On 20 April 2020, China's State Administration for Market Regulation ("SAMR") made public the case concerning a new joint venture between Shanghai Mingcha Zhegang Management Consulting Co., Ltd. ("Mingcha Zhegang") and Huansheng Information Technology (Shanghai) Co., Ltd. ("Huangsheng") (hereafter "the Mingcha Zhegang case"). It is clearly mentioned in the public statement that Mingcha Zhegang is controlled by a Cayman company "through related entities based on a series of agreements, which means this company has a VIE structure (namely, variable interest entity). From a practical perspective, this case serves as a landmark in the history of China's merger review and suggests the failure-to-file antitrust risks rise sharply for the VIEs.
I. The Dilemma of Antitrust Filing and Review for VIE-related Filings
The VIE structure is also known as the "Sina model" (Sina was listed in the United States in 2000). It is a creative overseas listing model adopted by Chinese companies for the dual purposes of realizing overseas listing and financing, and bypassing foreign investment restrictions simultaneously. However, this model has also raised a dilemma related to merger filing and review.
In the era when the Ministry of Commerce ("MOFCOM") was responsible for merger review, the authority was always worried that giving antitrust approval would be considered an official endorsement of the VIEs. In 2009, it was reported that the MOFCOM rejected the filing of the M&A transaction between Sina and Focus Media due to the VIE issue. In 2012, in the case of WalMart's acquisition of Yihaodian, MOFCOM conditionally approved this transaction with the requirement that Wal-Mart not to engage in businesses where foreign investment is restricted. In the face of a large quantity of VIE cases, the conditional approval procedure is too cumbersome to address the issue fundamentally.
With concerns that it is difficult to obtain antitrust approvals, some VIEs have adopted various commercial arrangements and measures in order to ensure antitrust compliance and avoid triggering merger filing obligations, while these solutions sometimes do not meet the commercial purpose of the transaction. On the other hand, taking the low cost of illegality into account, a large number of VIEs chose to disregard their antitrust filing obligations and illegally implemented concentrations.
II. Legal Risks for Gun-Jumping Are Soaring
The new Foreign Investment Law was expected to give a fundamental solution to the dilemma of antitrust filing and review related to VIE issues, but the final version officially released in 2019 finally deleted the provisions about the legality issue of the VIEs.
In January 2020, the SAMR announced the draft amendment to the Anti-Monopoly Law. Article 55 of the draft amendment provides that, the fines for gun-jumping will be increased dramatically from "no more than CNY 500,000" to "no more than 10% of the sales revenue in the previous year". In the future, the administrative penalties for gun-jumping may reach hundreds of millions or even billions, and therefore, the deterrent effect for gun-jumping will be greatly improved.
The Mingcha Zhegang case may serve as a significant turning point. After the case, merger transactions involving the VIE structure can be filed and negotiated with the SAMR, and possibility of facing investigations and penalties for gun-jumping case will increase significantly. Thus, antitrust filing has become an inevitable legal obligation for M&A transactions involving VIE structure.
III. Technical Issues and Uncertain Factors Coexist
Since the Foreign Investment Law finally avoided clear definition of the VIE structure, the SAMR's potential to have breakthrough in antitrust review was limited. If the issue concerning the positioning of the VIE structure cannot be completely addressed at the law level, the merger filing system under the Anti-Monopoly Law would continue to face many technical difficulties and uncertainties.
For example, before the Mingcha Zhegang case, there were a large number of VIE-related transactions which failed to conduct merger filing in the 12-year implementation history of the Anti Monopoly Law since it took effect in 2008. Many problems would arise like how to deal with these historical cases? How to calculate the two-year prosecution period prescribed in the Administrative Penalty Law? Should it be based on the closing date of the M&A transactions, or should it be based on the date of change or termination of the business structure after the transactions?
The principle of ex post facto prohibition is one of the basic principles for modern nomocracy. Can the public announcement of the Mingcha Zhegang case have the same effect of formal rules released to the public? If the authority penalizes future gun-jumping cases involving the VIE structure but does not penalize the historical cases, how can it face the challenges related to the unification of law enforcement standards and the principle of open administration?
In China's commercial practice, many VIEs are actually built by Chinese companies with the purpose to finance businesses abroad in which foreign investment is restricted in China. The actual controllers are often Chinese nationals. On the other hand, as Sino-US economic and trade frictions are increasing, the number of China Concepts Stock companies returning to the country may rocket. Many of these companies involve VIE structures, and it would be a complex problem to deal with these companies.
Despite the many challenges in reality, the Mingcha Zhegang case is considered as a landmark for legal practice. The case not only illustrates that the Chinese antitrust authorities have formally set about dealing with this dilemma that has plagued them for 12 years, but also warned all companies and related investors that the VIE structure will no longer be a shield for gun-jumping in the future. Merger filing must be included in the legal compliance framework for M&A transactions.
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