LEGAL
Facing a slowing Chinese economy, plummeting currency valuations, and an erratic stock market, investors in China are looking for higher returns and strategic acquisitions overseas. That includes the United States, which many view as the most attractive market for investment.
Earlier this year, O’Melveny & Myers issued its Foreign Direct Investment Report, the result of a survey of investors, nearly two-thirds of whom are from China. Much of the appetite for investing in the U.S., in particular, comes from Chinese companies seeking to stimulate growth by making strategic acquisitions or investments in a more attractive and stable environment.
If a Chinese suitor comes a-calling, the U.S. target’s general counsel must be sensitive to regulatory and litigation risks and data security concerns that are particular to Chinese transactions, both during and after the acquisition. The most immediate issues stem from the U.S. regulatory environment.
While some Chinese investors find the U.S. attractive because of the predictability and fairness under the U.S. rule of law system, other respondents to O’Melveny’s survey cited U.S. legal and regulatory hurdles as the greatest barriers to investment. This probably reflects a wariness stemming from dealings with the litigation in the U.S. It also may reflect past experience with the Committee on Foreign Investment in the United States (CFIU.S.), which reviews foreign investments for potential national security issues. While CFIU.S. clears most transactions it reviews, including Chinese investments, there have been several Chinese high-profile transactions that were blocked or cleared only with limitations.
According to the CFIU.S.’ 2014 public report (the most recent available), there were 147 notices of transactions filed with only 12 withdrawn and one rejected during review or investigation. In that year, 29 of the notices related to the manufacturing of computers and electronic products and seven to chemical manufacturing. For the period from 2012 through 2014, notices of acquisitions by investors from China made up the largest share, with more than 18% of the notices filed. Thus, the record for Chinese companies securing CFIU.S. clearance is actually quite good, but to be successful, here’s what U.S. general counsel can do to prepare for that process:
1) Negotiate a “CFIU.S. termination fee.” Several recent proposed transactions, including in the technology sector, did not go forward due in part to concerns about CFIU.S. The acquirer typically seeks to condition closing on CFIU.S. clearance; if CFIU.S. does not clear the deal in a timely manner in that case, the U.S. company will have limited recourse. It is thus common now for a seller to secure a buyer commitment to pay a termination fee if the buyer cannot secure CFIUS. clearance. (Recently published proposals indicate that such fees can be as high as 8% of the deal value.) The ability of an aggrieved target to collect these fees from the Chinese’ acquirer, however, as well as payments or performance related to alleged breaches of the deal, should be given careful consideration, especially given that, should a deal go awry, it will be difficult for that target to enforce any judgment or award in China.
2) Provide for arbitration and deposit/performance guarantees. Generally, the agreement should provide for arbitration outside of China as the exclusive forum for disputes. That’s because Chinese courts will likely not recognize U.S. court judgments. Chinese courts will recognize foreign arbitral awards, although there can still be difficulties in getting those enforced due to local protectionism and difficulty in locating assets in China. For these and other reasons, U.S. targets may require Chinese buyers to set up offshore a deposit, bond, letter of credit, or bank performance guarantee to secure payment obligations.
3) Determine at the outset whether the deal might trigger antitrust review in the U.S., China, or any other jurisdictions. Certain mergers, acquisitions, joint ventures, and minority investments may require review and clearance by competition regulators in multiple countries. Even if a transaction poses no substantive antitrust risks, review may still be required based on the parties’ revenues, assets, market shares, and other factors. Not all U.S. companies will be under the same scrutiny if targeted by a Chinese buyer. Certain deals elicit antitrust and competition reviews. If the target is publicly listed on a U.S. stock exchange, there may be Securities and Exchange Commission review. A target in a specific regulated industry, such as agriculture, mining, or electricity generation, may implicate additional regulatory reviews. Not all transactions are subject to these reviews, and usually the first step is determine if the transaction triggers antirust or other regulatory reviews.
4) Prepare for what comes after the merger. Beyond these regulatory issues, the new entity – including its overseas owners – must be prepared for continued operations in the U.S. regulatory environment; the days of a Chinese purchaser dismantling a brick-and-mortar plant and moving it overseas are long gone. Whether U.S. management simply completes the transition or continues to manage U.S. operations, U.S. general counsel is best equipped to appreciate the surrounding issues. For example, a Chinese parent that acquires U.S. operations may now be subject to the Foreign Corrupt Practices Act (FCPA), from its anti-bribery provisions to, in some cases, the FCPA’s requirement that accurate books and records be maintained as to transactions that include payments to foreign officials. The FCPA may not have applied to the foreign parent’s overseas dealings with foreign officials before the merger. The implications may even affect individual executives overseas, given the Department of Justice’s desire to pursue individual criminal liability for FCPA violations. (Similarly, a Chinese buyer may be unfamiliar with U.S. economic sanctions and export control laws.)
In addition, U.S. counsel will likely have an initial role in educating its Chinese parent about handling litigation in the United States. The new company’s U.S. operations would, as before, be the subject of the usual contract, tort, and other litigation that arises here. The Chinese parent must also consider whether its overseas operations may be the subject of U.S. litigation simply because the Chinese parent now has a U.S. subsidiary. U.S. courts do not exercise sweeping jurisdiction over a foreign company over all its activities worldwide simply because it owns a U.S. subsidiary, but whether a U.S. court will in fact exercise jurisdiction in a particular case will depend on how the merged entity is run, both in the U.S. and worldwide.
5) Protect your data and intellectual property during the merger process and long after. Another area of concern in a potential cross-border merger is digital privacy and the prospect of a data breach. During the transaction, there may need to be diligence reviews as to what data the new entity will collect and how the status of a Chinese owner may affect the collection and management of what could be a large body of personal information for employees, business partners, and customers. Those reviews may include the impact of foreign ownership on data breach vulnerabilities.
Once the deal is concluded, U.S. counsel will likely coordinate compliance with U.S. data security regulation, which is not centralized as in China or other countries. U.S. federal regulatory requirements and policies must be considered – as well as state regulation. Beyond regulation, there is the possibility of litigation in the event of a data breach. If there are to be cross-border data flows, there must be consideration of the regulatory requirements of not just the U.S., but all jurisdictions implicated.
As important, if not more so, than the entity’s digital data, is the entity’s newly acquired intellectual property. Indeed, one of the main purposes of the acquisition may be to obtain valuable intellectual property for use overseas. The continued retention and use of this intellectual property may have been the subject of antitrust and competition reviews in the U.S. (if not in China, the European Union, and elsewhere) at the time of the acquisition, but the new entity must be vigilant in continuing to protect this valuable asset.
While much of the attention has been focused on the mechanics and political sensitivities surrounding certain transactions, the regulatory and litigation issues that lie beyond the closing of the transaction loom as large, if not larger. There are of course additional considerations beyond the scope of this introduction, including integration of U.S. employees after the merger and additional regulation if the U.S. business involves the financial industry. Both parties in the U.S. and China should give careful consideration to these questions. If anticipated and addressed through planning, the new entity places itself in the best position for realizing the benefit of the bargain.
Ron Cheng is a partner in O’Melveny’s Los Angeles and Hong Kong offices and a member of the firm’s White Collar Defense & Corporate Investigations Group. Washington, D.C., partner Ted Kassinger counsels U.S. and foreign clients engaged in transnational business transactions, with an emphasis on international trade and investment regulatory matters. The opinions expressed in this article do not necessarily reflect the views of O’Melveny or its clients, and should not be relied upon as legal advice.
-->
