China Overhauls Takeover Code of Listed Companies

China’s new Takeover Code aims to boost domestic and cross-border merger and acquisition activities involving PRC-listed companies. It imposes stringent information disclosure requirements to improve transparency and clarifies rules to make the acquisition process more efficient.

By Jean-Marc Deschandol and Charles Desmeules, Norton Rose, Beijing

The China Securities Regulatory Commission (CSRC) issued the Acquisition of Listed Companies Administrative Procedures (Takeover Code) on July 31 2006. The Takeover Code became effective as of September 1 2006 and repealed the old procedures (Old Takeover Code), which had been effective since December 1 2002. The Takeover Code unifies provisions under a single piece of legislation, which were previously spread out over numerous circulars and regulations. In addition, this much welcomed piece of housekeeping legislation clarifies rules on partial offers, widens the’concerted action’ concept, updates rules on offer exemptions, regulates indirect acquisitions and redefines the role of financial advisers.

Improved transparency: disclosure requirements

The Takeover Code requires shareholders (and persons’acting in concert’ with shareholders) to disclose certain information as they increase their stake in the company. The information to be disclosed depends on how the shareholder has increased its stake. For example, shareholders increasing their stake in a listed company to 5% must, within three days, report the shareholding increase to the CSRC and the relevant stock exchange, and notify the listed company and the public. Subsequent shareholding increases reaching 5% must be disclosed in a similar manner. Different reporting requirements apply to different thresholds (5-20%, 20-30% and more than 30%). Under the Takeover Code, effective shareholding includes any convertible security or right to acquire shares.

Widened concerted action definition

In the Takeover Code, the expression “acquirer” includes the investor and other persons’acting in concert’ with the investor. ‘Concerted action’ is where two or more investors, through agreement or other arrangement, expand or consolidate their control over a listed company. The Takeover Code introduces a rebuttable presumption that investors will be’acting in concert’ if, among other factors, it is established that:

i. an investor holds shares via another shareholder of a listed company and can exert influence over major decisions made by that particular shareholder;

ii. two or more investors are controlled by the same person;

iii. directors, supervisors or senior managers of an investor hold similar positions with another investor;

iv. a non-bank person has provided financial arrangements to the investor in order to allow him or her to purchase the shares;

v. there exists an alliance, partnership, cooperation, or other form of economic relationship between two investors;

vi. a natural person shareholder holds 30% of the shares of an investor, who also holds shares in the company, or

vii. there is a “connected relationship” (as defined in the PRC Company Law) between the investors.

Acquisition by offer

The Takeover Code distinguishes between compulsory and voluntary offers. Under the Takeover Code, acquirers not otherwise subject to the obligation to launch an offer can choose between a general or partial offer as a strategy to acquire a listed company.

The Takeover Code clarifies the circumstances under which an acquirer can launch a partial offer (a concept introduced by the PRC Securities Law, effective since January 1 2006 ). A “partial offer” is defined as an offer for less than the whole of an issuer’s issued share capital. The Takeover Code requires the promoter of a partial offer to offer to purchase at least 5% of the issued shares of the listed company. Acquirers holding more than 30% of a listed company’s issued shares and who would like to continue to increase their shareholding may proceed by way of general or partial offer.

Acquirers intending (or required by law) to launch an offer must submit an acquisition report to the CSRC. The acquisition report is a key document in the offer process, as it will ultimately serve as a basis on which the CSRC decides whether to allow the acquirer to launch the offer.

Notably, the acquisition report must describe whether there exists connected transactions between the acquirer and the listed company, and whether there is actual or potential direct competition between the acquirer and the target company. In the case of competition or connected transactions, the acquisition report must also describe whether the acquirer has made any arrangements to prevent competition with the listed company.

The acquisition report must also describe’material transactions’ between the acquirer and the target company in the past 24 months. Unfortunately, the Takeover Code does not define what constitutes a’material transaction’. The acquisition report must also provide information on the acquirer’s purchase of the target company’s issued shares through a stock exchange in the six months preceding the preparation of the acquisition report. If the offer is a general offer, the acquisition report must also indicate the likelihood of the target company’s delisting and the arrangements in place for shareholders if such an event occurs.

The acquirer may withdraw its acquisition report after it has been submitted but not yet published, provided that it gives sufficient reasons to the regulator. In this case, however, the acquirer will be precluded from “acquiring the target company” for a period of 12 months following the public announcement of its withdrawal. It is unclear whether small shareholding increases that do not result in the change of the controlling shareholder will also trigger this blackout period.

Interestingly, the Takeover Code subjects the actual launch of an offer to the CSRC for approval. Pursuant to Article 28, the acquirer may launch its offer only if the CSRC “expressed no objection” within 15 days of submitting the acquisition report. It is unclear, under the Takeover Code, whether the CSRC will issue a written statement giving its consent or whether silence will be deemed to be consent. The acquirer cannot launch an offer if the CSRC finds that the report does not comply with PRC law, or presents a threat to “national security or the public interest”. The Takeover Code states that the activities related to the takeover of listed companies and associated shareholding changes must not harm national security or the public interest.

After the acquirer has launched its offer, the offer can last for between 30 and 60 days. The acquirer cannot cancel the offer before the term of the offer expires and must secure the CSRC’s approval to change the conditions of the offer. No changes are allowed in the last 15 days of the offer, unless the offer is contested. The acquirer is also precluded from purchasing the target company’s shares during the offer period.

Target company’s reaction to the offer

Within 20 days of launching the offer, the target company’s board of directors must:

i. examine the status and credit standing of the acquirer and the acquirer’s motives for the acquisition;

ii. perform an analysis of the terms and conditions of the offer, and

iii. make a proposal to shareholders as to whether they should accept the offer.

The target company’s board of directors must appoint an independent financial advisor to issue a professional opinion on the offer. The board’s report and independent financial advisor’s opinion must be submitted to the CSRC. Copies must also be submitted to the local CSRC bureau and the relevant stock exchange. The board’s report and independent financial advisor’s opinion must also be published.

With a greater percentage of their shares becoming publicly tradable, PRC-listed companies will have to develop anti-takeover strategies and defence mechanisms. As a general rule, under the Takeover Code, the target company’s board is entitled to make certain decisions and adopt measures in response to an offer (such as seeking alternative offers), but must ensure such decisions and measures are taken in the interests of the company and its shareholders. The board cannot create an’unsuitable obstacle’ to the acquisition and cannot make decisions that would damage the company’s and shareholders’ interests.

The Takeover Code makes PRC-listed companies particularly vulnerable to hostile takeovers. After launching an offer and until the offer expires or the acquisition is completed, the target company may only continue normal business operations and implement resolutions already passed at the shareholders’ general meeting. Specifically, the target company’s board of directors cannot transfer the company’s assets, perform investments, provide loans or guarantees, change the company’s business activities, or take any action that would have a material effect on the company. In practice, any anti-takeover ‘crown jewel defence’ (involving the spin-off of the target company’s main assets) would require shareholders’ approval. Directors of the target company are precluded from resigning during the offer.

Acquisition by agreement

If an acquisition by private agreement results in the acquirer holding a stake of 5-30% in the listed company, the acquisition will be subject to shareholding disclosure requirements.

Under the Takeover Code, to acquire more than 30% of the target company’s issued shares by agreement, the acquirer must proceed by way of offer for the shares in excess of the 30%, unless he or she obtains an exemption from the CSRC. If no exemption is obtained, or if the acquirer does not apply for an exemption, the acquirer must first proceed by way of offer before executing a private agreement (for those shares in excess of 30%). If the acquirer chooses to continue by way of partial offer, the offer must aim for at least 5% of the target company’s issued shares.

Between the signature of the acquisition agreement and the completion of share transfers, the company cannot reshuffle its board of directors (unless it has good reasons to do so); issue new shares; make important purchases, asset disposals or investments; provide guarantees to the acquirer or its connected persons; or enter into connected transactions with the acquirer.

Indirect acquisition

Persons indirectly holding shares in a listed company may also be subject to the Takeover Code. For instance, a person acquiring control of an offshore company that holds shares in a company listed on the Shanghai or Shenzhen stock exchange is deemed to acquire from the seller, shares of the listed company up to the percentage of the shares acquired in the offshore company. If the person’s deemed shareholding reaches 5% of the issued shares, he or she will be subject to the Takeover Code’s disclosure requirements; if the person’s deemed shareholding exceeds 30% of the listed company, the offer obligation applies.

The Takeover Code requires the de facto controlling person to cooperate with the listed company and to fully disclose all information in relation to the change of de facto controlling person. In case the de facto controlling person defaults, causing the listed company to become incapable of performing its information disclosure requirements, the Takeover Code provides the listed company with a statutory civil recourse against the de facto controlling person.

Exemption from offer obligation

The Takeover Code widens the range of circumstances where an acquirer, who is required to launch an offer, may apply for an exemption. An acquirer may apply for an exemption where:

i. the buyer and the seller are able to provide evidence that the transfer will not cause a change in the de facto controlling person of the listed company;

ii. the listed company faces great financial difficulties, the rescue plan proposed by the acquirer has been approved by the company’s shareholders, and the acquirer undertakes not to transfer the shares for a minimum three-year period;

iii. a private placement of shares with the acquirer causes his or her shareholding to exceed 30% of the company’s issued share capital, the acquirer promises not to transfer the shares for a three-year period and the shareholders support the exemption application, or

iv. other circumstances deemed appropriate by the CSRC.

The CSRC must make a decision within 20 days of receiving the application.

In addition, the Takeover Code provides that an exemption may be granted under a fast track procedure (whereby the CSRC renders a decision within five days of the application) in any of the following circumstances:

i. where relevant approvals have been given, the gratuitous transfer of state-owned assets causes an acquirer to hold more than 30% of the listed company’s issued shares;

ii. the acquirer’s shareholding reaches or exceeds 30% of issued shares and a year after the 30% threshold has been reached or exceeded, the yearly shareholding increase will not exceed 2% of the issued shares;

iii. the acquirer’s shareholding reaches or exceeds 50% of the issued shares and its continuous increase of shareholding does not affect the company’s compliance with listing requirements;

iv. the acquirer’s shareholding exceeds 30% as a result of the company’s buyback of a designated shareholder’s shares;

v. financial institutions (such as securities companies and banks) holding more than 30% of the issued shares, as a result of their underwriting business that do not intend to effectively control the listed company, and that have disclosed to non-related persons a plan to dispose of the shareholding within a reasonable period;

vi. the acquirer’s shareholding in the listed company exceeds 30% as a result of inheritance or donation, or

vii. other circumstances where the CSRC determines that an exemption should be granted.

Price and payment

Under the Takeover Code, the proposed price for the shares cannot be lower than the highest price paid by the acquirer for the target company’s shares, in the six months preceding the acquirer’s publication of a summarized acquisition report.

As it was the case under the Old Takeover Code, the share price may be made in a cash payment, securities or other methods authorised by law. However, the Takeover Code now stipulates that payment has to be made in cash in certain circumstances, such as when the offer is launched in view of delisting the company, or when the CSRC rejects a general offer exemption application. In addition, when the price is to be paid in non-listed securities, the acquirer must offer the choice to shareholders to opt for cash instead of securities. Under the Provisions on Acquisitions of Domestic Enterprises by Foreign Investors (effective from September 8 2006 ), 1 it should be noted that foreign acquirers may only pay in securities where an overseas listed company issues such securities.

The Takeover Code reiterates the requirement that a percentage of the price be deposited with a third party. The acquirer must, when the acquisition price is to be paid in cash, place at least 20% of the acquisition price into an escrow account managed by a bank designated by a securities deposit and clearing company. If the price is to be paid in shares, the acquirer must entrust the shares with the securities deposit and clearing company.

Broader role of financial advisers

The Takeover Code establishes a responsibility system in which the acquirer must appoint a CSRC-certified’financial advisor’ who will examine, track and supervise the acquirer before, during, and for a 12-month period, after the acquisition. The emphasis on the financial advisor’s role is aimed at reducing the involvement of administrative authorities, making transactions more market-oriented and increasing the accountability of professional intermediaries. However, the financial consultant’s new role as both advisor to, and supervisor of, the acquirer may give rise to conflicts of interest, as the consultant is usually employed by the acquirer to perform a financial due diligence on the target, as well as advise on strategies for the takeover. Under the Takeover Code, the financial advisor must refuse to provide financial advice if he or she believes the acquisition is detrimental to the interests and shareholders of the company.

management buyouts

Management buyouts (MBOs), especially leveraged MBOs, are subject to more rigorous scrutiny and additional hurdles under the Takeover Code. For instance, pursuant to Article 8, a listed company’s board of directors is precluded from using the company’s resources to finance the acquisition. Article 51 provides that when a listed company’s directors, management staff or employees plan to acquire (directly or indirectly) the control of a company, the company’s board of directors must be composed of at least one-half of independent directors. The acquisition must be approved by non-connected directors, two-thirds of the independent directors and more than one-half of the non-connected shareholders.

Takeover of PRC cross-listed companies

The CSRC’s admitted long-term objective of convincing quality overseas-listed PRC companies to list on the Shanghai or Shenzhen stock exchanges is reflected in its recent legislation. The Takeover Code considers this eventuality ( if the target company is listed in the PRC and overseas, the acquirer should comply with both CSRC rules and the relevant requirements applicable in the overseas jurisdiction where the target is also listed.

A boost for M&A activity

Without a doubt, the changes brought by the Takeover Code are of interest to a wide range of investors, including foreign strategic investors, which have recently been allowed to acquire tradable A-shares of PRC listed companies. 2 The widened definition of “concerted action” and the introduction of provisions on indirect acquisitions will subject more persons, including persons and entities located outside the PRC, to the Takeover Code’s interest disclosure and offer requirements. Investors may now opt for a general or partial offer as a strategy to acquire a listed company. These positive developments will significantly boost high-level domestic and cross-border mergers and acquisition activity involving PRC-listed companies.

Endnotes

1 See pg 21 in this issue of China Law & Practice for a detailed discussion of these provisions and pg 69 for the full translation.

2 See Deschandol, J. and Desmeules, C., ‘New Rules on Strategic Investments by Foreign Investors in Listed Companies’, China Law & Practice, February 2006, Vol.20, No.1, pg 13.