In response to the Chinese government’s “going global” strategy and its ambitious Belt & Road Initiative, Chinese state-owned enterprises (SOEs) have invested heavily around the world.
At the same time, we have noticed an increasingly prevalent phenomenon: due to strategic adjustment, tightened regulation of overseas state-owned assets (including the regulatory requirements for main and non-main businesses) and market changes, some SOEs are partially or wholly withdrawing from their invested assets. Undoubtedly, this is a fi ne example of the increasing marketization of SOEs' investment and post-investment management.
The sale of state-owned assets is under very strict legal regulation in China. The sale process often involves evaluation, approval (fi ling), floor trading and other special procedures. For the domestic sale of state-owned assets, market participants, whether acting as the seller or the buyer, are relatively familiar with the mechanisms and regulatory requirements. However, different from the well-established systems for such domestic disposals (including the floor trading in equity exchanges), there is neither clarified and consistent laws nor widely accepted practices in the market, regarding the sale of overseas state-owned assets by SOEs.
These overseas state-owned assets are in a business and legal environment entirely different from that in China, and potential buyers include both Chinese state-owned and private enterprises as well as overseas buyers (including the local shareholders of an overseas joint venture). Accordingly, the requirements and general practices for a majority of domestic transactions involving state-owned assets can hardly be copied in overseas transaction procedures (including buyers’ appeal), where the commercial and legal environment may be characterized as comparatively more market-oriented.
In cross-border transactions involving overseas state-owned assets, both SOEs acting as sellers, as well as Chinese and foreign buyers (including their professional counsels), face distinct legal and practical challenges. Whether the transaction procedures will match with well-established cross-border transaction rules and practices, and how to strike the right balance between market-oriented development and compliance of state-owned asset supervision call for the wisdom of the parties to such transactions and their professional counsels, while imposing higher requirements for supervision of state-owned assets (including top-level design).
Drawing from our valuable and extensive experience in advising SOEs on their sale of overseas state-owned assets, and from counselling a variety of Chinese enterprises in the purchase of overseas assets, this article aims to guide sellers (i.e. SOE’s) in their future transactions by discussing the salient issues and their solutions in overseas transactions involving state-owned assets, from the perspective of the seller (i.e. SOEs).
Further, the irreversible trend of SOEs becoming more market-oriented calls for improvement and innovation in the way state-owned assets are supervised. As part of the course, supervision methods require far-sighted, top-level design. This will prevent the loss of state-owned assets by disordered and uncertain supervision mechanisms, and will avoid leading the market in the opposite direction (rigid, non-market oriented regulatory requirements and mechanisms restricting market-oriented operations and developments). This article is therefore intended to serve as a reference for supervisory authorities presiding over state-owned assets, and domestic equity exchanges, in their formulation and improvement of the relevant legal mechanisms.
Note: This article only addresses the disposal of overseas state-owned equity by SOEs and their subsidiaries at all levels. Referring to the definition of “overseas state-owned equity” under the Regulatory Measures on Transactions of State-owned Assets of Enterprises (Order No. 32 of the SASAC and the Ministry of Finance), the overseas state-owned equity refers to the rights and interests formed by various forms of capital contributions made by SOEs and their subsidiaries of all levels to enterprises.
QUESTION 1: Are overseas state-owned equity required to be traded in an equity exchange?
Key takeaways
• Transaction of domestic state-owned equity“in principle must be traded in an equity exchange”. However, it’s not the case for transactions involving overseas state-owned equity.
• Floor trading is not mandatory for central enterprises directly under the administration of SASAC of the State Council, and central enterprises are only required to “select from among multiple interested transferees after comparison”. If practical, central enterprises shall openly solicit interested transferees and transfer by bidding or list and trade such equity in a pilot institution for transfer and transaction of state-owned equity of central SOEs.
• For local SOEs, floor trading is basically not a mandatory requirement, except for relatively strict requirements issued by the SASACs of certain provinces or municipalities (for example, Beijing and Guangxi require that the transaction should be traded in an equity exchange; Guangdong provides that floor trading should be prioritized; and Zhejiang stipulates that “if there is an eligible transferee domestically, a domestic exchange could be prioritized for such transaction.”)
Analysis
• The disposal of overseas state-owned properties is mainly regulated under the Interim Measures on the Administration of Overseas State-owned Properties of Central Enterprises (Order No. 27 of the SASAC, “Order No. 27”) issued by SASAC of the State Council on 1 July 2011. According to Order No. 27, local SASACs may refer to these Measures to formulate the administration measures relating to the overseas state-owned equity of the enterprises funded by them.
• Under the guidance of Order No. 27, local SASACs released the regulations on disposal of overseas state-owned equity of local SOEs around 2012. We selected the regulations issued by 16 local SASACs (including Beijing, Shanghai, Guangzhou, Shenzhen and other economically developed cities) from the legal database and summarized the provisions on floor trading as detailed in Appendix I. According to the various requirements of the local SASACs on floor trading listed in Appendix I, in general, floor trading is not a mandatory requirement except for some stricter regulations by certain SASACs (for example, Beijing and Guangxi, in principle, require the transaction to be made in a local equity exchange).
• Specifically, SASAC of the State Council and the Ministry of Finance issued the Regulatory Measures on Transactions of State-owned Assets of Enterprises (Decree No. 32 of the SASAC and the Ministry of Finance, “Decree No. 32”) on 24 June 2016. Decree No. 32, which governs the transaction of state-owned assets, explicitly provides that the domestic state-owned assets of domestic SOEs, in principle, should be traded in an equity exchange. However, Decree No. 32 does not provide clear requirements for floor trading of overseas state-owned assets.
• From the perspective of an equity exchange, it is the competent SASAC, rather than the equity exchange, which has the authority to determine whether overseas state-owned equity transactions require floor trading. Based on our knowledge of common practice in equity exchanges, major equity exchanges have not provided clear guides regarding the conducting of transactions involving overseas state-owned assets.
Recommendations
• As floor trading is not yet a mandatory requirement under existing laws and regulations on state-owned assets, and given the inconsistency between such floor trading mechanisms and the widely accepted transaction rules and practices on the global market, floor trading is not recommended as a first choice. Specific recommendations are discussed in Question 2.
QUESTION 2: If floor trading is not an appropriate choice for a transaction involving overseas state-owned equity, is there a better one?
Key takeaways
• In cross-border transactions, the seller of the assets (of a non-listed company) will generally adopt either one-to-one sales negotiations or a competitive sale (or bidding, auction) process. In cross-border M&A transactions, the most common approach is competitive sale process, which is generally more favourable to the seller. With respect to disposals of state-owned assets, however, a competitive sale process is not a familiar or acceptable way to transfer assets for Chinese sellers (especially SOEs).
• In the sale of attractive overseas state-owned equity, compared with the loose transaction mode of one-to-one sales negotiations, we strongly recommend the competitive sale process as the first choice for SOEs, unless the seller has selected or will soon target the appropriate true buyer due to special commercial reasons.
• Based on our project experience in particular of advising SOEs on their sale of overseas assets, it is suggested that SOEs carefully consider the method used to sell their overseas state-owned equity. As the most important concern in the early stages of the sale process, the choice of sale method will determine the difficulty of implementation, workload, certainty and success of the transaction. Therefore, as a part of SOE’s preliminary work, sellers should engage a professional advisor (intermediary) as early as practicable for discussions and demonstration to develop an optimal transaction plan.
• As cross-border investments by SOEs become more market-oriented, we expect that the competitive sale process will become a more common choice for SOEs selling their overseas assets.
Analysis
• A typical competitive sale process involves four stages, i.e., indicative offer (non-binding offer), final offer (final binding offer), negotiation and execution of transaction documents, and closing. At each stage, both the seller and the buyer will carry out different work streams according to the sale process designed and managed by the seller, as detailed in the picture below:
• In cross-border transactions, the seller of the assets (of a non-listed company) will generally adopt either a one-to-one sales negotiation or a competitive sale (or bidding, auction) process.
A typical one-to-one sales negotiation generally involves the following stages:
» early-stage negotiations (document stage);
» due diligence;
» transaction documents; and
» closing.
• Due to the lack of any process for “officially selecting the buyers”, there is much uncertainty whether the buyers and the seller are the most appropriate parties to the transaction. Additionally, as the buyers and the seller will decide the process and the timing for the transaction without any restriction, and will freely negotiate on the terms of the transaction, the transaction also faces a high degree of uncertainty.
• If the assets to be sold are very attractive, generally, the seller will choose a competitive sale process. The competitive sale process is widely regarded as the most favourable choice of sale method for sellers for the following reasons:
» As a generally accepted mechanism in the global M&A market, a competitive sale process is familiar to and widely accepted by domestic and overseas buyers and their advisors in terms of its rules, which will reduce the cost of communication and attract interested buyers;
» Leveraging the broad network of financial advisors both at home and overseas, the seller may not only hunt for interested buyers domestically, but also disseminate the sale information to appropriate potential buyers overseas, which greatly increases the chance of a successful transaction and obtaining more favourable transaction terms;
» The seller may gain complete control over the timing of the transaction, in contrast to the uncertainty of timing under one-to-one sales negotiations;
» Under a flexible competitive sale process, the most appropriate process may be tailored for each subject according to the assets to be sold and potential bidders. For example, a package sale of different countries’ assets is allowed and the offer to purchase all the assets by the bidder alone or together with others is also accepted, based on which the optimal sales plan will be developed;
» Generally speaking, the dynamic relations in competition force the bidders to offer the most favourable transaction terms (the highest price, the fewest conditions to closing, and compromise to the seller’s limited liability mechanism), bringing the most favourable terms and considerations to the seller. It is, therefore, the best mechanism for conforming to regulatory principles and for the purpose of value maintenance and the appreciation of state-owned assets;
» The competitive sale process values confidentiality and ensures its enforcement with well-established mechanisms, including prevention of collusion among bidders. Interested buyers are required to sign a strict confidential agreement before being granted access to the preliminary information relating to the project. The seller may strictly control the disclosure of information and the documents/information involved in due diligence may also be disclosed within a very strictly-controlled scope/stage (for example, key documents may be disclosed until the stage of “Black Box”). For disposal of sensitive assets by SOEs or a transaction involving listed companies at home and overseas, these mechanisms will provide strong protection; and
» As the bidders may only revise the seller’s transaction documents (before winning the bid, the bidders may not negotiate seller, and the degree of revision depends on the fierceness of competition), through the most commonly used limited liability mechanism, the seller may pass the risk of sale to the buyers to the largest extent (including through the warranty insurance effectively passing transaction risk to the respective insurance companies), so as to reduce the chance of claims raised against the seller after closing and the possible liabilities of the seller, if any.
• It should be noted that a competitive sale process, in essence, is consistent with the principles under Order No. 27 and local SASACs’ regulations, which require sellers “to “compare and select the potential buyers” and “to publicly solicit the potential buyers and carry out the transaction by bidding process”. The competitive sale process also provides a full set of well-established and widely accepted solutions to transactions.
QUESTION 3: If floor trading is carried out, what issues need special consideration?
Key takeaways
• As shown in Appendix I, some local SASACs require SOEs to adopt in principle or consider in priority flooring trading when selling overseas state-owned equity.
• A relative mature set of systems have been in place in terms of the floor trading for domestic transactions of state-owned equity; however, for the sale of overseas state-owned equity, many adjustments are required to make and therefore, special attention should be paid to the additional uncertainties and transaction risks in the course of transaction.
Analysis
• In general, floor trading requires sellers to confirm the cope of transactions and equity exchange, and carry out proposed transactions in accordance with the specific rules of respective equity trading institutions.
• Usually, after an equity exchange accepts the application of seller and the transaction enters the information announcement period, a preliminary information disclosure is needed if the control of the target has been actually transferred. The interested transferee is required to submit a transfer application and pay a deposit. Bidding is generally conducted in the methods of auction, bid submission, bidding online, etc. After the transferee is selected, the signing of contract and settlement of amounts in respect of transaction should be arranged and the amount of transaction should be paid up in one lump sum. An announcement on transaction results should also be made after the equity exchange issues relevant certificates. Taking the China Beijing Equity Exchange (“CBEX”) as an example, CBEX expressly provides that the transfer of overseas state-owned equity should also be carried out in accordance with its rules. The specific transaction procedures are shown in the following figure:
• Given the fact most state-owned equity transactions traded on domestic exchanges constitute domestic transactions, domestic trading methods are adopted in terms of language, trading mechanisms and common practices involved in the transaction. However, these methods are not suitable for transactions involving overseas state-owned equity as they may result in additional unnecessary uncertainties, risks and costs being encountered in the transaction. Based on our experience, the major issues include:
» If floor trading is to be carried out, the transaction needs to be listed on the Chinese equity exchanges to seek potential bidders, but most buyers on the exchanges are Chinese enterprises that are not interested in overseas assets. In addition, due to language problems and the influence of the exchanges, the transaction information may not be effectively obtained by desirable foreign buyers. Undoubtedly, these factors will significantly affect the sale;
» There are many restrictions and rules on domestic floor trading. The exchanges have specific requirements for the format, form and actual content of the transaction documents (an agency may need to be engaged as these requirements are usually ambiguous). The samples provided by the exchanges are too simple and are usually completely different from the sophisticated documents used in cross-border transactions, leading to inconsistencies in many trading mechanisms. For example, if the buyer is a foreign entity with no Chinese office, the buyer will be required to pay a performance deposit and may spend a long time period navigating the necessary registration and bidding processes with the relevant exchanges;
» An important principle in overseas sales includes the “(seller) disclosure exception”, which is designed to encourage sellers to disclose information by allowing due diligence to be conducted by prospective buyers. By doing so, buyers will determine the prices of assets and reach responsibility (risk) sharing arrangements through negotiations with sellers. But as similar mechanisms and transaction documents are not adopted by domestic equity exchanges, sellers may not be able to reasonably and effectively reduce the risk of claims after sales while sophisticated buyers overseas may need to develop other complicated transaction documents (therefore, how to adjust these documents in accordance with documents and mechanisms adopted by the national exchanges is also an issue); and
» The way shareholders in overseas target companies exercise their right of first refusal (ROFR) will become more complex. First, even if the parties to a joint venture have agreed on the sale (pre-emptive arrangements), mandatory requirements for floor trading require the relevant floor trading procedures be completed. Second, general practices of the domestic equity exchanges require the party with the ROFR to participate in the floor trading, and exercise the ROFR on an equal footing with other potential bidders. This mechanism may be inconsistent with the local laws in terms of the ROFR of the shareholders of the target company. It is therefore difficult to discern how an overseas party with a ROFR may comply with the procedures of domestic equity exchanges. For other buyers involved in the bidding process, this mechanism is a comparatively less fair and certain mechanism. Lastly, equity exchanges also face challenges in determining the efficacy of overseas preemptive arrangements and whether these have been validly waived.
Recommendations
• It is recommended the buyer and the seller include additional documentation as part of the transaction, based on cross-border M&A practices other than the template documents of the equity exchanges. These additional transaction documents will typically cover the “mechanism of offshore transaction”, including price adjustment mechanisms, conditions precedent, reverse breakup fee, interim period covenants, representations and warrants, individual indemnity, and the seller’s limitation of liability, etc. It is also recommended that parties agree that the transaction documents of equity exchanges will only apply to the floor trading process. After the buyer wins the bid, the transaction documents separately entered into by the parties will supersede those of equity exchanges and will be the legally binding documents with respect to the transaction between the parties. It requires prior communication with the relevant equity exchange to obtain their approval or comments. Further, the major equity exchanges are also encouraged to be more open-minded to evaluate and improve the current transaction mode (including engaging professional counsels to revise relevant transaction documents) and to introduce a more market-oriented transaction system.
• The transaction documents separately entered into by the parties should clearly provide whether the contemplated sale requires the completion of applicable floor trading procedures and who is obligated, and to what extent that party is required to implement those procedures. The parties should also consider whether the requirement to complete applicable floor trading procedures should be reflected in the conditions precedent, liabilities for breach, indemnification, reverse breakup fee vand other terms forming part of the transaction documents.
• If the floor trading procedures are necessary, the specific procedures and timing of floor trading should be clarified, in particular, the seller’s specific obligations to implement various procedures of floor trading. As the buyer is a foreign party, and given the limited period for information disclosure required by the equity exchanges, the foreign party should leave sufficient time to register with and submit its bid to the equity exchanges, and make preparations and arrangements for payment of the transaction deposit.
• If there is a requirement for the buyer to pay a transaction deposit, the parties should consult with the local equity exchange as to whether the transaction price could be directly offset by the deposit, and what the relevant conditions are for the seller or the buyers to request a refund of deposit. They should also pay special attention to and agree on these issues in transaction documents; and
• If the overseas buyer does not have any domestic presence (i.e. onshore entity) or domestic employee(s), it should as a priority consider engaging an experienced PRC legal counsel to obtain professional legal advice and assistance regarding the various issues involved in floor trading.
QUESTION 4: Why is it necessary for the seller to conduct due diligence reviews for sale of overseas state-owned equity?
Key takeaways
• In the times where state-owned assets were transferred at nil consideration by a “red-head document” issued by the government, it was a rare request to conduct due diligence on the target assets prior to the completion of the transfer. Given the transfer was made at nil consideration and neither the transferor nor the transferee would be responsible for the transfer, there was indeed no need for due diligence.
• As China’s reform deepens and the market-driven transaction approach comes into being, it has become widely accepted practice among investors, including SOEs, to conduct“(buyer’s) due diligence” to address the information asymmetry between the buyer and the seller, identify potential risks, and price the target assets. However, despite this trend, such arrangements for conducting relatively comprehensive formal legal, technical, financial and tax due diligence reviews on proposed sale assets has been far less understood or readily accepted by SOE sellers (in particular).
• In a complex asset sale process, especially for overseas assets, once the process is initiated, it will require substantial inputs from both parties in terms of time and money. Moreover, some steps, once commenced, would be very hard to reverse in light of businesses’ interests, tax liability and the necessary legal arrangements. It would, therefore, be essential for the seller to conduct due diligence in the early stages of the sale process to identify and resolve any issues potentially restricting or impeding the proposed sale.
Analysis
• The “seller’s due diligence” refers to the process where the seller engages legal counsels, accountants and other professional advisers to conduct a comprehensive legal, financial, tax and technical due diligence review on the assets proposed for sale, and prepares a written due diligence report that meets internal and external compliance requirements for both SOEs and the sale. Generally, sellers’ due diligence is used alongside competitive bidding. However, even without using competitive bidding, a seller’s comprehensive due diligence is still what the seller should consider for a successful sale process.
• As part of the seller’s due diligence, they are required to prepare the requisite disclosure documents and the data room for potential buyers to conduct their due diligence reviews, and provide its due diligence report to potential buyers for the purpose of efficiently progressing their due diligence to the next stage in the transaction process.
• The seller’s legal due diligence for cross-border transactions is far more complicated than for domestic deals. As it may involve assets located in multiple countries and laws of different jurisdictions, generally, it is the seller’s lead counsel that coordinates with offshore counsels in all the relevant jurisdictions to conduct the due diligence. As it often involves multiple legal and language systems, it is necessary for the offshore legal counsels in relevant jurisdictions to prepare their due diligence reports in English. The corresponding lead PRC counsel will then finalise the report in Chinese. Accordingly, cross-border legal due diligence requires excellent management, communication (in both English and Chinese), global support skills and capabilities on the part of the lead counsel.
• A comprehensive and high-standard due diligence (by legal and other professional advisers) in the early stage of the sale process can help SOE sellers comply with relevant requirements, identify and avoid potential risks and improve their sale structure and process, as follows:
» It can help the seller’s counsels and advisors to better understand the target company, assets and its operations, and make accurate judgments on the feasibility, potential obstacles and solutions in the transaction. It can also provide necessary support for deal structuring and process design, and lay down important foundations for transaction terms and conditions and future negotiations;
» Disposal of state-owned assets needs to go through complex compliance and approval processes. The seller’s due diligence may help the SOE seller discover potential compliance issues and develop supporting documentation for internal and external approvals;
» Irrespective whether a “one-on-one” negotiation or “competitive bidding” method is used, the seller can provide its due diligence report to the buyer (subject to the signing of non-reliance letters by the buyer or other customary deal arrangements), to assist the buyer to gain a quick understanding about the assets, while only needing to conduct due diligence for verification purposes. This will save the buyer’s time and assist to mitigate the buyer’s concerns in relation to the transaction, speeding up the overall sale process; and
» The seller may include existing or potential issues and risks identified during the due diligence process in its disclosure letter. This will ensure the seller gains protection under the “seller disclosure exemption”, preventing claims from the buyer after completion of the deal.
Recommendations
• In summary, the sale of overseas state-owned equity involves various complex issues arising from cross-border transactions, laws, tax, finance, technology and compliance.
• To address these issues, it is necessary to engage professional service agencies with extensive cross-border experiences as early as possible, including financial advisors, legal counsels, accountants, and appraisers. Their roles are as follows:
» Financial advisors will lead and manage the project, assist the company by recommending, screening and engaging other intermediaries, and take the lead in project valuation, marketing, approaching of potential buyers and transaction structuring;
» Legal counsels lead the seller’s legal due diligence review, coordinate with offshore counsels in relevant jurisdictions to advise on issues concerning their respective jurisdictions, assist with the selected transaction process, draft various transaction documents for the seller, participate in the revision, negotiation and finalisation of relevant transaction documents, handle or assist with regulatory reviews and approvals and the close of the deal; and
» Accountants to conduct financial and tax due diligence for the seller, participate in the tax analysis of the transaction structuring, provide opinions on valuation, comment on transaction documents from the taxation perspective, and participate in the revision of relevant transaction documents.
QUESTION 5: Is it mandatory to perform the appraisal and filing formalities required for state-owned assets before selling overseas state-owned equity?
Key takeaways
• As long as the proposed sale assets constitute state owned property, it is mandatory for the SOEs to perform the appraisal and filing formalities, regardless of domestic or overseas transactions.
• Carrying out the appraisal and filing formalities required for state-owned assets and carrying out floor trading are two separate compliance issues.
Analysis
• According to China’s laws and regulations on state-owned asset supervision, the principles of equal value, transparency, fairness, and impartiality shall be followed in the transfer of the state-owned assets. Meanwhile, for the transfer of state-owned assets, a minimum transfer price shall be reasonably determined on the basis of the price that is legally appraised and confirmed by the body performing the contributor's functions or approved by the corresponding people's government after being reported thereto by the body performing the contributor's functions.
• For sale of overseas state-owned equity, it is still necessary to perform the appraisal and filing formalities and use the appraisal as the basis for determining the sale price for the assets, which shall, in principle, not be less than 90% of the filed appraisal price. However, as the sale and purchase of assets are entirely market-driven, the two prices may diverge.
• For sale of state-owned domestic equity, it would generally suffice to retain only one domestic appraisal agency with relevant qualifications. Whereas for sale of overseas state-owned equity, given that target assets are in a foreign country and that the appraisal agencies must be retained by the SOE seller, especially in case of foreign buyers, it is advisable for the SOE seller to retain one of the Big Four accounting firms or offshore appraisers with cross-border experience, to ensure a fair and market-based appraisal of the assets, which a qualified domestic appraiser can subsequently review and produce a report. Alternatively, the SOE seller may retain a qualified domestic appraiser to coordinate with offshore appraisers, having cross-border experience, in the preparation of the relevant appraisal report. Both options require coordination between domestic and international agencies, the failure of which may result in a substantial gap between the target asset valuation and the appraisal.
• Generally, the appraisal report will remain valid for one year from the reference date and the SOE seller needs approximately three months for the filing formalities. It is generally difficult to manage the time frame for one-on-one sale processes for overseas state-owned equity, which may pose significant challenges for closing the deal within the effective term of the appraisal report.
Recommendations
• It is advisable to include a comprehensive appraisal mechanism clause in the transaction documentation; the seller’s legal counsel needs to have sufficient communication with the seller and appraisers in drafting this clause to consider the following factors (inclusive without limitation):(1) determination of the valuation approach; (2)determination of the reference date; (3) how to settle the differences regarding the appraisal results between the parties; and (4) the allocation of the appraisal fees and costs.
• To prevent losses during the sale of state-owned assets, currently the state-owned asset supervision mechanism sets a minimum threshold on the sale price. In contrast, purchase and sale of assets are essentially market-oriented behaviors and are up to the free negotiation between the parties in the competitive market. As a result, if the potential sale price is significantly lower than the appraisal result, the SOE seller needs to be practical in making their business decisions. Prior written approvals from relevant entities and authorities (i.e. the SOE’s headquarters or relevant SASAC bodies) are required if the sale has to be made at a price lower than 90% of the appraisal result.
QUESTION 6: Do the parties have the discretion to decide on the payment terms?
Key takeaways
• The state-owned asset supervision laws and regulations have set stringent restrictions as to the payment terms, the decision of which is beyond the discretion of the parties.
• According to the current laws and regulations for state-owned asset supervision, the transaction price shall, in principle, be paid in full within 5 working days from the date when the purchase and sale agreement comes into effect. Where the amount is relatively large and difficult to pay in full, the payment instalments may be permitted. Where such a payment instalment arrangement is in effect, the down payment shall not be less than 30% of the total price and shall be paid within five (5) working days from the effective date of the sale and purchase agreement. Regarding the outstanding amount, a lawful and effective guarantee recognised by the seller shall be in place and the interest on the outstanding amount as calculated using the banking loan interest rate of the same period shall be paid to the seller. The duration of the payment instalment arrangement shall not exceed one year.
• From the perspective of the SOE seller, the mandatory requirements place it at a strong position and help it to achieve favourable terms during negotiation. However, the SOE seller needs to understand the common practice and arrangements in cross-border transactions and adopt a more flexible and market-based strategy while taking into consideration the compliance requirements during the sale process.
Analysis
• According to the current laws and regulations for state-owned asset supervision, the payment of the price is triggered upon the effective date of the sale and purchase agreement, with stringent requirements in place pertaining to the timeline for payment instalments, the minimum down payment percentage, the criteria for guarantee and the interest. In summary, these provisions offer strong protection for the SOE seller, however, differ from common international rules and practices in the following aspects:
» There is a distinction between the execution date of the documentation (which is usually the same as the effective date) and the deal close date and payment is conditional upon the fulfilment (or waiver) of certain closing conditions. Without making such distinctions, the current payment requirements simply state that the payment liability will be triggered once the effective date of the agreement. Such provisions are rarely acceptable to foreign buyers as there is still uncertainty regarding the completion of the transaction when conditions precedent remain to be fulfilled;
» To minimise the risk of potential claims against the seller arising under the transaction documentation in cross-border transactions, the buyer will typically demand an escrow arrangement whereby the down payment or a certain percentage of the total consideration will be deposited in the escrow account. This amount will be released to the seller at an agreed date post the completion of the deal or subject to the fulfilment of certain conditions. Strictly speaking, such escrow arrangements may not comply with the current Chinese laws and regulations for state-owned asset supervision; and
» Where there is a payment instalment arrangement, the buyer shall provide a lawful and effective guarantee recognised by the seller, and pay interest on the outstanding amount. Such provision is generally arranged at the discretion of both parties to a cross-border transaction, however, it is regarded as mandatory under current Chinese laws and regulations. Consequently, it is necessary for the SOE seller to engage experienced counsels to assist with the understanding of relevant requirements and prepare legal opinions to minimise potential obstacles for the sale.
Recommendations
• In practice, payment of the transaction price ‘by the effective date of the sale and purchase agreement’ is instead routinely replaced with ‘by the closing date’. Such a contractual arrangement is consistent with international practices and relieves the buyer from considering how to pursue its deposit in the event of its failure to complete the transaction, especially when the buyer has paid the transaction price in part or in whole. In the future, it will be necessary to consider modifying the statutory supervision mechanism regarding state-owned equity in order to provide more freedom for the parties and align with international (or market-based) transaction practices.
• If it is necessary to carry out the process of the intended sale in an exchange, and the buyer is required to pay a security deposit, it is necessary to contemplate in the transaction documents the connection between such security deposit and the earnest money for the transaction, including the release of such security deposit in case of breach of contract.
• If the parties indeed require an escrow (account) agreement, the agreement will need to comply with the requirements for supervision of state-owned assets to greatest extent practicable with respect to the time limit for release of escrowed funds.
Appendix I: summary of provisions of central SOEs and 16 provincial/municipal SASACs on floor trading in disposal of overseas state-owned equity
