By Bill H. Zhang

 

Background

 

After more than ten years’ drafting and debating, China passed its first Anti-monopoly Law (“AML”) on August 30, 2007, which took into effect on August 1, 2008. AML prohibits three types of monopolistic conducts, including prohibiting business operators from (i) reaching monopoly agreements; (ii) abusing dominant market status; or (iii) conducting concentration which may have the effect of eliminating or restricting competition. AML requests business operators to a concentration to declare with the anti-monopoly enforcement agency designated by the State Council (“Anti-monopoly Enforcement Agency” or “AMEA”) before concentration which triggers for certain criteria prescribed by the State Council. Only a few days before AML took into effect, Chinese government designated a three-pronged AMEA structure. Till nowadays, the Detailed Implementation for AML has not yet been promulgated. In order to guide the pre-concentration declaration, the Legislative Affairs Office under the State Council worked out a draft on business operator pre-concentration declaration provisions (“Draft”) in March, 2008 for public opinion and comments. After having gathered and studied public comments, the State Council promulgated a five-article Provision on Business Operators Pre-concentration Declaration Threshold (“Declaration Threshold”) on August 3, 2008, effective on the same day, two days after AML took into effect to regulate concentration declaration.

 

The designated AMEA structure and the Declaration Threshold are problematic and worrisome to foreign investors. This China Legal Watch article will briefly address the AMEA structure and the threshold for business operators to declare with AMEA before concentration and further analyze its impact on foreign mergers and acquisitions (“M&A”) in China.

 

AMEA Structure and Functions of Each AMEA

 

Before the effectiveness of AML and the Declaration Threshold, the Regulations on the Mergers & Acquisition of Domestic Enterprises by Foreign Investors (“M&A Regulations”)[1] has delegated the powers for anti-trust review on foreign M&A transactions only to the Ministry of Commerce (“MOFCOM”) and the State Administration for Industry and Commerce (“SAIC”), but has not clarified the division of the functions and responsibilities of MOFCOM and SAIC in terms of anti-trust review. It is unclear the application, under what circumstances, shall be filed individually with MOFCOM or SAIC or with both. AML only prescribes that AMEA is the authority in charge of anti-monopoly law enforcement, but keeps silent on the structure and composition of AMEA. After long beggaring, Chinese government adopted a three-pronged AMEA structure. In addition to MOFCOM and SAIC, the National Development and Reform Commission (“NDRC”) was newly added as AMEA member. Each of these three authorities has retained significant power to enforce AML.

 

SAIC will establish the Anti-monopoly and Anti-unfair Competition Bureau which will be in charge of anti-trust investigation and review involving monopoly agreements, abuse of market dominance status and administrative power to eliminate or restrict competition, excluding price-related agreements or abuse. The power for anti-trust review on business operator concentration is solely delegated to the Anti-monopoly Investigation Bureau under MOFCOM. While the Price Department under NDRC will be solely responsible for investigating and reviewing price-related monopoly conducts or abuse.

 

Compared with the former parallel anti-trust review structure under M&A Regulations which has no clear-cut division between SAIC and MOFCOM in terms of their functions and responsibilities during the anti-trust review, the three-pronged AMEA structure has made a great development to have clarified the scope of functions and responsibilities of SAIC and MOFCOM in terms of anti-trust investigation and review. It is clear that SAIC will no longer engage in anti-trust review on business operator concentration which will be solely conducted by MOFCOM after AML took into effect. However, the three-pronged AMEA structure has also created new overlapping and conflict between SAIC and NDRC in terms of their supervision and investigation on price-related and non-price-related monopoly conducts or abuse. It is unclear the application shall be filed with SAIC or NDRC when the business operators have reached menology agreements relating to price monopoly or abuse of price control. This overlapping issue is anticipated to be clarified in the Detailed Implementations of AML to be issued soon.

 

Concept of Concentration by Business Operator

 

AML and the Declaration Threshold have both defined concentration by business operators as three circumstances, (i) merger of business operators; (ii) control of other business operators by one business operator through acquiring their equities or assets; or (iii) where a business operator acquires control over other business operators or is able to exert a decisive influence on other business operators by contracts or any other means[2]. However, AML fails in defining “control” and “what circumstances constitute exertion of a decisive influence”. The Draft has made this shortcoming up by defining “control” of other business operators and narrowing down the scope of “decisive influence” to the impact on manufacture and operation decisions of other business operators. The Draft specified four circumstances which shall fall within the concept of “control” of other business operators, such as acquisition of more than 50% of equity or assets of other business operators with voting rights, becoming the biggest holder of equity or assets of other business operators with voting rights, actual control of the majority voting rights of other business operators, and having the power to determine more than half of the board memberships of other business operators.[3]

 

Very surprisingly, the Declaration Threshold has finally deleted the definition of “control” and the scope of “decisive influence” prescribed by the Draft. This will give AMEA more power to interpret “control” of and “decisive influence” on other business operators at will. The free interpretation by Chinese governmental authorities at will is problematic and worrisome to foreign investors for their M&A transactions in China as they do not know whether their situation constitutes concentration.

 

Though the definition of “control” and the scope of “decisive influence” prescribed by the Draft are not finally adopted, however, in practice, AMEA may still possibly refer to the above-mentioned four specific circumstances and scope prescribed by the Draft though they may have even more broad interpretation. Therefore, those aforesaid four specific circumstances and scope are still referable to foreign investors to determine whether their situation falls within the concept of business operator concentration.

 

Declaration Threshold for Concentration

 

According to the Declaration Threshold, a pre-concentration declaration must be filed with MOFCOM if a proposed concentration has met with any one of the following conditions where, within the preceding accounting year,

 

(1)     the turnover in the aggregate achieved by all the business operators participating in the proposed concentration exceeds RMB ten billion world-wide; and at least two of these business operators each has reached a turnover of more than RMB 400 million within mainland China; or

 

(2)     the turnover in the aggregate achieved by all the business operators participating in the proposed concentration exceeds RMB two billion within mainland China; and at least two of these business operators each has reached a turnover of more than RMB 400 million within mainland China.

 

Compared with the Draft and the M&A Regulations, the Declaration Threshold has abolished the “market share” criteria under which a declaration must be filed with AMEA before the concentration where the proposed concentration will lead the business operators participating in the concentration to own more than 25% of relevant market shares of an industry within China. The elimination of market share is a great improvement to AML and the M&A Regulations because it is quite difficult to define “relevant market” and the calculation of relevant market shares as well as the collection of evidence thereof will be inherently subjective and indeterminate, and thus unrealistic to apply in practice. Further when determining the market shares of the business operators to a concentration, it also needs to measure, assess the competitive positions and calculate the market shares of the other competitors, which will be very complex and time-consuming to analyze. As a result, the Declaration Threshold has finally abolished the “market share” criteria.

 

Problems of The Concentration Declaration Threshold and Impacts on Foreign M&A Transactions

 

Compared with the Draft, the very simplified Declaration Threshold is less directive, but more worrisome in the following aspects to foreign investors for their M&A transactions and concentration activities in China.

 

1.    Overlap and Conflict with AML

 

Notwithstanding the declaration filing requirements when the above-mentioned two thresholds are satisfied, however, according to AML, the pre-concentration declaration filing is still exemptible under either of the following two circumstances:[4]

 

(1)     Among all business operators participating in a concentration, one business operator owns more than 50% of the voting shares or assets of each of the other business operator; or

 

(2)     A business operator not participating in the concentration owns more than 50% of the voting shares or assets of each of the business operators which are participating in the concentration.

 

Interestingly, these two circumstances may possibly overlap with the situations prescribed by the Declaration Threshold where the turnover achieved by all the business operators participating in a concentration has reached the declaration criteria specified by the Declaration Threshold, however, more than 50% of the voting shares or assets of each of the business operators participating in the concentration is owned by one business operator participating or not participating in the concentration. In such occasion, it is not clear whether a pre-concentration declaration shall be filed or not. This is unpredictable and worrisome to foreign investors in their M&A activities in China. These issues are expected to be further clarified in the Detailed Implementations of AML to be issued in the future.

 

2.    MOFCOM’s Active Investigation on Concentration Not Reaching Thresholds

 

Though the declaration criteria prescribed by the Declaration Threshold can be quantified, however, the Declaration Threshold also provides that MOFCOM may initiate investigation on a proposed concentration in accordance with the laws even if the concentration does not trigger for any of the prescribed two thresholds, but it has evidences collected through lawful procedures to believe that the proposed concentration has or may have effects of eliminating or restricting competition. This is a subjective rather than objective and transparent criteria which MOFCOM may take at will to review and object a concentration if it “believes” that the proposed concentration may eliminate or restrict competition. Also this is a very broad provision and it is unclear and unpredictable what circumstances will trigger for MOFCOM’s active investigation and review. Such vague and non-transparent provision is problematic and worrisome to foreign investors when merging or acquiring Chinese enterprises. However, it is notable for business operators to a proposed concentration to oppose MOFCOM’s initiation of anti-trust review by challenging whether (i) MOFCOM has enough evidence that the proposed concentration may eliminate or restrict competition; and (ii), if so, the procedures and methods to collect evidence are lawful.

 

3.    Lack of Calculation Method and Composition of Turnover

 

Though the turnover of business operators participating in a proposed concentration can be quantified, however, the Declaration Threshold has not specified on how to calculate the turnover and the composition thereof, leaving them to be addressed at a later stage by MOFCOM in cooperation with other relevant authorities under the State Council. This will be problematic too after the effectiveness of AML because it will render difficulties for business operators and AMEA in calculating and reviewing the turnover of business operators to a proposed concentration. The results of the turnover may vary greatly depending on the calculation method and the composition of the turnover of the business operators. Therefore, it is unpredictable and worrisome for foreign investors when merging and acquiring Chinese enterprise whether their concentration will trigger for the declaration threshold. When adopting a calculation method different from the non-transparent governmental practice due to the uncertainty, thus determining the proposed concentration does not trigger for the declaration threshold and further conducting the concentration, the business operators to the concentration, including foreign investors when merging with and acquiring Chinese enterprises, may possibly subject to serious of civil and administrative liabilities imposed by AMEA, including stopping the concentration, disposing shares or assets, transferring the business or adopting other necessary measures to restore the market situation before the concentration within a time limit, and even being fined up to RMB five million.[5] Since the calculation method and composition of turnover is vital to business operators to determine whether a pre-concentration declaration shall be filed, the Chinese authorities are anticipated to make a clear clarification on the calculation method and composition of the turnover of business operators in the Detailed Implementations of AML to be issued.

 

4.    Unclearness of Declaration Obligor

 

The Draft had clearly specified who shall be the declaration obligor depending on different methods of concentration adopted by business operators.[6] This is very helpful and directive to business operators for preparing for the declaration. Unfortunately, the Declaration Threshold does not keep this clarification. It is unclear who shall file and who is qualified to file the pre-concentration declaration in different situations of concentration by business operators.

 

5.    No Prior Filing Consultation System

 

The Draft had established a prior filing consultation system under which the business operators to a concentration may consult with AMEA before the filing and AMEA shall guide the business operators on the filing. As above analyzed, many provisions by AML and the Declaration Threshold are vague and overlapping, prior filing guidance and clearance by AMEA is necessary. Unfortunately, Chinese governmental authorities do not want to burden themselves for such consultation. Again, this will be worrisome to foreign investors. The situations of multi-national companies are very complex, thus they need some guidance on how to calculate and compose their turnover word-wide and within China when they intend to conduct M&A or concentration activities in China. As an alternative, seeking for Chinese legal council’s opinion may be of some help.

 

6.    Vagueness of National Security Review

 

It is notable that, in the event where a foreign investor participates in the concentration of business operators by merging or acquiring Chinese enterprises or by any other means, and national security is involved, apart from pre-concentration examination and review, Chinese government will further conduct national security examination and review on the concentration[7]. Since neither AML, the M&A Regulations and the Declaration Threshold have identified what circumstances constitute and trigger for national security review, what factors shall be involved in national security examination and review and how the review will be conducted. Once again this is a vague and non-transparent provision which is unpredictable and worrisome to foreign investors merging and acquiring Chinese enterprises or engaging in concentration in China. It is advised the law makes a more clear clarification to the national security review and the criteria.

 

Conclusion

 

China’s first Anti-monopoly Law prohibits foreign investors from reaching monopoly agreement, abusing dominant market status or conducting concentration which eliminates or restricts competition by merging with or acquiring Chinese enterprises. Just a few days before AML took into effect, Chinese government designated a three-pronged AMEA structure among MOFCOM, SAIC and NDRC, under which the functions and responsibilities of SAIC and MOFCOM for anti-trust review are clear, however, the supervision and review of SAIC and NDRC for price-related and non-price-related monopoly conducts or abuse may overlap and conflict.

 

Under the new AMEA structure, the power for anti-trust review on concentration is solely delegated to MOFCOM. When the concentration triggers for certain threshold, the business operators must declare with MOFCOM for approval. AML empowers the State Council to work out the threshold for pre-concentration declaration, unfortunately, only after AML took into effect, the State Council just hastily published the simplified Declaration Threshold which are very vague and worrisome to foreign investors for their M&A and concentrations in China. It is an improvement that the Declaration Threshold has abolished the “market share” criterion because such criterion is determined by referring to “relevant market” which will be inherently subjective and difficult to calculate.

 

Among others, the serious problems to the Declaration Threshold foreign investors concern are those that the Declaration Threshold has specified the objective turnover criteria of business operators world-wide and within China, however, it also fails in specifying how to calculate the turnover as well as the composition thereof, which are critical for calculating the turnover. In addition, it is unclear whether pre-concentration declaration must be filed when the proposed concentration reaches the criteria specified by the Declaration Threshold, but also satisfies the exempted declaration conditions specified by AML. What worries foreign investors most are the MOFCOM’s active review and investigation on the concentration which has not reached the declaration threshold but MOFCOM “believes” it will eliminate or restrict competition, and the uncertainty of the non-transparent national security review for foreign M&A. Since the Declaration Threshold is vague, necessary prior filing consultation and guidance is vital for business operators, however, this is not addressed in the Declaration Threshold. All these uncertainties and vagueness need to be further clarified in the Detailed Implementations of AML to be issued.

 

About The Author

 

Bill H. Zhang is the managing partner of China Sunbow & Associates with rich experience in cross-board transactions involving China with more focus on corporate and commercial matters, such as mergers and acquisitions, direct investment in China, joint venture, intellectual property, technology license and transfer, international trade, corporate governance and compliance, restructuring and reorganization, labor and employment, and dispute resolutions. He has represented many multi-national companies to merge and acquire Chinese enterprises, make investment, register and enforce various trademarks, patents and copyrights, resolve commercial disputes in China. He has also counseled many foreign invested enterprises on their daily operations in China.

 

For more information about this article and the author, please contact:

 

Bill H. Zhang

 

T: +8621 5081 5229

F: +8621 5081 5239

E: bill.zhang@chinasunbow.com

 

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