In 2014, mainland China's investment in Australia totalled $64.5 billion and Australia's investment in mainland China reached almost $58 billion. Australia maintained its position as the second largest recipient country of aggregated global mainland Chinese direct investment between 2007 and 2014, behind the United States in first position. And in 2014, mainland China was Australia's 6th leading investment destination country behind the United States, the United Kingdom, New Zealand, Japan, and Germany. In this context, there has been a substantial amount of mergers and acquisitions (M&A) activity between Australia and China, not to mention the activity that has been channelled through investment vehicles in jurisdictions such as Singapore and Hong Kong.
Yet, even with fairly high levels of cross-border M&A between Australia and mainland China, it is staggering how little is known by each side of the other side's M&A environment. There is a tendency for investors from each country to expect that M&A deals in the other country will unfold in much the same way as they do in their own country. In some ways, this is not surprising given that we are all creatures of our own experience and perspective. However, such expectations are often worlds apart from reality. Investors from both sides would do well to develop a clear understanding of key differences in the legal and regulatory framework for M&A in the target jurisdiction.
Although mainland Chinese investment is welcomed in Australia and Australian businesses may be attractive targets for many mainland Chinese investors, the role of law, sources of law and legal system in Australia are all fundamentally different to their equivalent in mainland China. In the M&A context, this gives rise to practical differences in the ways in which transactional risks are allocated, transaction documents are drafted and deals are completed.
Although Australian businesses are eager to enter the enormous mainland Chinese market through M&A, the inbound investment process in mainland China is highly regulated and subject to a number of bureaucratic hurdles. Most foreign acquisitions of mainland Chinese companies will, for instance, at least need approval from mainland China's Ministry of Commerce, or one of its local commissions (the MOC). As documents requiring submission to the MOC for approval must be governed by mainland Chinese law, it is important for those negotiating and drafting transactional documents to understand the salient differences between mainland Chinese contract law and contract law in Australia. Attention should also be paid to differences in corporations law between the two jurisdictions.
The table below provides a high-level summary of some key differences in law and practice between Australia and mainland China in respect of private share deals.
| ASPECT | AUSTRALIA | MAINLAND CHINA |
| Forms of Companies, Sources of Law and Types of Agreement |
Two types of companies:
Most commonly used form of proprietary company is a company limited by shares. Law applicable to Australian incorporated companies is derived from two sources: Australian common law (also known as "case law") and Australian federal and state statutes, the principal one being the Corporations Act 2001 (Cth). The agreement for the sale and purchase in Australia of a shares in a proprietary company limited by shares is usually called the "Share Sale (and Purchase) Agreement". Although such an agreement does not require any governmental approval in order to bind the parties, such an agreement often includes a provision which states that the agreement (sometimes excluding certain clauses such as confidentiality, notices, etc) does not have effect or become binding unless, and completion will only occur if, certain conditions have been satisfied or waived in accordance with the agreement. |
Most private companies in mainland China are in the form of limited liability companies (LLCs). LLCs do not issue shares or share certificates, but rather their ownership structure is in the form of "equity interests" - equity interest holders have a participation in the LLC's registered capital (similar to "paid-in capital" or "issued capital"), as substantiated by the LLC's capital verification report and business licence. Most foreign-invested LLCs take the form of Sino-foreign joint ventures or wholly foreign-owned enterprises (commonly referred to as "foreign invested enterprises" or FIEs). LLCs and FIEs are governed by mainland China's Company Law. FIEs also have their own separate legislation which can give rise to inconsistencies with the Company Law. The agreement for the sale and purchase in mainland China of an equity interest in an LLC is usually called the "Equity (Interest) Transfer Agreement". The transfer of an equity interest in an FIE in the form of an LLC is ineffective under mainland Chinese law unless the necessary approval from the MOC, or one of its local commissions, has been obtained. The acquisition agreement signed between the parties does not take effect until it is approved by the relevant governmental authorities. |
| Pre-emption Rights on Share/Equity Transfers | No statutory pre-emption right for a remaining shareholder to purchase the shares of a selling shareholder. Pre-emptive rights (or rights of first refusal) may arise under a proprietary company's constitution. | Unless contrary provisions are included in the LLC's articles of association, the pre-emption rights set out in Article 72 of the Company Law apply on the transfer of equity to parties other than existing equity interest holders. If an equity interest holder of an LLC intends to transfer its equity to a non-equity interest holder, it must first secure the approval of the majority of the company's other equity interest holders. |
| Completion/Closing | Exchange (signing) and completion can occur simultaneously. Sellers obviously tend to prefer that there is no time gap between exchange and completion and, to the extent that there are any conditions precedent, sellers prefer to minimise the number and extent of such conditions so that the sale is less conditional. Where required, merger filings and foreign investment approvals will usually be conditions precedent and give rise to a gap between signing and completion. | The requirement for approval from relevant governmental authorities means that equity transfer agreements are recommended to be expressed as conditional upon receipt of such approval. Completion will therefore necessarily take place at a date later than that of exchange (signing). Other conditions precedent giving rise to a gap between signing and completion can include, for example, merger filings and national security review. |
| Representations and Warranties | Australian contract law provides for the differing nature and materiality of conditions and representations and warranties. If breached, conditions, representations and warranties give rise to different consequences (e.g. termination plus damages vs just damages; various scales of damages). | Mainland Chinese contract law does not distinguish between conditions, representations and warranties. Rather than seeing representations and warranties as statements of fact given at a particular time, a mainland Chinese court would likely interpret them as ordinary contractual obligations. Under mainland China's Contract Law, breach of contractual obligations may give rise to a right to damages and/or a right to termination. Article 113 of mainland China's Contract Law provides that where a party has failed to perform or rendered non-conforming performance of a contract, the non-breaching party can sue for damages for the foreseeable losses arising out of the breach. |
| Repetition of Warranties/Representations | Although it is not uncommon for warranties and representations to be given at signing and then repeated at completion, most sellers will seek to resist this approach and, sometimes, will argue for repetition of only those warranties over which they have direct control. Most buyers will want sellers to warrant and represent certain facts at both signing and completion. | Most equity interest transfer agreements in mainland China will simply specify representations (??) and warranties (??) as being primary obligations which, if breached at any time during the life of the contract, would allow the non-breaching party to terminate the contract. Once the contract is terminated, the non-breaching party may then request to be restored to their pre-contractual position and would be entitled to compensation for their actual losses. |
| Disclosure | In share sale and purchase agreements, the seller's disclosures against the warranties (which are commonly contained in a separate disclosure letter) shift the risk associated with the transaction back to the buyer. The disclosure letter usually sets out "general" disclosures, which qualify all warranties, and "specific" disclosures, which - although typically cross-referenced to specific warranties in the agreement - are often treated as effective disclosures in relation to all warranties. The disclosure letter invariably has annexed to it a large volume of documents (often called the "disclosure bundle"). Usually, the buyer is not able to sue for breach of warranty in respect of matters which have been fairly disclosed. | Due to the fact that mainland Chinese law does not adopt the same mechanism as that which applies under Australian common law in respect of representations, warranties and disclosures, many sellers in mainland China are not be familiar with the concept of disclosing against, or amending, warranties. It is, therefore, important to be aware that a lack of negotiation of warranties or disclosure does not necessarily mean that the warranties agreed upon are entirely accurate. Thorough due diligence and verification is extremely important. |
| Alternative Measures of Damages |
The usual remedy for breach of warranty is damages, calculated on normal common law contract principles. This aims to place a purchaser in the position it would have been in if the warranty had been true. The damages in a share sale will generally be the difference between the value of the shares at the time of completion with all the warranties fulfilled and their actual value at the time given the breach of warranty. An alternative to contractual damages is a liquidated damages clause which specifies the basis on which damages are assessed (e.g., by reference to any diminution in value of assets or any increase in liabilities arising from a breach of warranty). This is known as the "indemnity basis". Liquidated damages clauses will only be enforceable if the court regards it as a genuine pre-estimate of loss. If the amount stipulated in the contract is not considered a genuine pre-estimate of the loss that will be suffered, the courts will not enforce the clause because it offends the doctrine of penalties. Indemnities are a useful protection for those who have the benefit of them as there is no requirement to mitigate loss and no test for remoteness of loss. |
The Contract Law provides that a mainland Chinese court can award damages in excess of the capped amount agreed by way of liquidated damages. While on the one hand damages under the Contract Law are generally recoverable by reference to the actual loss which is suffered and in this way tend to be compensatory as opposed to punitive in nature, liquidated damages are not purely compensatory in nature. A liquidated damages clause serves more as a penalty imposed on the party failing to render timely or conforming performance of the contract. Under Article 114 of the Contract Law, a mainland Chinese court may adjust the liquidated damages upwards only when the actual damages (which are subject to proof and evidentiary constraints) greatly exceed the amount of liquidated damages agreed by the parties. |
| Limitations on Claim | It is common to set out limitations to a seller's liability in the share sale and purchase agreement. In respect of time limitations for claims for breach of warranty, the limitation periods will vary according to the practice in the different jurisdictions, but will generally be less than the period to claim under the general law. It is also common for sellers to seek to limit claims under the warranties to those in excess of a specified amount for any particular claim and/or all claims in aggregate to avoid time-wasting actions for small amounts. | Liability limitations may not be effective. For example, provisions providing that claims may only be brought for breach of warranty within an agreed period of time will be void as there exists a statutory time limit for bringing civil claims under the General Principles of Civil Law, namely two years, and such limit may not be varied by contract. If the parties agree to a total liability cap in the contract, such a cap will act as the ultimate amount of damages payable by a breaching party under the contract. The aggrieved party must first prove the damages up to the agreed cap (proof of damages is subject to significant evidentiary constraints in mainland China, particularly in respect of lost profits). It should also be noted that no concept of "consequential loss" exists. The two distinct categories commonly used by courts are "direct" and "indirect loss", although these terms are not defined in legislation. |
| Material Adverse Change | Material adverse change (MAC) clauses are useful in allocating risk in an agreement when there is a substantial gap between signing and completion. However, MAC clauses that take the form of a general condition to completion are not particularly common in Australia (certainly in comparison with the U.S.). | Article 26 of the Supreme People's Court's Interpretation on Several Issues Concerning the Application of the 'PRC Contract Law' (2) states that, even in the absence of an express material adverse change clause, a party will still have a legal right to terminate or amend an agreement if a material change in the objective circumstances that could not have been foreseen at the time of the conclusion of the agreement caused by something other than force majeure and falling outside commercial risk occurs that would render impossible the performance of such agreement manifestly unfair to one of the parties or the realisation of the agreement's objectives. |
| Force Majeure | Although the term "force majeure" is well known to lawyers and business people in most jurisdictions, it derives from French law and it has no recognised meaning under Australian law. In Australia, it should therefore only be used in agreements when it is properly defined. A properly drafted force majeure clause in Australia would state words to the effect that any party affected by continuing force majeure events (as defined in the agreement) will not be required to perform, or be liable for failure to perform, its obligations as a result of those events. | A concept of "force majeure" is recognised under Article 117 of the Contract Law. It states: "Force majeure as referred to in this Law means an objective circumstance that is unforeseeable, unavoidable AND insurmountable (emphasis added)". All three preconditions of unforeseeability, unavoidability and insurmountability should exist for a party to claim force majeure. Such an event gives rise to a right to terminate the contract. |
| Language | The concept of freedom to contract is paramount. The courts will enforce a prevailing language clause where parties include such a clause in a multilingual contract. However, if a prevailing language clause is not included in a multilingual contract it is likely that Australian courts would adopt a similar approach of contractual interpretation currently used for any other event of ambiguity; that being to give effect to the parties' intent at the time of contracting. This is generally done by adducing external evidence to evince what the parties intended a contract, clause or term to mean. | Documents requiring submission to governmental authorities in mainland China will require a Chinese language version that must at least be of equal status to the English language version. Under the Contract Law, where two or more languages are adopted in the text of a contract and it is agreed that all versions are equally authentic, it will be presumed that the terms and expressions in each version have the same meaning. If the terms and expressions in different versions are inconsistent, they will be interpreted according to the purpose of the contract. |
| Execution |
For share sale and purchase agreements in Australia, parties often insist on signing under section 127(1) of the Corporations Act so that is possible to rely on the assumption in section 129(5) and insist on printing the document and signing it manually, even in counterparts if that is necessary because the signing parties are in different locations. Share sale and purchase agreements often reference supporting documents in the form of deeds. At common law, a deed must be a signed and witnessed paper document. |
The mainland Chinese Contract Law provides that written contracts can be concluded by either signing or sealing (affixing the signing party's chop to) them. However, it is still common practice for the official company seal/chop of the signing party to be affixed alongside the signature of the signing party's authorised signatory, where both mainland Chinese and foreign parties are involved. Deeds are not recognised under mainland Chinese law as a different form of agreement from simple contracts. Deeds are, therefore, signed in the same manner as contracts under mainland Chinese law. This publication does not deal with every important topic or change in law and is not intended to be relied upon as a substitute for legal or other advice that may be relevant to the reader's specific circumstances. If you have found this publication of interest and would like to know more or wish to obtain legal advice relevant to your circumstances please contact one of the named individuals listed. |
This publication does not deal with every important topic or change in law and is not intended to be relied upon as a substitute for legal or other advice that may be relevant to the reader's specific circumstances. If you have found this publication of interest and would like to know more or wish to obtain legal advice relevant to your circumstances please contact one of the named individuals listed.
