MOFCOM in M&A deals – increasing certainty of outcomes and managing expectations
October 2015 | PROFESSIONAL INSIGHT | MERGERS & ACQUISITIONS
Financier Worldwide Magazine
Merger control can have significant implications for the timing and structure of any M&A transaction. Where a transaction is subject to the Chinese merger control regime, regulated by the Anti-Monopoly Bureau of the PRC’s Ministry of Commerce (MOFCOM), the parties need to factor a considerable clearance timeframe into the transaction timetable. The parties should proactively manage the MOFCOM approval process and should also consider seeking to achieve timeframe certainty and additional value for shareholders in the event that timeframes blow out, through a variety of measures.
When will a deal need MOFCOM approval?
Parties to M&A transactions should consider at an early stage of a transaction whether the Chinese merger control regime could apply to their transaction. Two tests based on the turnover of the parties apply to determine whether MOFCOM notification is required, which impose relatively low thresholds.
The first test is where the aggregate global turnover of all undertakings participating in the concentration exceeded approximately $1.5bn during the previous financial year, and at least two undertakings (e.g., bidder and target, or two joint bidders) each had turnover of around $63m within China during the previous financial year.
The second test is where the aggregate turnover within China of all undertakings participating in the concentration exceeded $315m during the previous financial year, with at least two undertakings each having a turnover of $63m within China during the previous financial year.
However, even if neither of the two turnover thresholds above is met, MOFCOM can still exercise jurisdiction over a transaction on its own initiative if it considers that the transaction “may result in the elimination or restriction of competition in China”.
The Chinese regime takes a unique approach to joint ventures, where the formation of any kind of joint venture company can require notification to MOFCOM. This contrasts with the position in other regimes, most notably the EU, where a joint venture needs to be deemed ‘full-function’ in order to fall within the merger control regime. Accordingly, joint ventures which are set up to carry out only one function, such as R&D, or which have no market facing activities, such as a joint venture which makes sales only to its parents, which would not trigger EU merger control, may nevertheless trigger the Chinese regime. The formation of an offshore joint venture without any economic activities in China can also be caught by the merger control regime based on the turnover of its parent companies alone (although a simplified review procedure may apply to such joint ventures).
A two-phase review process applies for merger notifications in China. The initial period can last up to 30 days (Phase I), which can be extended by another 90 days (Phase II). MOFCOM may, under special circumstances, extend the review process by a further 60 days (Extended Phase II). However, for those transactions which raise competition concerns (as was the case in the high profile Glencore/Xstrata transaction), the process may take upwards of a year to negotiate and settle remedies with MOFCOM. Parties should also factor in the time it could take to gather the information required for the notification; and an additional ‘pre-acceptance’ period between submission of the notification form and the formal commencement of the review process.
In 2014, MOFCOM introduced new procedures for the notification of ‘simple cases’ which apply to (among others) offshore joint ventures with no impact on the Chinese market or transactions which trigger the above thresholds but where the parties have low combined market shares. Under the simple regime, companies can expect shorter review periods and less extensive information requirements, unless a third party objects to the use of the simple regime procedure in relation to the transaction.
Where a transaction raises competition law concerns in China, MOFCOM clearance can be made conditional on a substantial remedies package (including behavioural and divestment commitments). Since its inception in 2008, MOFCOM has demonstrated its willingness to intervene in international M&A transactions and has imposed remedies in a number of cases that were cleared unconditionally by other regulators.
How to increase certainty of outcomes and manage expectations
The long timeframes that may be involved in obtaining MOFCOM approval, together with the uncertainty as to the time at which approval will be received or the conditions on which approval may be received, means that parties in transactions which are subject to MOFCOM clearance need to proactively manage the MOFCOM approval process should consider seeking to impose some certainty around timeframes and should also actively manage shareholder expectations more generally to ensure a successful outcome.
As transactions which are subject to MOFCOM approval could remain conditional on MOFCOM approval for a number of months, the parties will be keen to minimise completion risk and the target in particular will want to provide its shareholders with maximum certainty.
There are a number of mechanisms in agreed transactions the parties could look to employ in an agreed transaction to incentivise the buyer or bidder to file its application as quickly as possible, ensure that the target or seller has a path out of a transaction where approval takes a disproportionate length of time or compensate the target or its shareholders for losses caused by a transaction failing to proceed. A target in a listed company takeover, or a seller in a regulated private M&A deal, may be able to secure additional value in the event that MOFCOM approval is not received by a particular time (e.g., payment of a dividend in respect of a period between when the parties expect to receive the approval and when the approval is in fact received). The deal documentation could specify an ‘end time’, beyond which time the target or seller is entitled to cease to proceed with the deal if certain milestones (e.g., the obtaining of necessary regulatory approvals) have not been achieved. It may also be desirable for the target or seller to have the right to elect unilaterally to extend this ‘end time’. This would provide an exit mechanism from a transaction where MOFCOM approval takes longer than anticipated, such that a bidder or buyer does not simply have a free ‘option’ to keep the transaction on foot indefinitely. Parties that are concerned about the uncertainty attached to a regulatory approval condition may require that a reverse break fee be payable in the event that a regulatory approval is not obtained and the transaction is terminated.
It will be important for bidders in transactions involving listed targets (and for listed targets in recommended transactions) to manage shareholder expectations generally for a successful outcome. In both schemes of arrangement and takeovers, the bidder and target may also consider more regular updates than usual to the market in order to encourage maximum bid acceptances or maximum favourable participation at the shareholder meeting to approve the scheme.
In a takeover bid, for example, shareholders may be reluctant to accept into a bid and lock up their shares until MOFCOM approval has been received, or there is certainty as to the timeframe in which it is likely to be received. Further, keeping shareholders informed (as best they can be) as to the progress of MOFCOM approval may minimise the risk of having accepting shareholders withdraw their acceptances in circumstances where they become entitled to do so.
The market is seeing greater awareness of the need to obtain MOFCOM clearance in transactions where the parties do business in China. While there is no ‘one size fits all’ approach to structuring a transaction to accommodate MOFCOM approval, parties need to be aware of mechanisms that can be used to increase certainty, secure additional value and maintain shareholder engagement for a successful outcome to the transaction.
Tony Damian and Mark Jephcott are partners at Herbert Smith Freehills. Mr Damian can be contacted on +61 2 9225 5784 or by email: firstname.lastname@example.org. Mr Jephcott can be contacted on +852 2101 4027 or by email: email@example.com.
© Financier Worldwide
Tony Damian and Mark Jephcott
Herbert Smith Freehills