Let the Games Begin: New Takeover Code Opens Door to Acquisition of Listed Companies
The China Securities Regulatory Commission (CSRC) finally promulgated the long awaited Administration of the Takeover of Listed Companies Procedures on September 28, with effect from December 1 this year. For the first time, clear rules have been spelled out as to how a takeover of listed Chinese companies can be done.
By Jonathan Z. Zhou, Fangda Partners
Before the Administration of the Takeover of Listed Companies Procedures (the Takeover Procedures or Procedures) were issued, various rules and provisions in the PRC Securities Law and different stock exchange listing rules governed takeover activities in the PRC. The lack of a systematic legislative framework governing listed companies takeover activities has led to considerable uncertainty for investors and practitioners alike. As the first takeover code in the PRC, the Takeover Procedures provide comprehensive guidelines for parties to use in takeover transactions.
Concept of Control
According to Article 3 of the Takeover Procedures, any acquisition of shares in a listed company by way of private sale, tender offer or public trading that aims at gaining control of such a listed company shall be subject to the Procedures.
The Takeover Procedures define what constitutes “control” of a listed company. The definition is the first in Chinese legislation since the PRC Company Law became effective in 1993. According to Article 61 of the Procedures, a person or person(s) controls a listed company if:
(i) they are the single largest shareholder on the share register of the company;
(ii) the voting rights being exercised or controlled by them are more than those exercised by the largest shareholder of the company;
(iii) they hold or control more than 30% of the shares or voting rights in the company;
(iv) they have the right to appoint more than half of the board members by exercising voting rights; and
(v) other circumstances determined by the CSRC.
Control of Chinese listed companies has usually been transferred by private sale and purchase of non-listed shares. The Takeover Procedures now offer substantial information on how a private sale shall be conducted.
For any takeover by private sale, the acquiring party shall prepare a takeover report and submit it to the CSRC on the second day subsequent to the execution of the takeover agreement. The takeover report shall be copied to the relevant CSRC local office and the stock exchange concerned. In the meantime, a notice shall be sent to the target company and the summary of the takeover report shall be made public.
Upon receipt of the notice, the board of the target company shall give an opinion on the impact of such takeover to the company, and independent directors shall give separate opinions on such impact. If the board thinks it necessary, an independent financial adviser shall be appointed to give advice. The opinions of the board and independent directors as well as the advice provided by professional advisers shall all be made public. In the case of a management buy-out, retaining an independent financial adviser is compulsory for the company.
For the transfer of state-owned shares or those shares requiring government approval, the takeover agreement can only be performed after the relevant approval has been obtained.
Transfer of Listed Shares by Private Sale
Transfer of legal person shares and state-owned shares by way of private sale has become a common method to takeover the control of a listed company in the PRC. Neither of these types of shares are listed or publicly traded. Until the Takeover Procedures were issued, it wasn’t clear under PRC law whether publicly traded shares could be transferred by private sale. According to Article 19 of the Procedures, publicly traded shares can be transferred in this way, provided that certain procedures are complied with, as follows:
(i) a securities company shall be retained to handle the transfer and settlement procedures and this securities company shall apply to the stock exchange and clearing house for the suspension of trading of the shares to be transferred and the holding of such shares in custody;
(ii) the transferor shall make a public announcement of matters such as the transfer agreement and the name of the securities company retained on the subsequent day after the application of such transfer has been submitted to the stock exchange on which the shares to be transferred are listed;
(iii) the stock exchange concerned shall review the application and decide whether or not to approve the application within three working days after the application is received;
(iv) the securities company shall apply to the clearing house for the transfer of shares upon the approval of the stock exchange and the transferee shall announce this to the public within two working days after such a transfer is completed;
(v) after the shares transfer procedure has been completed, the securities company shall apply to the stock exchange for the release of the custody of the shares and the transferee shall announce this to the public within two working days after the release. The public trading of such shares can then be resumed on the stock exchange.
The Takeover Procedures also provide that a shareholder may sell their shares in a listed company by public soliciting, provided that the CSRC and the relevant stock exchange have approved such soliciting and it is made through a securities company. However, the term “public soliciting” is not defined in the Procedures and it is unclear what the difference is between public soliciting and public offering. According to a notice issued by the CSRC on September 30 2001, such public soliciting shall refer to the transfer of non-listed shares in a listed company by way of auction1 or other legitimate means.
In line with the PRC Securities Law, the Takeover Procedures require the acquiring party to make a general offer to all the shareholders of the target company should it intend to hold or control more than 30% of the outstanding shares of the target company unless waived by the CSRC.
In addition to the compulsory general offer triggered by the 30% threshold, an acquiring party, which originally held less than 30% of the shares in the target company, can increase its stake in the target company by making a tender offer, provided that the shares to be purchased do not exceed 5% of the outstanding shares and the result of such offer shall not cause its held shares to exceed the 30% threshold.
The acquiring party shall prepare a tender offer report (Tender Offer Report) and submit such report to the CSRC as well as the stock exchange on which the target company is listed. In the meantime, the target company shall be notified and a public announcement indicating the proposed offer (Indicating Announcement) shall be made accordingly. Should the CSRC have no objection to the Tender Offer Report within 15 days after the receipt of such report, the acquiring party can make the offering documents public. If there are any objections, the acquiring party shall amend the report or submit supplemental documents to the CSRC as requested.
For the purpose of making a tender offer, the acquiring party shall appoint a legal counsel to opine on the truthfulness, correctness and completeness of the Tender Offer Report. It is also required to retain a financial adviser to opine on the performance ability of the acquiring party. The board of the target company shall retain a financial adviser for the company to assess the financial conditions of the target company and give an opinion on the fairness of the offer. In the case of a management buyout, the independent directors, instead of the board, shall retain a financial adviser to undertake the works above-mentioned. The board of the target company shall prepare a report (Response Report) setting out the recommendation of the board to the shareholders as to whether the offer is acceptable. Such Response Report and the said opinions shall be submitted to the CSRC and be made public by an announcement together with the separate opinions given by the independent directors.
If the acquiring party intends to make the payment by cash, 20% of the transaction value shall be placed in a bank account designated by the securities clearing house as a performance bond at the time when the Indicating Announcement is made. If the payment is to be made by transferable securities, such securities shall be held in custody by the securities clearing house.
Permissible Offer Price
For offers made for listed shares, the offer price shall not be lower than the higher of the following: (i) the highest price the acquiring party has paid within six months prior to the date of the Indicating Announcement in buying the securities of the target company via public trading; or (ii) 90% of the average daily weighted trading prices of such listed shares in the past 30 trading days prior to the date of the Indicating Announcement.
For non-listed shares, the offer price shall not be lower than the higher of the following: (i) the highest price paid by the acquiring party within six months prior to the date of the Indicating Announcement; or (ii) the most recent audited book value per share of the target company.
The CSRC may waive the restrictions on offer prices in certain special circumstances. It is not, however, indicated in the Takeover Procedures what these special circumstances are. In the meantime, in the Takeover Procedures, the CSRC has established itself the right to intervene if it thinks the transaction price is obviously unfair.
Vulnerability of the Target Company
According to the Takeover Procedures, the directors and senior officers of the target company shall not take any action against the interest of the company and its shareholders in responding to the takeover offer. The board of the target company is restricted in its ability to take the following actions after the acquiring party has made the Indicating Announcement:
(i) issuing new shares;
(ii) issuing convertible bonds;
(iii) redeeming the company’s shares;
(iv) amending the company’s articles of association;
(v) entering into any contracts that may have a material impact on the assets, debts, interests or performance of the company, except for those being made in the ordinary course of the company’s business; and
(vi) disposing of or purchasing material assets of the company or adjusting the core business of the company unless the business adjustment or asset restructuring is undertaken by a company facing serious financial difficulty.
According to the above restrictions, the management of the target company is in general prevented from taking any active anti-takeover actions, and as a result the target company is very vulnerable in defending any hostile takeover.
Amendment and Withdrawal of Tender Offer
If the acquiring party has withdrawn its takeover plan after the Tender Offer Report has been submitted to the CSRC and before the tender offer is made, it cannot restart a new offer until a 12-month period has expired since its withdrawal.
Unless a competitive tender is in place, the term of a tender offer shall not be less than 30 days or longer than 60 days. However, it is not clear in the Procedures whether the “day” refers to a trading day or a calendar day. An offer is not allowed to be withdrawn within the term of the offer. If the acquiring party intends to revise a made offer, it shall submit a prior written application to the CSRC and copy such to the stock exchange concerned and the target company. Unless approved by the CSRC, any condition of the offer cannot be revised.
Waiver of General Offer
According to the Takeover Procedures, in the following circumstances the acquiring party can apply to the CSRC for waiver or partial waiver of its general offer obligation:
(i) shares in a listed company are transferred between different entities controlled by the same person and the ultimate control of such listed company is not changed after the transfer, provided that the transferee undertakes to perform the obligations as a promoter;
(ii) a listed company is in serious financial difficulty and the acquiring party intends to rescue such company by making viable asset restructuring proposals;
(iii) a listed company issues new shares according to the resolution of a shareholders meeting and the result of such issuance causes the shares held or controlled by the acquiring party to exceed 30% of the total outstanding shares of such listed company;
(iv) the holding of the acquiring party in a listed company exceeds the 30% threshold due to enforcement of court orders;
(v) a shareholder holding more than 50% shares in a listed company intends to increase its holding and the result of such increase will not cause the shares held by such shareholder to exceed 75% of the outstanding shares of such company;
(vi) the 30% threshold is exceeded due to the capital reduction of the listed company concerned;
(vii) a securities house holds more than 30% of the shares in a listed company as a result of carrying on its normal stock underwriting business without the intention to control such listed company, and a proposal has been made on transfer of the shares in excess of the 30% threshold to non-related parties;
(viii) a bank holds more than 30% of the shares in a listed company as a result of carrying on its normal banking business without the intention or action to control such listed company and a proposal has been made on transfer of the shares in excess of the 30% threshold to non-related parties;
(ix) a person holds more than 30% of the shares due to the allocation of state-owned assets by administrative orders;
(x) a person holds more than 30% of the shares due to lawful successions; and
(xi) other circumstances decided by the CSRC for the purpose of responding to changes of the securities market and protecting the lawful interests of investors.
In the case of the first four circumstances given above, a written waiver from the CSRC is necessary before the relevant transaction can be concluded. For the circumstances in items (v) to (x), the transaction parties shall submit the application documents to the CSRC and, if the CSRC has no objection within five working days upon receipt of such application, the transaction can be concluded. As to circumstance (xi), it seems that the CSRC has discretion in deciding to give a written waiver or simply to give the green light by making no objection.
Compared to the previous rules and practices, the scope of waiver events has been broadened by the Takeover Procedures.
Takeover of Listed Companies by Foreign Acquiring Parties
The Takeover Procedures do not mention if foreign companies are allowed to take over a Chinese listed company. However, the CSRC, the Ministry of Finance (MOF) and the State Economic and Trade Commission (SETC) jointly issued a notice on November 4 of this year that covers the transfer of state-owned shares and legal person shares in listed companies to foreign companies. The November 4 notice releases the restriction issued by the State Council in June 1995 on the transfer of non-listed shares, which are classified as state-owned shares and legal person shares, to foreign investors.
The November 4 notice is important given its status as a policy statement on further opening of the Chinese capital market to foreign investment. In addition, from a practical point of view, attention should be paid to the following points:
(i) the transfer of such non-listed shares in Chinese listed companies cannot violate the industry policies under the Foreign Investment Industrial Guidance Catalogue. For companies in restricted sectors, the result of such a transfer shall not cause foreign majority ownership in listed companies;
(ii) in general, the transfer of non-listed shares shall be made by way of open bidding;
(iii) any transfer involving industry policies or company restructuring shall be approved by the SETC and in the meantime, any transfer involving state-owned assets shall be approved by the MOF. The CSRC’s regulations on takeover and related information disclosure shall be complied with as well. It is interesting to see that approval from the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) is no longer required. This departs from the former practice whereby MOFTEC approval was definitely required for a foreign company to acquire more than a 25% stake in Chinese companies;2
(iv) the full payment of the purchase price shall be completed before the transferred shares can be legally registered in the name of foreign transferees. The payment shall only be made in freely exchangeable foreign currencies or renminbi profits made by foreign transferees from their previous investments in China;
(v) the parties to the transfer shall register with the State Administration of Foreign Exchange before the legal title of the shares has been transferred;
(vi) the non-listed shares acquired by foreign companies shall not be resold within 12 months after the full payment of the purchase price is made; and
(vii) after the transfer has been completed, the listed company cannot enjoy any treatment enjoyed by foreign-invested enterprises and all the original policies applicable to such a listed company shall remain.
Under current PRC law, foreign companies are still not able to acquire publicly traded shares via stock exchanges. This prohibition looks unlikely to be lifted until the Chinese currency can be freely exchanged. Notwithstanding this restriction, it is not only legally permissible but also commercially viable for foreign companies to take over control of listed companies in China, given the fact that the majority stake of Chinese listed companies are non-listed shares.
The rules have been laid down. It is time to play the game.
1 Usually those non-listed shares may be auctioned upon a court order in case the shareholder concerned is not able to enforce a court judgment.
2 According to MOFTEC’s Certain Questions on the Establishment of Foreign-funded Companies Limited by Shares Tentative Provisions, acquisition of a Chinese enterprise and conversion of such company into a company limited by shares shall be approved by MOFTEC. According to the PRC Company Law, all listed companies have to be established in the form of companies limited by shares.