtao Brewery could not be increased.
InBev would need to notify MOFCOM in a timely manner of change(s) to the controlling shareholder of InBev, or to the shareholder(s) of the controlling shareholder.
InBev could not increase its current 28.56 percent shareholding in Zhujiang Brewery (a Chinese brewer).
The post-merger company could not seek to acquire shares of China Resources Snow Brewery or Beijing Yanjing Brewery (two Chinese brewers).
The InBev/Anheuser Busch case is the first case to pass the anti-monopoly clearance under the AML with conditions attached and the second instance of having public hearings before clearance was granted.
BHP Billiton Ltd.’s Formal Takeover Bid for Rio Tinto Ltd.
In conjunction with its February 6, 2008, formal takeover bid, BHP made anti-monopoly filings with the competition regulators of the European Union, the United States, Australia, Canada, South Africa and China. The filing transaction was cleared in the United States and Australia, but the clearance process was suspended in the European Union. In China, filing materials were filed with MOFCOM in June 2008. However, on November 25, 2008, the very date that MOFCOM formally accepted the case to begin its review process, BHP withdrew the bid for Rio.
Coca-Cola’s Announcement That it Would Acquire the Shares of China Huiyuan Juice Group Ltd.
Coca-Cola announced on September 3, 2008, that it would acquire the shares of China Huiyuan Juice Group Ltd, a leading Chinese soft drink company. On December 2, 2008, Coca-Cola and Huiyuan jointly announced that they had submitted the pre-merger anti-monopoly filing. The Coca-Cola/Huiyuan case is still being reviewed by MOFCOM. The Coca-Cola/Huiyuan case triggered discussion as to whether or not Coca-Cola should be allowed to purchase the “national brand” of Huiyuan, thereby raising the important question of the extent to which MOFCOM will take industrial policy and other non-competition considerations into account in the merger review process argued a decision on a motion for injunctive relief that the merger documentation revealed a lack of sound business reasons and that the majority shareholder had clearly approved and caused the merger for the sole purpose of obtaining the delisting.
These recent pre-merger anti-monopoly cases provide important lessons for companies contemplating anti-monopoly filings in China. These cases, as well as recent pronouncements by MOFCOM, demonstrate that MOFCOM is increasingly active in pre-merger review. Further, MOFCOM’s level of review will undoubtedly increase even more under the new AML.
This enforcement climate and the new pre-merger notification regime ushered in by the AML have important ramifications for companies contemplating transactions that have any significant nexus with the Chinese marketplace. Key planning considerations include the following:
Early Preparation of Pre-Merger Filings
There are several reasons for early preparation of pre-merger filings. First, an anti-monopoly filing in China requires significant substantive information and a high level of business and market analysis in a narrative format, including details regarding the relevant market, the parties’ positions in the market, the competitive landscape, rationale for the transaction and public-interest considerations. A typical pre-merger report (including attachments) will run more than 100 pages. For more complex cases, a report can run 300 pages or more.
Such information must also be confirmed with a series of final guidelines regarding merger -notification procedures (Notification Guidelines) and draft guidelines regarding the relevant market definition (Draft Relevant Market Guidelines) under the AML. The Notification Guidelines were published by MOFCOM during the first week of 2009, offering MOFCOM’s first clarification to the merger notification process under the AML.
Second, it may take a much longer time to collect market information in China than in other jurisdictions. Unlike some western countries, market-information services in both the public and private sectors are relatively unsophisticated in China. That said, MOFCOM places great importance on these market-information resources and the reliability of such resources. Thus, while statistical data from internal studies are useful, a well-balanced report should also include sufficient data from reliable external resources.
Third, a buffer period must be factored into the timeline for anti-monopoly clearance. For example, the first stage of review has a 30-day period that does not commence until MOFCOM deems a report as complete. Thus, the actual timing of anti-monopoly clearance depends on the nature of the additional information or documents that might be required by MOFCOM before it formally deems that report as complete, which can range from one to several weeks. In addition, the report and most of its appendices must be submitted in Chinese. Therefore, additional time should be allocated to translate the report. Finally, as further detailed below, evaluating the need for pre-notification consultation with relevant Chinese administrative agencies should be taken into account in connection with the notification and review process.
Pre-Notification Consultation with MOFCOM and/or the National Development and Reform Commission
Although not required, a pre-notification consultation with MOFCOM may be quite important, especially for market players in certain sensitive industries (e.g., the steel industry). Compare, for example, the positive result achieved in InBev/Anheuser Busch (where pre-notification consultation was undertaken) with the unsuccessful outcome in ArcelorMittal/China Oriental (where pre-notification consultation did not occur—although other factors undoubtedly also contributed to that result). Indeed, in some instances, it may be prudent to consult with MOFCOM even before the definitive agreement is concluded and/or publicly announced.
Issues to be covered in a pre-notification consultation with MOFCOM must be assessed on a case-by-case basis. As a general proposition, however, the parties should be prepared to provide MOFCOM with a full briefing with respect to the proposed transaction and any anticipated competitive effects it may have on the Chinese market. In those instances in which there may be possible competitive concerns, the pre-notification consultation may also include discussion of restrictive conditions or other undertakings that might be required to obtain anti-monopoly clearance.
The parties may also consider communicating with the National Development and Reform Commission (NDRC) as part of the pre-notification consultation process or in a parallel consultation process. As the watchdog of industrial policy of China, the NDRC plays a very important, though invisible, role in the anti-monopoly clearance process. As a consequence, where industrial policy considerations (e.g., national champion/brands) may come into play, having the NDRC on board may be critical.
The Importance of Public Opinion
It seems that MOFCOM attaches importance to public opinion of a proposed transaction, including the opinion of industry associations and other constituencies. However, the extent to which public opinion affects the anti-monopoly review process remains unclear. In the BHP/Rio case, for example, MOFCOM consulted the China Iron and Steel Association (CISA), and CISA publicly expressed its opposition to the proposed transaction. The European Commission also consulted with CISA before taking its negative decision in BHP/Rio.
It is likely that public opinion will play an even greater role in the anti-monopoly clearance process under the new AML merger review process. The newly promulgated Notification Guidelines provide that a party (or parties) to the proposed transaction shall submit the opinion of the public, including local governments, governmental authorities in charge of the industry in which the merging parties belong, and the people of all walks of the communities involved in or affected by the proposed transaction. Apparently, MOFCOM will require a party to gather and submit to MOFCOM such public opinions related to the proposed transaction.
Although MOFCOM does not place the opinions of competitors and customers in the category of public opinion, the notification guidelines nonetheless requires a party to the proposed transaction to analyze potential impacts of a proposed transaction on competitors and customers.
It remains unresolved whether or not parties to the transaction may engage a public-relations company to collect opinions that are in favor of the proposed transaction. In any event, it is clear that parties to proposed transactions that have an effect on the Chinese market must give due regard to anticipated public reaction to the proposed transaction and, correspondingly, should implement an effective public-relations strategy in their planning process.
Non-Reportable Transactions May Also Be Subject to Possible Investigation and Challenge
In accordance with the Regulations of the State Council on the Criteria for Notification of Concentrations of Business Operators (Notification Criteria) that were issued on August 3, 2008, non-reportable transactions may also be subject to possible investigation and challenge. On January 19, 2009, MOFCOM issued the Interim Measures on the Evidence Collection for Suspected-of-Monopoly Concentrations of Business Operators Without Reaching the Notification Thresholds (draft) to implement the Notification Criteria. Thus, it seems clear that MOFCOM will actively monitor transactions that still have a nexus with China but fall below the AML’s pre-merger notification thresholds. On February 6, 2009, MOFCOM issued for public comment draft Interim Measures on the Investigation and Handling of Suspected-of-Monopoly Concentrations of Business Operators Without Reaching the Notification Thresholds. The deadline to submit comments is March 6, 2009. This draft rule provides some guidance as to how MOFCOM likely will enforce China’s Anti-Monopoly Law (AML) in connection with those transactions that do not meet the AML’s notification thresholds. Visit http://www.mwechinalaw.com/news/2009/chinalawalert0209b.htm for more information about this draft rule.
The precise contours of MOFCOM’s merger enforcement policies under the new AML are still developing. As reflected above, however, it is already clear that MOFCOM will have an active enforcement agenda and that it will be critical for companies to take this new enforcement climate into account whenever they consider transactions that will have an effect on the Chinese market. Under MOFCOM’s new merger review procedures, advance planning and early consultation with counsel are essential to ensure compliance with the new notification procedures and to optimize the likelihood of positive and timely outcomes under the AML. Moreover, early consultation with counsel should also be undertaken even if the proposed transaction does not meet the AML’s merger notification thresholds, particularly in cases in which the transaction involves a sensitive industry or may have a significant competitive impact in China, given MOFCOM’s broad authority to investigate and challenge transactions under the AML.
China’s MOFCOM Issues Additional Draft Merger Review Rules for Public Comments
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 Henry (Litong) Chen
Recently, China’s Ministry of Commerce (MOFCOM) has significantly stepped up its pace in proposing rules to implement the Anti-Monopoly Law (AML) and the Regulations of the State Council on the Criteria for Notification of Concentrations of Business Operators (Notification Criteria). After releasing the merger notification and draft relevant market definition guidelines during the first week of 2009 (for more information, see MWE China Law Offices’ article “China Releases Merger Notification Guidelines and Draft Relevant Market Definition Guidelines”, available at http://www.mwechinalaw.com/news/2009/guidelines.html), MOFCOM released four new draft rules for comments on its website on January 19 and 20, 2009:
- Interim Measures on Notification of Concentrations of Business Operators (draft) (Notification Measures)
- Interim Measures on Examination of Concentrations of Business Operators (draft) (Examination Measures)
- Interim Measures on the Investigation and Handling of Concentrations of Business Operators without Notifications (draft) (Investigation Measures)
- Interim Measures on the Evidence Collection for Suspected-of-Monopoly Concentrations of Business Operators Without Reaching the Notification Thresholds (draft) (Evidence-Collection Measures)
Acquisition of Control
The Notification Measures define and specify several key concepts on concentrations of business operators as stated in the AML. For example, the Notification Measures clarify what constitutes an acquisition of control over other business operators:
A business operator acquires 50 percent or more shares or assets with voting rights attached (Voting Shares or Assets) of other business operators
Even if a business operator does not acquire 50 percent or more Voting Shares or Assets of other business operators, it can nonetheless decide certain factors of another business operator, such as the appointment of one or more members of the board of directors and key managerial personnel, financial budget, business operation and sales, pricing making, major investments, or other important management and business decisions.
As regards the criteria to determine whether any concentration of business operators requires an anti-monopoly notification, Article 3 of the Notification Criteria provides for only one criterion—turnover—and the Notification Measures provide important guidance as to how the relevant turnover figures are to be calculated. Pursuant to the Notification Measures, the turnover equals the revenue that a business operator obtains from the sale of products and the provision of services in the previous fiscal year, minus various taxes and surcharges. However, the taxes and surcharges that are taken away from the turnover shall not include enterprise income tax and the deductible value-added tax.
With respect to the calculation of the turnover of a single business operator participating in a concentration, the Notification Measures provide that the turnover of this single business operator shall be the sum of the turnover of all controlling or controlled business operators of this single business operator (e.g., parent and subsidiary companies, sister companies or the companies under their common control). However, the turnover shall exclude the turnover arising from the transactions among the single business operator, its controlling and controlled business operators.
The Notification Measures also specify how to take account of the total turnover of all concentrating parties. If any business operators participating in a concentration jointly control a business operator, then the following apply:
The turnover arising between the controlled business operator and any controlling business operator shall be excluded. So shall the turnover between the controlled business operator and any other business operator(s) that has a controlling relationship with the aforementioned controlling business operator(s).
The turnover between the controlled business operator and a third-party business operator shall be included, and such a turnover shall be equally allocated among the controlling business operators.
Turnover on Partial Acquisitions
When a concentration involves the acquisition of part of one or several business operators, only the turnover attributable to the business involved in the concentration shall be included when calculating the turnover of the seller. Several consecutive concentrations between the same buyer and seller conducted within one year shall be deemed as one concentration, and the relevant turnover is represented by the aggregate turnover of the businesses acquired during that one-year period.
Establishment of a New Enterprise
According to the Notification Measures, any establishment of a new enterprise by two or more business operators will also constitute the concentration of business operators.
The Examination Measures address MOFCOM’s examination procedures, examination methods and various rights of the applicant(s) that file a notification.
MOFCOM may hold a hearing during the anti-monopoly examination at its own discretion.
A hearing shall not be open to the public. If the hearing involves any business secret, the concerned party attending the hearing may apply for an individual hearing.
When MOFCOM believes that a concentration results in or may result in eliminating or restricting competition, it may notify the parties of the decision in writing. In the notification, MOFCOM shall set a reasonable period within which the parties may defend themselves in a written response.
Either MOFCOM or an applicant may propose restrictive conditions upon clearance. The restrictive conditions may include structural conditions such as divesture of assets or business units, behavioral conditions such as providing access to the merged companies’ network, and/or comprehensive conditions consisting of both structural and behavioral conditions.
The Examination Measures provide that the restrictive conditions should be effective and practical.
The Investigation Measures are directed at imposing sanctions on business operators of a concentration for failure to file merger notifications required under the AML (Un-notified Concentration).
MOFCOM may launch an investigation on such an Un-notified Concentration on the basis of the information that was collected through a lawful channel—the information could be from a whistle blower, public media or governmental authorities.
During the investigation, if MOFCOM finds that the concentration has not yet been implemented, it may request the business operators under investigation to file a notification in time, as required under the AML. If MOFCOM finds that the concentration has been implemented, MOFCOM may impose punishment pursuant to Article 48 of the AML, which includes ceasing the concentration, disposing of its shares or assets by a deadline, transferring the business, taking other necessary measures to restore the status quo prior to the implementation of the concentration, and a fine of up to RMB 500,000.
According to Article 4 of the Notification Criteria, although a concentration of business operators does not reach the notification threshold as judged from the turnover of the business operators, if such a concentration results in or may result in eliminating or restricting competition based on facts and evidence collected, MOFCOM shall investigate the concentration. The Evidence- Collection Measures were issued to implement Article 4 of the Notification Criteria.
The process consists of three stages: primary analysis, evidence collection and case establishment for investigation.
MOFCOM may launch a preliminary analysis on the basis of the information that is obtained through any legitimate channel. In conducting the preliminary analysis, MOFCOM will take into account factors such as market share, territorial scope, competitors, upstream and downstream enterprises, consumers and public opinion, among others.
On the basis of its primary analysis, MOFCOM shall start the procedure for evidence collection when it suspects, “based on sufficient justification,” a concentration results in or may result in eliminating or restricting competition. However, the Evidence- Collection Measures do not clarify what is “based on sufficient justification”—it is apparently as undefined as the phrase “at the discretion” of MOFCOM.
Evidence can be collected from public channels, business operators involved in the concentration, industrial associations, administrative departments, local governments, suppliers, customers, competitors and other related organizations or individuals.
If there is sufficient evidence to show that the concentration has or may have the effect of eliminating or restricting competition, MOFCOM will initiate an investigation of the concentration. The Evidence-Collection Measures do not provide for any time limit for the investigation. It appears that MOFCOM may initiate the investigation no matter whether or not the concentration has been completed.
The draft rules provide important interpretive guidance on the merger notification and review provisions of the new AML. They also signal that merger enforcement will be one of MOFCOM’s top enforcement priorities, including the possible investigation of transactions that do not qualify for mandatory pre-merger notification under the AML.
This article was originally published as an MWE China Law Offices China Law Alert.