Author: Xu Meng
Acquisitions of enterprises are normally seen as economic activities. However, legal issues sometimes are the key to successful acquisitions. Acquisitions of enterprises are normally seen as economic activities. However, legal issues sometimes are the key to successful acquisitions. Xu Meng of V&T Law Firm explains the legal issues concerning interested party, target, process and right protection in acquisitions of state-owned enterprises.
Acquisitions of enterprises are normally seen as economic activities. However, legal issues sometimes are the key to successful acquisitions. This article attempts to analyze the key legal issues in acquisitions of state-owned enterprises, and answer some questions about the acquirer, target companies, process and right protection in acquisitions of state-owned enterprises. This article is intended to help our readers better understand and implement acquisitions of state-owned enterprises.
There is no doubt that acquisitions of enterprises are economic activities in the first place.
In considering to acquire a state-owned enterprise, an entrepreneur usually analyzes the interests and makes decisions in the economic point of view. However, economic activities without legal protection cannot survive. An acquisition which is not legally protected will not only adversely affect the acquirer’s intended purpose, but also result in unnecessary disputes in the future. According to the author's experience in advising an acquisition of a local state-owned enterprise by a private company, it was found that neither the acquirer nor the seller was well prepared for or had sufficient legal knowledge of the proposed acquisition. Legal requirements do exist and cannot be avoided. With regards to an acquisition of a state-owned enterprise, the following legal issues cannot be overlooked:
I. Who has the right to sell the state-owned enterprise?
Every transaction must have a buyer and a seller, and it is commonly known that only the owner has the right to sell the proposed property. However, when an enterprise is being sold, the identity of the legally permitted seller is rarely considered. Sometimes, a factory director or manager may act as the seller, while sometimes the administrative industry bureau, commerce bureau or foreign trade bureau may act as the seller. According to many people’s general understanding, these persons or organizations are supposed to be the owner of state-owned enterprises.
When an enterprise is being sold, what is actually being sold is the ownership to such enterprise. Generally speaking, the ownership to an enterprise belongs to the investors of such enterprise. Therefore, only the investors of such enterprise have the right to sell it. For state-owned enterprises, the parties who have the right to sell them mainly include:
1. Governments at all levels - China’s state-owned enterprises, which are divided into central enterprises and local enterprises, are owned by the country and the governments at all levels are delegated to exercise such ownership rights. Accordingly, local governments have the rights to sell their subordinate enterprises.
2. Organizations and enterprises authorized by governments at all levels - Organizations authorized by governments mainly refer to administrative bureaus of state-owned assets or state-owned group companies which are authorized to dispose of state-owned assets. Organizations and enterprises authorized by governments are not the real owners of state-owned enterprises, but only the representatives of the owners.
II. Who has the right to sell the assets of a state-owned enterprise?
Sale of a state-owned enterprise and sale of the assets of a state-owned enterprise are two legal issues and of different nature. After a state-owned enterprise is sold, the assets of such enterprise will remain unchanged. The only change is the change of the shareholders or owners of such enterprise. Sale of the assets of a state-owned enterprise is to sell such enterprise’s assets to another enterprise or individual, but the right to control or own such enterprise will remain unchanged.
In accordance with the current laws, after the state’s investment is injected into a state-owned enterprise and becomes part of such enterprise’s property, such state-owned enterprise, as a legal entity, shall have the right to lawfully possess, use, make profits from and dispose of its property, which means that such state-owned enterprise has the right to act as a legal entity to possess its property. Therefore, such state-owned enterprise has the rights to lawfully dispose of its property. Sale of its property by such enterprise represents that such enterprise enjoys property rights as a legal entity. After selling an asset, the enterprise, as a seller, transfer the rights to such asset to the purchaser, but the purchaser will not become a shareholder of such enterprise as a result. That is it is the state-owned enterprise itself which sells its assets. However, to sell the key equipment, whole set of equipment or other importance assets of a state-owned enterprise, , interests of such state-owned enterprise will be significantly affected. In order to protect state-owned assets and prevent the loss of state-owned assets, before such enterprise sells such assets, it must obtain the approval of the government authorities concerned. Since an enterprise’s sale of its assets will not result in any change in its investors, after the sale of its assets, such enterprise will keep its original nature.
III. What are the required procedures for selling a state-owned enterprise?
As mentioned above, to sell a state-owned enterprise, it is necessary to make contact with the government. The government, when deciding or approving the sale of the proposed state-owned enterprise, needs to comply with certain examination and approval procedures, so as to maintain the stability of economy, prevent the loss of state-owned assets, and protect the interests of the enterprise's employees. In accordance with the current laws, regulations and rules, the sale of a state-owned enterprise, except the transfer of financial state-owned property rights or the transfer of state-owned equity of a listed company, shall comply with the following procedures:
1. The seller of the enterprise shall formulate a plan for sale of the enterprise
The supervisory and administrative authority of state-owned assets and the enterprises which holds the state-owned assets must conduct feasibility study for sale of the proposed state-owned enterprises, undergo the internal decision making process and conclude written resolutions. Where any legitimate interests of the enterprise's employees are involved, opinions of the employee representative assembly must be obtained, and the employment-related arrangements must be discussed and approved at the employee representative assembly.
2. The administrative department of state-owned assets shall approve or decide the matters concerning the sale of the enterprise.
Sale of state-owned enterprises must be approved or decided by the supervisory and administrative authorities of state-owned assets, which is of crucial importance to the legitimacy of the sale of such enterprises. The supervisory and administrative authorities of state-owned assets or the governments at the same level shall decide the sale of the enterprises that they invests in. Sale of subsidiaries of parent companies that are invested by the governments at any level and organizatioin designated by the State is to be decided by such parent companies. However, sale of important assets of the key subsidiaries must be approved upon the countersignature by the supervisory and administrative authorities of state-owned assets at the same level and the departments of finance.
3. Assets Evaluation
In order to guarantee the State’s rights and interests as owner and prevent the loss of state-owned assets, after the matters concerning the sale of an enterprise are approved and decided, the transferor shall reappraise the stocks and assets of such sold enterprise, and appoint an accounting firm to conduct a full audit, based on which an assets evaluation agency with the required qualification shall be authorized to implement an assets evaluation, which will provide reference for the determination of such enterprise’s selling price.
4. Open invitation of interested buyers is required for transfers of property rights.
The sale of a state-owned enterprise shall be conducted publicly at a legally established property rights transfer agency. The seller shall authorize the property rights transfer agency to disclose information concerning the sale of such enterprise so as to attract more interested buyers.
Where two or more interested buyers are interested, the sale of such state-owned enterprise may be may be determined by auctioning; where there is only one buyer, or upon the approval of the competent supervisory and administrative authority of state-owned assets, the sale of such state-owned enterprise may be completed by agreement. After the conclusion of the property rights transfer, both parties shall enter into a property rights transfer contract.
5. Property rights registration.
6. Industrial and commercial registration.
IV. How to handle the creditor’s rights and debts?
In the course of selling a state-owned enterprise, the enterprise's debts and creditor’s rights and legitimate interests are often overlooked that usually results in new disputes over assumption of debts after the sale of such enterprise. Whether the creditor’s rights and debts of such enterprise are handled correctly or not is directly related to the vital interests of both parties to the sale of such enterprise as well as the creditors and debtors of such enterprise. Therefore, the seller of a state-owned enterprise, before selling the state-owned enterprise, shall organize the debts and express how the debts and creditors' rights are to be handled.
With regards to the creditor’s rights of the sold enterprise, both parties to the contract for sale of the state-owned enterprise may stipulate a transfer in full or in part of such creditor’s rights to the buyer, and give the debtors a prompt notice. Otherwise, the transfer of such creditor’s rights will have no effect on the debtors, which will, however, directly affect the buyer’s exercise of its rights.
Without breaking any laws and regulations, or impairing any other person’s legitimate interests, the seller and buyer of the enterprise may stipulate the following issues in relation to the debts of the sold enterprise:
1. all of the enterprise’s debts shall be assumed by the buyer; or 2. the enterprise’s debts shall be assumed by the seller, and the seller shall be responsible for the debts within the scope of the proceeds from the sale of such enterprise; or 3. the enterprise’s debts shall be continuously assumed by the enterprise. In case of any change of any debtor, the consent of the creditor must be obtained, or else, the agreement on change of debtor shall have no effect on the creditor.
Where an enterprise’s debts are omitted or concealed when such enterprise is being sold, because the enterprise will continue to exist, the sold enterprise shall still be liable for its debts. If, however, the net assets of the enterprise are reduced as a result of an omitted or a concealed debt, the buyer will be entitled to claim for the loss directly caused by the omission or concealment of such debt.
V. How to handle the contingent debts?
Contingent debts are different from the omitted or concealed debts. Omitted or concealed debts are debts which already exist at the time of the acquisition of the enterprise, and well established debts that the seller already know or should have known, while contingent debts are undetermined debts which do not exist at the time of the acquisition of the enterprise. That is contingent debts are potential debts. Contingent debts are usually incurred after the sale of an enterprise in consequence of the occurrence of certain legal facts, which mainly include guaranteed debts arising out of the provision of guarantee by the enterprise, damages for breach of contract, tortious liability for defective products, or administrative penalties arising out of breach of regulations, etc.
Because contingent debts have not yet been actually incurred at the time of the sale of an enterprise, the buyer is unable to determine in advance the amount of such contingent debts or to predict the risks it may face after its acquisition of the enterprise Therefore, the buyer needs to safeguard its interests by making some relevant arrangements in the acquisition agreement. In general, there may be several kinds of arrangements: (1) the buyer, before it acquires the enterprise, should take active measures to conduct investigations in the situations concerning the performance of contracts signed by the sold enterprise and the provision of guarantees to other parties by such enterprise, and should also require the seller to honestly and adequately to disclose such information, so that both parties could evaluate the contingent debts as accurately as possible . (2) both parties should stipulate in the agreement that after the completion of the acquisition, once the contingent debts become direct debts, such debts shall be assumed by the seller or indemnified by the seller to the buyer. (3) Where the abovementioned provisions are still not adequate to protect the buyer’s interests, the buyer may require the seller to provide guarantee for any losses arising out of any matters concerning such contingent debts.
VI. Should a buyer acquire an enterprise or the enterprise’s assets?
When studying an acquisition plan, the first question to answer is: which should be the target of the acquisition, the enterprise itself or its assets? Which should be chosen depends on the buyer’s purposes in the acquisition. If an enterprise plans to acquire another enterprise for the purposes of acquiring the whole or part of the ownership rights or shareholdings on the target enterprise so as to develop its brand name, acquire the specific qualifications, improve the technology and market share or expand its its business to another industry, the buyer shall acquire the target enterprise itself. However, the buyer must consider that the acquired enterprise is an existing enterprise, so its value is variable. In addition, an existing enterprise inevitably owes some external debts and contingent debts, so there are some potential risks for the buyer. Therefore, in case of acquisition of an enterprise, the buyer shall, on the one hand, pay attention to whether the seller is the investor or owner of the acquired enterprise, and on the other hand, investigate the indebtedness of the acquired enterprise and enter into an agreement with the parties concerned in respect of the assumption of the debts.
Where an interested buyer plans for an acquisition merely for the purpose of obtaining certain assets of the target enterprise, such as land-use rights and special equipment, the interested buyer needs not to acquire the whole enterprise. The buyer, when buying the assets, needs not consider the target enterprise’s indebtedness, but only needs to inspect whether the ownership of the purchased assets are ascertsained and completer, and where such assets are free from any mortgage, pledge or co-ownership, so as to prevent any losses arising out of the exercise of any mortgage, pledge or other rights by the owners of such rights or the invalidation of the assets purchase contract as a result of any violation of the essential requirements for assets transfer provided by laws.
VII. How will the rights of the sold enterprise’s creditors be protected?
In acquisitions of state-owned enterprises, most of the sold state-owned enterprises are not productive, and even owing huge debts. How to realize each creditor’s rights is an important issue in the sale of an enterprise. However, many government authorities and state-invested institutions often overlook this issue when they are selling enterprises, and sometimes even intentionally cause damage to the creditors' interests.
In practice, after acquiring a state-owned enterprise, the buyer will usually reorganize or restructure the acquired enterprise. When any creditor’s rights are claimed against the acquired enterprise, such acquired enterprise may have been merged or deregistered. Where both parties to the sale of such enterprise fail to stipulate the assumption of the debts, the buyer may refuse to assume any responsibility on the ground that it has paid the relevant amount to the seller, and the seller may also refuse to assume any responsibility on the ground that the enterprise has been sold out and all the interests in the enterprise have been transferred to the buyer. The creditors in question will not be able to enforce their rights. Therefore, the "Interim Measures for the Administration of Transfer of State-owned Property Rights of Enterprise" require expressly that the seller and buyer of an enterprise shall formulate a plan for handling the creditor’s rights and debts of such enterprise, and they shall stipulate the assumption of such enterprise’s debts in the contract for sale of the target enterprise and obtain the creditors' consent.
Regarding the identities of the sold state-owned enterprises' creditors, state-owned banks are usually the major creditors. Most of the state-owned banks' non-performing loans are just those loans to state-owned enterprises. During the sale of an enterprise, the avoidance of repaying debts does not only cause the banks suffering loss and harm the credit rating system, but also results in serious loss of state-owned assets. In order to prevent enterprises from avoiding to repay the banks' loans after their restructurings, the relevant authorities such as the State Council and the People’s Bank of China have formulated a series of regulations to protect financial creditors' rights, according to which, during the sale of a state-owned enterprise, the principal and interest of any bank loan that has become due must be repaid firstly from the seller’s proceeds from the sale, and the seller must enter into on-lending and repayment agreements with the financial institutions which are creditors of the sold enterprise in respect of any loans that have not yet become due, and provide relevant guarantees for such loans. Where the sold enterprise has provided guarantees for loans from other units and individuals, such enterprise, after it is sold, shall continue to assume the original enterprise’s liability to the guarantees. Any unit or department must not require any bank to reduce or remit the sold enterprise’s debts. Where both parties to the acquisition and the creditors fail to reach such agreements, the enterprise must not be sold.
During the sale of a state-owned enterprise, non-bank creditors also have the right to require the enterprise to ascertain their creditors' rights and guarantee the repayment of the debts. The creditors have the right to decide whether to accept the agreement for assumption of debts reached between the seller and the buyer. Where a creditor refuses to accept the agreement, such agreement has no effect on such creditor.