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28 Apr 2020
On 20 April 2020, the State Administration for Market Regulation (“SAMR”) published a merger filing case, submitted under SAMR’s simplified review procedure, regarding the establishment of a new joint venture by Shanghai Mingcha Zhegang Management Consultant Company (“Mingcha Zhegang”) and Huansheng Information Technologies (Shanghai) Limited (i.e., the “Mingcha Zhegang / Huansheng Information Case”).
A remarkable development under the Mingcha Zhegang / Huansheng Information Case is that Mingcha Zhegang expressively disclosed in its publicity form that it is a company controlled under a variable interest entity (“VIE”) structure. Specifically, according to the transaction description, it was disclosed that the ultimate controller of Mingcha Zhegang is Leading Smart Holdings Limited, a company registered in the Cayman Islands, which controls Mingcha Zhegang through a series of affiliated entities on the basis of contractual arrangements.
This development marks a significant milestone in that, by publishing the Mingcha Zhegang / Huansheng Information Case, SAMR is publicly signaling that it has formally accepted a merger filing involving a VIE structure, and that it is willing to initiate its merger control review procedures over a transaction involving a VIE structure. In doing so, SAMR has also signaled that transactions meeting merger control filing thresholds should indeed file notifications to SAMR even if such transactions involve a VIE structure, and that VIE structures will no longer constitute an adequate reason for a party not to file a transaction for merger control clearance.
MOFCOM: Deadlock in Merger Control Review for VIE-Involved Transactions
Considering that VIE structures are often used in China by foreign investors seeking to circumvent comparatively rigid PRC foreign investment restrictions, China’s regulatory authorities have long maintained a considerably vague attitude regarding the legal status of VIE structures. In past years, when the PRC Ministry of Commerce (“MOFCOM”) was responsible for merger control reviews, there had long been a market rumor that MOFCOM was reluctant to accept and review merger control filings that involved VIE structures. This was partly because MOFCOM had been simultaneously responsible for both reviewing merger filings in China and regulating market access policies concerning foreign investment in China, and it was believed that if MOFCOM ever accepted and approved a proposed merger involving a VIE structure, such approval could potentially be construed as MOFCOM (one of China’s primary foreign investment authorities) tacitly acknowledging the lawfulness of VIE structures.
For this reason, in the past, many parties that have undertaken mergers in China have chosen not to submit required merger filings if any of such parties involved a VIE structure, or if such envisioned transactions were related to a VIE structure. This created a virtual deadlock, considering that MOFCOM was reluctant to confirm whether these practices were legally compliant or not, nor did MOFCOM issue any penalty decisions against VIE-related fail-to-file transactions. Taken together, this eventually led to a stalemate and vacuum in China’s antitrust enforcement practices with respect to proposed mergers involving VIE structures.
SAMR: Review of VIE-related Transactions in Accordance with Laws and Regulations
However, since May 2018, the merger review work previously conducted by MOFCOM has been officially subsumed within SAMR, and is no longer under the auspices of MOFCOM. As a result, because SAMR is not directly in charge of regulating foreign investment in China, this organizational reform has had the effect of separating China’s anti-monopoly regime from China’s foreign investment regulatory body, thereby making the merger review work more “neutral” .
Since this regulatory reshuffling, SAMR has been working hard to resolve the above-mentioned law enforcement deadlock involving VIE structures. Now, with the formal initiation of the Mingcha Zhegang / Huansheng Information Case, SAMR has responded to the longstanding market rumors and uncertainties highlighted above in a clear manner. As such, the case represents a major breakthrough in PRC merger control enforcement practices.
Important Signals & Outstanding Issues
As noted above, the Mingcha Zhegang / Huansheng Information Case, clearly signals a deliberate shift by SAMR to ensure that market participants take their compliance obligations seriously in merger filings regarding VIE-related transactions. Because the VIE structure will no longer be viewed as a “get out of jail free card”, parties that utilize a VIE structure will need to immediately change their strategies of strategically overlooking or simply ignoring their merger control obligations, and should also evaluate their compliance risks under any past mergers or concentrations involving VIE structures. In the event that such the transactions meet specified regulatory thresholds, such parties should seriously consider their merger filing obligations for their transactions in order to avoid any risk of antitrust investigations and punishment.
Notably, Mingcha Zhegang / Huansheng Information Case is just SAMR’s first step in trying to resolve the historical PRC regulatory difficulties endemic to the VIE structure. This step itself is of great significance, however there are still many issues that will need to be further clarified and resolved. For example, it remains to be seen how SAMR will handle historic fail-to-file transactions involving VIE structures, and whether the parties to such transactions will be retroactively held accountable and punished for their failure to file their past transactions. Likewise, if a transaction directly involves a VIE structure or such VIE structure specifically designed to circumvent foreign investment restrictions, will the filings of such transactions also be accepted? These sorts of issues are still subject to further clarification and guidance from SAMR, and we will continue to keep tracking and analyzing policy changes and progress on this front.