Notice on the establishment of a security review system regarding merger and acquisition (“M&A”) transactions over domestic enterprises executed by foreign investors (“the Notice”) was issued by China's State Council on February 3, 2011, which will come into effect on March 5, 2011.

In order to establish a formal process for reviewing national security issues in international M&A transactions, China will launch an inter-ministry foreign investment security review committee (the “Committee”) which will be led by the State Council.

The security review will be required when the following conditions concur simultaneously:

1. Review Scope

The domestic enterprise involved in the security review shall be:

1. A military or military-related enterprise, enterprise physically surrounding a key or sensitive military infrastructure or other military-related units;
2. A key national security-related enterprise regarding agricultural products, energy and resources, infrastructure, transportation, technology industries, or equipment manufacturing.

2. M&A of a Domestic Enterprise by Foreign Investors

The M&A of a domestic enterprise by foreign investors is defined as follows:

1. Foreign investors purchase the equity of a domestic enterprise or subscribe to the capital increase of this domestic enterprise;
2. Foreign investors purchase Chinese shareholders’ equity of a foreign-invested enterprise (the “FIE”) or subscribes to the capital increase of the FIE;
3. Foreign investors set up a FIE, and use the FIE to purchase the assets of a domestic enterprise or purchase the equity of this domestic enterprise;
4. Foreign investors directly purchase the assets of a domestic enterprise and use these assets to set up a FIE.

3. Actual Control of a Domestic Enterprise

The actual control of a domestic enterprise by foreign investors means that foreign investors become the controlling shareholders or actual controllers of a domestic enterprise after the M&A transaction takes place, which includes:

1. The foreign investor, its controlling parent company or its controlled subsidiary holds more than 50% of the equity of the new enterprise after the M&A transaction;
2. Two or more foreign investors totally hold more than 50% of the equity of the new enterprise after the M&A transaction;
3. Although the foreign investor holds less than 50% of the equity of the new enterprise after the M&A transaction, the foreign investor’s voting right as the shareholder of the new enterprise will significantly influence the decisions of shareholders’ meeting or board of directors of the new enterprise;
4. The foreign investor controls the important matters of the new enterprise after the M&A transaction, including business decision-making, finance, human resource or technology, etc.

4. Review Standard

1. The impact of the transaction on national security, including the domestic production capacity, domestic service capacity and related equipment and facilities for the purposes of national security;
2. The impact of the transaction on China's economic stability;
3. The impact of the transaction on basic social order;
4. The impact of the transaction on research and development capacity of key technology regarding national security.

5. Committee

According to the Notice, the Committee mentioned above is co-chaired by the National Development and Reform Commission (“NDRC”) and the Ministry of Commerce (“MOFCOM”). Other relevant government departments will be involved in the review, depending on the industry fields involved.

The major responsibilities of the Committee include the following:

1. Analyzing the national security impact of M&A transactions;
2. Researching and coordinating major issues during the review;
3. Conducting the M&A transaction review and making a decision accordingly.

6. Procedures

1. The foreign investor shall apply to MOFCOM for the review over every M&A transaction that falls within the “Review scope”. If the transaction falls into the scope of national security review, MOFCOM will submit the application to the Committee for national security review within 5 working days.
2. The Committee shall first conduct a general review of the M&A transaction submitted by MOFCOM. The Committee shall send a notice of the application to the relevant departments within 5 working days. Relevant departments shall provide their opinions in writing within 20 working days. If the M&A transaction is deemed not to have impact on national security, the Committee will send its opinion to MOFCOM based on the opinions of the relevant departments within 5 working days.
3. If a M&A transaction is not passed after the general review, a special review shall be conducted subsequently within 5 working days after receiving the written opinions from relevant departments. The Committee shall complete the special review within 60 working days after the launch of the special review.
4. Where the M&A transaction has had or may have a material impact on national security, the Committee shall require MOFCOM, together with the relevant departments, to terminate the transaction or transfer relevant equities/assets or take other effective measures to eliminate the impact of the M&A transaction on national security.

Comments

• The scope of the key national security-related enterprises is broad, and the category related to “energy and resources” is extremely wide.
• The Notice does not clearly establish how a foreign investor can be clear about whether his/her project needs review.
• The Notice does not clearly specify the standard for evaluating impact on national economic stability and basic social order.
• The Notice does not clearly define the function of the five-day review by MOFCOM, or the difference of its review from the general review by the Committee.
• The Notice does not establish the penalties for violating the Notice.