Advisory Board

  • Cai Hongbin
  • Peking University Guanghua School of Management
  • Peter Clarke
  • Barry Diller
  • IAC/InterActiveCorp
  • Fu Chengyu
  • China National Petrochemical Corporation (Sinopec Group)
  • Richard J. Gnodde
  • Goldman Sachs International
  • Lodewijk Hijmans van den Bergh
  • De Brauw Blackstone Westbroek N.V.
  • Jiang Jianqing
  • Industrial and Commercial Bank of China, Ltd. (ICBC)
  • Handel Lee
  • King & Wood Mallesons
  • Richard Li
  • PCCW Limited
  • Pacific Century Group
  • Liew Mun Leong
  • Changi Airport Group
  • Martin Lipton
  • New York University
  • Wachtell, Lipton, Rosen & Katz
  • Liu Mingkang
  • China Banking Regulatory Commission (CBRC)
  • Dinesh C. Paliwal
  • Harman International Industries
  • Leon Pasternak
  • BCC Partners
  • Tim Payne
  • Brunswick Group
  • Joseph R. Perella
  • Perella Weinberg Partners
  • Baron David de Rothschild
  • N M Rothschild & Sons Limited
  • Dilhan Pillay Sandrasegara
  • Temasek International Pte. Ltd.
  • Shao Ning
  • State-owned Assets Supervision and Administration Commission of the State Council of China (SASAC)
  • John W. Snow
  • Cerberus Capital Management, L.P.
  • Former U.S. Secretary of Treasury
  • Bharat Vasani
  • Tata Group
  • Wang Junfeng
  • King & Wood Mallesons
  • Wang Kejin
  • China Banking Regulatory Commission (CBRC)
  • Wei Jiafu
  • Kazakhstan Potash Corporation Limited
  • Yang Chao
  • China Life Insurance Co. Ltd.
  • Zhu Min
  • International Monetary Fund

Legal Roundtable

  • Dimitry Afanasiev
  • Egorov Puginsky Afanasiev and Partners (Moscow)
  • William T. Allen
  • NYU Stern School of Business
  • Wachtell, Lipton, Rosen & Katz (New York)
  • Johan Aalto
  • Hannes Snellman Attorneys Ltd (Finland)
  • Nigel P. G. Boardman
  • Slaughter and May (London)
  • Willem J.L. Calkoen
  • NautaDutilh N.V. (Rotterdam)
  • Peter Callens
  • Loyens & Loeff (Brussels)
  • Bertrand Cardi
  • Darrois Villey Maillot & Brochier (Paris)
  • Santiago Carregal
  • Marval, O’Farrell & Mairal (Buenos Aires)
  • Martín Carrizosa
  • Philippi Prietocarrizosa & Uría (Bogotá)
  • Carlos G. Cordero G.
  • Aleman, Cordero, Galindo & Lee (Panama)
  • Ewen Crouch
  • Allens (Sydney)
  • Adam O. Emmerich
  • Wachtell, Lipton, Rosen & Katz (New York)
  • Rachel Eng
  • WongPartnership (Singapore)
  • Sergio Erede
  • BonelliErede (Milan)
  • Kenichi Fujinawa
  • Nagashima Ohno & Tsunematsu (Tokyo)
  • Manuel Galicia Romero
  • Galicia Abogados (Mexico City)
  • Danny Gilbert
  • Gilbert + Tobin (Sydney)
  • Vladimíra Glatzová
  • Glatzová & Co. (Prague)
  • Juan Miguel Goenechea
  • Uría Menéndez (Madrid)
  • Andrey A. Goltsblat
  • Goltsblat BLP (Moscow)
  • Juan Francisco Gutiérrez I.
  • Philippi Prietocarrizosa & Uría (Santiago)
  • Fang He
  • Jun He Law Offices (Beijing)
  • Christian Herbst
  • Schönherr (Vienna)
  • Lodewijk Hijmans van den Bergh
  • De Brauw Blackstone Westbroek N.V. (Amsterdam)
  • Hein Hooghoudt
  • NautaDutilh N.V. (Amsterdam)
  • Sameer Huda
  • Hadef & Partners (Dubai)
  • Masakazu Iwakura
  • TMI Associates (Tokyo)
  • Christof Jäckle
  • Hengeler Mueller (Frankfurt)
  • Michael Mervyn Katz
  • Edward Nathan Sonnenbergs (Johannesburg)
  • Handel Lee
  • King & Wood Mallesons (Beijing)
  • Martin Lipton
  • Wachtell, Lipton, Rosen & Katz (New York)
  • Alain Maillot
  • Darrois Villey Maillot Brochier (Paris)
  • Antônio Corrêa Meyer
  • Machado, Meyer, Sendacz e Opice (São Paulo)
  • Sergio Michelsen Jaramillo
  • Brigard & Urrutia (Bogotá)
  • Zia Mody
  • AZB & Partners (Mumbai)
  • Christopher Murray
  • Osler (Toronto)
  • Francisco Antunes Maciel Müssnich
  • Barbosa, Müssnich & Aragão (Rio de Janeiro)
  • I. Berl Nadler
  • Davies Ward Phillips & Vineberg LLP (Toronto)
  • Umberto Nicodano
  • BonelliErede (Milan)
  • Brian O'Gorman
  • Arthur Cox (Dublin)
  • Robin Panovka
  • Wachtell, Lipton, Rosen & Katz (New York)
  • Sang-Yeol Park
  • Park & Partners (Seoul)
  • José Antonio Payet Puccio
  • Payet Rey Cauvi (Lima)
  • Kees Peijster
  • COFRA Holding AG (Zug)
  • Juan Martín Perrotto
  • Uría & Menéndez (Madrid/Beijing)
  • Philip Podzebenko
  • Herbert Smith Freehills (Sydney)
  • Geert Potjewijd
  • De Brauw Blackstone Westbroek (Amsterdam/Beijing)
  • Qi Adam Li
  • Jun He Law Offices (Shanghai)
  • Biörn Riese
  • Jurie Advokat AB (Sweden)
  • Mark Rigotti
  • Herbert Smith Freehills (Sydney)
  • Rafael Robles Miaja
  • Robles Miaja (Mexico City)
  • Alberto Saravalle
  • BonelliErede (Milan)
  • Maximilian Schiessl
  • Hengeler Mueller (Düsseldorf)
  • Cyril S. Shroff
  • Cyril Amarchand Mangaldas (Mumbai)
  • Shardul S. Shroff
  • Shardul Amarchand Mangaldas & Co.(New Delhi)
  • Klaus Søgaard
  • Gorrissen Federspiel (Denmark)
  • Ezekiel Solomon
  • Allens (Sydney)
  • Emanuel P. Strehle
  • Hengeler Mueller (Munich)
  • David E. Tadmor
  • Tadmor & Co. (Tel Aviv)
  • Kevin J. Thomson
  • Barrick Gold Corporation (Toronto)
  • Yu Wakae
  • Nagashima Ohno & Tsunematsu (Tokyo)
  • Wang Junfeng
  • King & Wood Mallesons (Beijing)
  • Tomasz Wardynski
  • Wardynski & Partners (Warsaw)
  • Xiao Wei
  • Jun He Law Offices (Beijing)
  • Xu Ping
  • King & Wood Mallesons (Beijing)
  • Shuji Yanase
  • OK Corporation (Tokyo)
  • Alvin Yeo
  • WongPartnership LLP (Singapore)

Founding Directors

  • William T. Allen
  • NYU Stern School of Business
  • Wachtell, Lipton, Rosen & Katz
  • Nigel P.G. Boardman
  • Slaughter and May
  • Cai Hongbin
  • Peking University Guanghua School of Management
  • Adam O. Emmerich
  • Wachtell, Lipton, Rosen & Katz
  • Robin Panovka
  • Wachtell, Lipton, Rosen & Katz
  • Peter Williamson
  • Cambridge Judge Business School
  • Franny Yao
  • Ernst & Young

GLOBAL STATISTICAL UPDATE – XBMA Quarterly Review for First Quarter 2019

Editors’ Note: The XBMA Review is published on a quarterly basis in order to facilitate a deeper understanding of trends and developments. In order to facilitate meaningful comparisons, the XBMA Review has utilized generally consistent metrics and sources of data since inception. We welcome feedback and suggestions for improving the XBMA Review or for interpreting the data.
Executive Summary/Highlights:
  • Global M&A volume, which exceeded US$4.0 trillion in 2018, continued at a similar pace in Q1 2019, reaching US$958 billion.
  • Global M&A volume in the first quarter of the year has been primarily driven by record levels of deal activity in the United States. It was the most active first quarter for U.S. M&A in recent history, with more than US$500 billion in announced transactions. Acquisitions of U.S. companies accounted for more than half of global deal volume in Q1 2019 (compared to 40% over the period 2007-2019).
  • While M&A in the United States was robust in Q1 2019, cross-border M&A activity has not been as strong in the face of trade anxiety and macroeconomic concerns. The volume of cross-border transactions was US$240 billion in Q1 2019, 25% of the quarter’s overall transaction volume, as compared to 39% of all deal volume in 2018 and an average of 36% of each year’s deal volume over the years 2007-2018.
  • Large deals drove global M&A activity in Q1 2019. Large deals valued in excess of US$500 million accounted for 81% (US$780 billion) of all global deal volume in Q1 2019, compared to 73% of all deal volume over the years 2007-2018. The 10 largest deals of Q1 2019 contributed more than 35% of the quarter’s total global deal volume.
  • Highlights in Q1 included Bristol-Myers Squibb’s US$93 billion acquisition of Celgene and two transactions in the financial payments industry of approximately US$40 billion each: FIS’s acquisition of Worldpay and Fiserv’s combination with First Data.

Click here to see the Review.

 

The views expressed herein are solely those of the author and have not been endorsed, confirmed, or approved by XBMA, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

CHINESE UPDATE – Legal Commentary on New Foreign Investment Law

Contributed by: Adam Li, JunHe LLP (Shanghai) & Fang He, JunHe LLP (Beijing)

Editors’ Note: Contributed by Adam Li and Fang He, partners at JunHe and members of XBMA’s Legal Roundtable.  Mr. Li is a leading expert in international mergers & acquisitions, capital markets and international financial transactions involving Chinese companies.  Ms. He has broad experience in M&A, outbound investment, foreign direct investment, and private equity.

This article was authored by Mr. Zheng Yu, a partner at JunHe.  Mr. Zheng has broad experience advising multinational companies on their business and investment projects in China, including complex foreign direct investments, cross-border M&A, dispute resolution (arbitration and litigation), corporate compliance, employment issues and tourism real estate projects in China.  Xiao Wang, an associate at JunHe, also contributed to the article.

“Grand Unification” Era of China’s Administration on Foreign Investment –
A Brief Commentary on the New Foreign Investment Law

On December 26, 2018, the National People’s Congress published the Foreign Investment Law of the People’s Republic of China (Draft) (the “Draft”) in order to solicit public opinion. Based on a wide variety of opinions received and several rounds of reviews, on March 15, 2019, the Foreign Investment Law of the People’s Republic of China (the “FIL”) was adopted at the second session of the 13th National People’s Congress. Scheduled to come into force on January 1, 2020, the FIL provides a unified rule on the access, promotion, protection, administration and other aspects of foreign investment, thereby becoming the new fundamental law in respect of foreign investment in China. Meanwhile, once FIL takes effect, the Law on Sino-Foreign Equity Joint Ventures, the Law on Sino-Foreign Cooperative Joint Ventures and the Law on Wholly Foreign Owned Enterprises (collectively, the “FIE Laws”) will be repealed simultaneously. The FIE Laws have played a significant role in China’s attraction and utilization of foreign investment, but now they’re about to step down from the historical stage.

This article provides a brief introduction of the main content of the FIL, the major changes since the Draft, FIL’s highlights and impact on foreign-invested enterprises, and provides comments and suggestions on issues to be further clarified in the implementing regulations of the FIL.

 

1. Main Content of the FIL

 

The FIL comprises 6 chapters (General Provisions, Investment Promotion, Investment Protection, Investment Administration, Legal Liability and Supplementary Provisions) and 42 articles in total, which is 3 articles more than the 39 articles that made up the Draft. The following table provides a summary of the main content of the FIL.

 

Main Content –
FIL

Major Differences
from the Draft

Definition

The FIL defines foreign investment (Article 2) as “any investment activity directly or indirectly carried out by foreign natural persons, enterprises or other organizations (“foreign investors”) within the territory of China”.

Specifically, the FIL describes four types of investment activities that represent foreign investment:

(i)        Foreign investors, separately or jointly, establishing foreign-invested enterprises in mainland China;

(ii)      Foreign investors acquiring shares, equity interests, shares of property or other similar interest in enterprises in mainland China;

(iii)    Foreign investors, separately or jointly, investing in new construction projects in mainland China;

(iv)    Foreign investors making investments through other means as provided by laws, administrative regulations or State Council provisions.

 

No substantial changes compared to the Draft.
Investment Promotion

The FIL explicitly provides for the following means of promoting foreign investment:

Market Environment:FIL emphasizes the aim of creating a stable, transparent, foreseeable and level-playing market environment (Article 3);

National Treatment: The FIL makes it clear that all national policies in supporting of the development of enterprises shall equally apply to foreign-invested enterprises in accordance with the laws (Article 9); foreign-invested enterprises can equally participate in setting standards in accordance with the laws, and the compulsory standards formulated by the State shall equally apply to foreign-invested enterprises (Article 15); the State shall guarantee that foreign-invested enterprises can participate in government procurement activities through fair competition in accordance with the laws. Products produced and services provided by foreign-invested enterprises within the territory of China shall be treated equally in accordance with the laws in a government procurement (Article 16);

Preferential Treatments: The State may encourage and guide foreign investors to invest in specific industries, fields and areas. Foreign investors and foreign-invested enterprises may enjoy preferential treatments in accordance with laws, administrative regulations or provisions of the State Council (Article 14);

 

Compared to the Draft, the FIL contains the following major changes:

Market Environment: The “investment environment” in the Draft is replaced by “market environment”. In addition, the FIL emphasizes the need to create a “level-playing” market environment;

National Treatment: The exception to the consistent application of national policies in support of the development of enterprises on foreign-invested enterprises, i.e. “except as otherwise provided in laws and regulations”, is replaced by “equally apply to foreign-invested enterprises in accordance with the laws”. The phrase “foreign-invested enterprises can fairly participate in government procurement activities” in the Draft is changed into “foreign-invested enterprises can participate in government procurement activities through fair competition in accordance with the laws”, emphasizing that the FIL only protects lawful activities, and the fairness mainly refers to the process of competition. It is further specified that not only the products, but also the “services” shall be treated equally;

Preferential Treatments: The preferential treatments offered to the foreign investors in the Draft is limited to those explicitly stipulated by laws, administrative regulations or State Council provisions. This can be understood as meaning that none of the national ministries and commissions, local legislature or government may, without a legal ground provided by upper laws, offer any preferential treatments to foreign investors in specific industries, fields or areas through department rules, local laws or regulations;

Investment Protection

The FIL explicitly provides the following protection for the foreign investment made by foreign investors:

National Expropriation: The State shall not expropriate foreign investments. Under special circumstances, the State may expropriate or requisite an investment made by foreign investors for public interests in accordance with the laws. Such expropriation or requisition shall be conducted in accordance with legal procedures and fair and reasonable compensation shall be given in a timely manner (Article 20);

Profit Remittance: Foreign investors’ capital contributions, profits, capital gains, proceeds from assets deposition, intellectual property rights royalties, lawfully obtained compensation or indemnity, proceeds from liquidation may be freely remitted inward or outward of China in RMB or foreign currency (Article 21);

Intellectual Property Rights: The State shall protect the intellectual property rights of foreign investors and foreign-invested enterprises. The terms for any technology cooperation shall be determined through fair negotiation between the parties to the investment under the principle of equity. Administrative means shall not be used to compel the transfer of technology (Article 22);

Duty of Confidentiality: Administrative departments and their staff members shall keep confidential in accordance with the laws any business secret of foreign investors or foreign-invested enterprises they are aware of during the performance of their duties, and shall not divulge or illegally provide the same to others (Article 23). A penalty will be imposed in accordance with the laws in case of any violation; if a crime occurs, such staff will be held criminally liable (Article 39);

 

Administrative Intervention: Foreign investment rules formulated by the State shall be in compliance with laws and regulations, and shall not illegally (i) impair the legitimate rights of or impose additional obligations on foreign-invested enterprises; (ii) set any conditions for market access or exit, or (iii) intervene or influence normal production and operation activities of foreign-invested enterprises without provisions of laws and administrative regulations (Article 24);

Government Commitment: Governments shall strictly abide by all policy commitments made to, and contracts concluded with the foreign investors and foreign-invested enterprises in accordance with the laws (Article 25).

Foreign Investors’ Complaints: The State shall establish and improve a complaint mechanism for foreign-invested enterprises. In case that the mechanism fails to resolve a complaint, foreign investors may apply for administrative review, or institute administrative litigation in accordance with the laws (Article 26).

Compared to the Draft, the FIL contains the following major changes:

National Expropriation: The FIL specifically requires that the expropriation and requisition shall only be conducted in accordance with law, and that compensation shall be given in a timely manner;

Profit Remittance: proceeds from assets deposition” and “proceeds from liquidation” have been included in the scope of remittance in this article, and free remittance “inward” has been added on top of “outward”;

Intellectual Property Rights: The terms for technology cooperation are required to be determined through “fair negotiation under the principle of equity”;

Duty of Confidentiality: The duty of confidentiality and the legal liability for a breach were not contained in the Draft, but a newly added content in the FIL;

Administrative Intervention:

Government intervention (such as impairment of rights, imposition of additional obligations, market assess or exist conditions) is limited to the extent that it is “in compliance with laws and administrative regulations”. This can be understood as meaning that none of the national ministries and commissions, local legislature or government may, without the legal ground provided by upper laws, intervene or restrict foreign investment through department rules, local laws or regulations;

Government Commitment: No substantial changes compared to the Draft.

Foreign Investors’ Complaints: Compared to the Draft, the FIL specifically provides that in case that the mechanism fails to resolve the complaint, foreign investors may apply for administrative review, or institute administrative litigation in accordance with the laws.

Investment Administration

The FIL specifies the following three investment administrative systems for foreign investment:

(i)        Pre-establishment National Treatment and Negative List administrative system (Article 28);

(ii)      Information Reporting system (Article 34); and

(iii)    National Security Review system (Article 35).

On the basis of the definition of the Negative List given in the Draft, the FIL adds the definition of “Pre-establishment National Treatment”, which means “the treatment given to foreign investors and their investments at the investment access stage shall not be less favorable than those given to the investors of the host country”.

The FIL also adds a new article (Article 33) providing that foreign investors that acquire companies within the territory of China through mergers and acquisitions or participate in the concentration of undertakings by other means shall be subject to the scrutiny of merger control as stipulated by the Anti-Monopoly Law of the People’s Republic of China.

Legal Liability

The FIL stipulates the following legal consequences for any violation of the negative list, information reporting system or laws and regulations:

(i)      Violation of the Negative List: Foreign investors shall be ordered to rectify or stop investment activities, or dispose of shares and assets within the prescribed time limit, or take other necessary measures to restore to the original state prior to investment. If there have been any gains derived from such investment, such gains shall be considered illegal and confiscated by the government, and the foreign investors shall bear corresponding legal liability in accordance the laws (Article 36).

(ii)    Violation of the Information Reporting System: Foreign investors shall be ordered to rectify within a prescribed time limit by competent department of commerce; if rectification is not made in time, a penalty of between CNY100,000 and CNY500,000 shall be imposed (Article 37).

(iii)  Violation of laws and regulations: Foreign investors shall be subject to investigation in accordance with laws and blacklisted in credit information systems (Article 38).

Compared to the Draft, the FIL adds “corresponding legal liability in accordance with the law” as the legal liability for the violation of negative list on top of administrative sanctions. Further, FIL also adds the legal liability for the violation of information reporting system, and deletes “sanctions jointly taken by relevant authorities” as the legal liability for the violation of laws and regulations.

 

Exceptions

(i)      Exception of Pre-establishment National Treatment and Negative List Administrative System: If more preferential treatment concerning investment access is offered to a foreign investor under any international convention or treaty that the People’s Republic of China concludes or joins in, relevant provisions in such convention or treaty may be applied. (Article 4);

(ii)    Exception of Special Industries: For foreign investment administration in financial industries such as banking, securities and insurance, or in financial markets such as securities market and foreign exchange market within the territory of China, where the State has special regulations, such regulations shall be applied for foreign investment in those industries (Article 41).

Compared to the Draft, the applicable international convention or treaty only refers to the one with “more preferential treatment”, and the State shall have the discretion to decide whether to apply such more preferential treatment, which means the more preferential treatment “may”, but not “shall”, be applied.
Transition Period Foreign-invested enterprises, which were established in accordance with the FIE Laws before the implementation of the FIL, may keep their existing organization forms and other aspects for five years upon the implementation of the FIL. Specific implementation measures shall be formulated by the State Council (Article 42). No substantial changes compared to the Draft.

 

2. Highlights of the FIL 

 

Among the highlights of the FIL are the clear responses to various long-held concerns from foreign investors and foreign-invested enterprises, which should go some way to improving the environment for foreign investment and shoring up foreign investors’ confidence in investing in China. They include:

2.1 – National treatment: all national policies in supporting of the development of enterprises shall equally apply to foreign-invested enterprises in accordance with the laws (Article 9); foreign-invested enterprises can equally participate in setting standards in accordance with the laws, and the compulsory standards formulated by the State shall equally apply to foreign-invested enterprises (Article 15); the State shall ensure that foreign-invested enterprises can participate in government procurement activities through fair competition in accordance with the laws. Products produced and services provided by foreign-invested enterprises within the territory of China shall be treated equally in a government procurement in accordance with the laws (Article 16);

2.2 – Prevention of compulsory technology transfer: The terms for any technology cooperation shall be determined through fair negotiation between the parties to the investment under the principle of equity. Administrative means shall not be used by administrative departments or theirs staff members to compel the transfer of technology (Article 22); and

2.3 – Governmental commitment: Local governments and their relevant departments shall strictly abide by all policy commitments made to, and contracts concluded with the foreign investors and foreign-invested enterprises in accordance with the laws (Article 25).

 

3. Impact of the FIL on FIEs

 

Upon the FIL coming into effect, the FIE Laws will be repealed simultaneously. This will have a different impact on the legal form of the Sino-Foreign Equity Joint Ventures, Sino-Foreign Cooperative Joint Ventures and Wholly Foreign Owned Enterprises (collectively, the “Foreign-invested Enterprises” or “FIEs”). Article 31 of the FIL provides that “the legal form, organization structure and code of conduct of a foreign-invested enterprise shall be governed by the provisions of the Company Law of the People’s Republic of China, the Partnership Enterprise Law of the People’s Republic of China, and other applicable laws.” Based on this provision, we have summarized the major impact of the FIL on the FIEs in the following table:

 

  Existing Enterprises New Enterprises
Sino-Foreign Cooperative Joint Ventures

–    Existing enterprises that have been established as legal persons shall, during the 5-year transition period, be transformed to limited liability companies or joint-stock companies in accordance with the Company Law;

–    Existing enterprises that have been established without legal person status may, during the 5-year transition period, be transformed to partnerships in accordance with the Partnership Enterprise Law, or limited liability companies or joint-stock companies in accordance with the Company Law.

–    The legal form of the Sino-Foreign Cooperative Joint Ventures shall not exist anymore following the implementation of the FIL.
Wholly Foreign Owned Enterprises

–    No substantial impact since such enterprises are basically limited liability companies incorporated in accordance with the Company Law.

 

–    To be established as a limited liability company or joint-stock company (applicable for a company with at least two foreign investors) in accordance with the Company Law;

–    As for an enterprise invested in by a foreign natural person investor, such enterprise can be in the form of individual proprietorship enterprise provided that the Law on Individual Proprietorship Enterprise will be amended to be applied to foreign natural persons[1].

Sino-Foreign Equity Joint Ventures –    Although the legal form of Sino-Foreign Equity Joint Ventures is already a limited liability company, their articles of association need to be revised within the 5-year transition period in order to comply with the requirements of the Company Law in respect of organization structure and corporate governance. .

–    To be established as a limited liability company or joint-stock company in accordance with the Company Law.

 

 

Since the Sino-Foreign Equity Joint Venture is an important type of entity among the FIEs, and its corporate governance structure will be significantly affected by the FIL, we hereby set out the major impact that the FIL may impose on Sino-Foreign Equity Joint Ventures taking the form of limited liability companies.

 

  Sino-Foreign Equity Joint Ventures Before the FIL After the FIL
1 Restriction on Chinese Shareholder Chinese natural persons cannot be the shareholder of newly incorporated joint ventures[2]. No restriction
2 Investment Percentage of Foreign Shareholder Generally no less than 25% No restriction
3 Highest Authority Board of Directors Shareholders’ meeting
4 Appointment of the Directors Directors shall be appointed or removed by respective shareholders of the joint ventures. Directors who are not employee representatives shall be elected and replaced by the shareholders’ meeting
5 Chairman and Vice Chairman of the Board Chairman and Vice Chairman of the Board shall be appointed by the Chinese shareholder and the foreign shareholder respectively No restriction
6 Legal Representative Chairman of the Board Chairman of the Board, Executive Director or General Manager
7 Voting Requirement for the Highest Authority to Approve Important Matters

Matters mandatorily subject to unanimous approval of all Directors presenting at the meeting of the Board:

–    Amendment of articles of associations;

–    Increase or reduction of registered capital;

–    Suspension or dissolution of the company;

–    Split-up or merger of the company.

Matters mandatorily subject to approval of shareholders holding more than 2/3 of the voting rights:

–    Amendment of articles of associations;

–    Increase or reduction of registered capital;

–    Dissolution or change of company form;

–    Split-up or merger of the company.

 

8 Appointment of Senior Management Personnel General/Deputy General Manager (or Factory Head/Deputy Factory Head) shall be appointed by the Chinese shareholder and the foreign shareholder respectively No restriction
9 Foreign Partner’s Contribution in Form of Industrial Property Rights or Know-how

Industrial Property Rights or Know-how used for capital contribution must meet either of the following conditions:

–    The technology that can significantly improve the performance, quality or production efficiency of the current product; or

–    The technology that can significantly save raw materials, fuels or power.

No specific restriction, as long as it does not fall into properties that cannot be used as capital contribution according to the laws and administrative regulations.
10 Restriction on Equity Transfer The transfer of any shareholder’s equity interest is subject to the consent of all other shareholders. Unless otherwise provided in the articles of association, a shareholder may freely transfer part or all of its equity interest to another shareholder. Transfer to third parties shall require consent from more than half of all other shareholders. Other shareholders failing to reply within 30 days from receipt of the written notice shall be deemed to have consented to the proposed transfer. Where more than half of the other shareholders do not consent to the proposed transfer, the non-consenting shareholders shall purchase such equity interests, failing which they shall be deemed to have consented to the proposed transfer. Where the consent has been given to the proposed transfer, the non-transferring shareholders shall have right of first refusal to purchase such equity interests on the same conditions.
11 Profit Sharing Rules All parties to the joint venture shall share the profit in proportion to their respective contribution to the registered capital. Shareholders shall be entitled to the profit in proportion to their respective paid-in capital in the registered capital, unless all the shareholders agreed otherwise.
12 Mandatory Fund Allocation and Percentage

–    Reserve Funds

–    Employee Bonus and Welfare Reserve

–    Enterprise Development Reserve

Ratio of the above reserves shall be determined by the Board

– Statutory Reserve

– Discretionary Reserve

Contribution of statutory reserve shall be 10% of the post-tax profit, but such contribution is not required if the aggregate sum of the statutory reserve reaches 50% of the registered capital.

13 Governing Law of Joint Ventures Contract –    Chinese law (Article 12 of the Implementing Regulation of the Law of the People’s Republic of China on Sino-Foreign Equity Joint Ventures, Article 126 of the Contract Law) Chinese law (Article 126 of the Contract Law)

 

4. Comments and Suggestions on FIL’s Implementing Regulations

 

As a fundamental law, the FIL has provided several principles on the promotion, protection and administration of the foreign investment, thus it must require implementing rules or other ancillary regulations (the “Implementing Regulations”) to facilitate its implementation. Our comments and suggestions on some issues that are to be clarified in the Implementing Regulations are as follows:

1.       Definition of “Foreign Investor” and “Foreign Investment” (Article 2, Paragraph 2) For the purpose of this law, foreign investment refers to any investment activity directly or indirectly carried out by foreign natural persons, enterprises or other organizations (“foreign investors”) within the territory of China”, including…

Comments/Suggestions

 We suggest that the Implementing Regulations should further clarify the definition of “Foreign Investor” and “Foreign Investment” in the following aspects:

(i)       Whether “foreign investors” may include foreign or regional governments, and international organizations.

(ii)     Since, in addition to direct investment, the definition of investment includes “indirect investment”, it is not clear whether for an investment in China, the identity of its foreign investor shall be determined by such investor’s ultimate controlling shareholder.

(iii)   It needs to be clarified whether an investment made in China by an overseas company that is controlled by a Chinese company will be classified as “foreign investment”.

We believe that it is necessary to clarify in the Implementing Regulations whether the identity of a “foreign investor” will be determined by the place of registration of the foreign investor that directly holds shares, equity or interest of the invested enterprise in China, or by the place of registration of the ultimate controller of such foreign investor. If it is the latter, a definition of “control” is also required.

Given the increasing number of overseas investments emanating from China, a lack of such criteria may lead to severe confusion regarding whether investment in China conducted by overseas companies directly or indirectly controlled or wholly-owned by Chinese enterprises or natural persons will be governed by the FIL.

Moreover, with increasing numbers of Chinese citizens migrating overseas and foreign citizens becoming resident in China, we suggest that there is a need for clarification as to whether an enterprise invested in China by foreign individuals that acquire Chinese nationality or by Chinese citizens that obtain foreign nationality shall be governed by the FIL.

2.       National Security Review (Article 35) “China shall establish a foreign investment national security review system to perform security reviews on foreign investment that affects or may affect national security. National security decisions made according to the law shall be final.”

Comments/Suggestions

The FIL provides that there shall be a foreign investment national security review system, without further specifying any detailed rules, such as in terms of the scope and content of the review, requirements of application documents, procedure or time limit of the review, etc. Currently, the only rules that regulate a national security review of foreign investments are the Notice of the General Office of State Council on the Establishment of a Security Review System Pertaining to Mergers and Acquisitions of Domestic Enterprises by Foreign Investors[3] and the Notice of the General Office of State Council on the Promulgation of the Trial Measures on National Security Review for Foreign Investments in Pilot Free Trade Zones[4]. There is no clear legal basis for a national security review of foreign-invested enterprises that will be set up outside free trade zones. We suggest that the Implementing Regulations shall provide for the scope, content and procedures of the national security review for all kinds of foreign investment.

3.       Transition Period of Existing Foreign-invested Enterprises(Article 42) “Foreign-invested enterprises, which were established in accordance with the FIE Laws before the implementation of the FIL, may keep their legal forms and other aspects for five years upon the implementation hereof. Specific implementation measures shall be formulated by the State Council”

Comments/Suggestions 

After the FIL comes into force, the Sino-Foreign Cooperative Joint Ventures as a legal form for enterprises shall not exist anymore. Article 21 of the Law on Sino-Foreign Cooperative Joint Ventures provides that “when the Chinese and foreign partners agree in the co-operative enterprise contract that, on the expiry of the term of co-operation, all the fixed assets of the co-operative enterprise shall be owned by the Chinese partner, methods to allow the foreign partner to recover its investment in advance within the term of co-operation may be stipulated in the co-operative enterprise contract.

As for a Sino-foreign Cooperative Joint Venture adopting the above provision, when it is transformed to a limited liability company in accordance with the Company Law during the 5-year transition period, the investment recovery issue can be resolved by an agreement based on Article 34 of the Company Law, pursuant to which the shareholders may agree that the profit will not be distributed in proportion to their respective contributions to the company’s registered capital.

However, the Company Law does not provide a legal basis pursuant to which all the fixed assets of the company can be owned by the Chinese partner only on the expiry of the term of co-operation. Paragraph 2 of Article 186 of the Company Law provides that the residual assets of a company after liquidation “shall be distributed to shareholders in accordance with the ratio of capital contribution”, without any exceptions. Therefore, we suggest that the Implementing Regulations provide clear guidance on such issue in relation to the transition period.

4.       Governing Law of Partnership Agreement

Comments/Suggestions 

Article 126 of the Contract Law provides that “parties to a contract with a foreign element may choose the law to be applied in the handling of contractual disputes, except where laws provide otherwise. Where the parties to a contract with a foreign element fail to choose the governing law of the contract, the law of the country with the closest connection to the contract shall be applied.

Sino-foreign equity joint venture contracts, Sino-foreign cooperative enterprise contracts and Sino-foreign contracts for the cooperative exploitation and development of natural resources which are to be performed within the territory of the People’s Republic of China shall be governed by the law of the People’s Republic of China.

Hence, after the repeal of the FIE Laws, joint venture contracts of Sino-Foreign Equity Joint Ventures that are incorporated in accordance with the Company Law shall still be governed by the Chinese laws. However, in the absence of any rules in the Contract Law requiring the partnership agreement of Sino-Foreign Partnership under the Partnership Enterprise Law to be governed by the Chinese law, whether the parties to the Sino-foreign partnership agreement will be free to choose a foreign governing law, pursuant to the PRC Contract Law?

We suggest that the Implementing Regulations should further clarify this issue. Theoretically, the restriction in Article 126 of the Contract Law on the choice of law refers only to restriction made by laws, thus neither administrative regulations nor department rules may formulate provisions that are not in compliance with the Contract Law.

5.         Applicability of FIL to Investors from Hong Kong, Macau and Taiwan

Comments/Suggestions

The definition of “foreign investor” in the FIL does not cover investors from Hong Kong, Macau or Taiwan, whose investments in mainland China were previously considered to be “foreign investment”. Therefore, we suggest that the Implementing Regulations clarify whether the FIL shall apply, by reference, to investment in mainland China made by investors from Hong Kong, Macau and Taiwan.

 

5. Outlook

 

If the Law on Sino-Foreign Equity Joint Ventures promulgated in 1979 is considered the first window left ajar by a less-developed China to attract foreign investment, the FIL promulgated in 2019 can be seen as a large door opened by a striding forward China with a more open mind and more positive attitude to attract foreign investment. By stepping through this door, China’s administration on foreign investment has entered a stage of grand unification, which will significantly increase the efficiency of foreign investment while reducing the investment cost. Except for industries in the negative list, all foreign investment will not be subject to any prior approval or filing, and the national treatment is fully assured by law. In this regard, the FIL is no doubt a good news for foreign investors who come to invest in China, and a signal of a more mature, open and confident foreign investment administration of China.

In addition, the FIL is not just a good news for foreign investors. Almost forty years has passed since the establishment of the first Sino-Foreign Equity Joint Ventures in China. Upon the repeal of the FIE Laws, the era in which there is no legal basis for a Chinese natural person to be a shareholder of a Sino-Foreign equity joint venture or cooperative joint venture has gone for good. As such, the promulgation of FIL serves not only a milestone of the development of foreign investment in China, but also exhilarating news for Chinese individuals who have increasing financial capability and wish to participate more in the international economic exchange and cooperation.

*******************

[1] Article 31 of the FIL provides that the legal form of a foreign-invested enterprise shall be governed by the provisions of the Company Law, the Partnership Enterprise Law, and other applicable laws. Compared to the Draft submitted for second review on January 29, 2019, the FIL has added “other applicable laws” in this article, which can be understood that foreign-invested enterprises are theoretically able to take a legal form other than those stipulated in the Company Law or Partnership Enterprise Law. For example, foreign natural persons should be able to set up individual proprietorship enterprises in accordance with the Law on Individual Proprietorship Enterprises. In order to show the national treatment and consistent treatment established by the FIL, we understand that the provision “This law shall not apply to wholly foreign owned enterprises” under Article 64 of the Law on Individual Proprietorship Enterprises shall be removed.

[2] Article 54 of the Provisions on Merger and Acquisition of Domestic Enterprises by Foreign Investors (Decree 6 of the Ministry of Commerce 2009) provides that “A Chinese natural person shareholder of a domestic company whose equity is acquired by a foreign investor may, upon approval, continue to be the Chinese investor of the foreign-invested enterprise after the conversion.” However, this provision does not apply to newly incorporated Sino-Foreign Equity Joint Ventures.

[3] Guo Ban Fa [2011] No. 6

[4] Guo Ban Fa [2015] No. 24

The views expressed herein are solely those of the author and have not been endorsed, confirmed, or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

Spotlight on Boards

Editor’s Note: This article was authored by Martin Lipton of Wachtell, Lipton, Rosen & Katz.

Spotlight on Boards

The ever-evolving challenges facing corporate boards prompt periodic updates to a snapshot of what is expected from the board of directors of a major public company—not just the legal rules, or the principles published by institutional investors and various corporate and investor associations, but also the aspirational “best practices” that have come to have equivalent influence on board and company behavior. Today, boards are expected to:

  • Recognize the heightened focus of investors on “purpose” and “culture” and an expanded notion of stakeholder interests that includes employees, customers, communities, the economy and society as a whole and work with management to develop metrics to enable the corporation to demonstrate their value;
  • Be aware that ESG and sustainability have become major, mainstream governance topics that encompass a wide range of issues, such as climate change and other environmental risks, systemic financial stability, human capital management, worker retirement, supply chain labor standards and consumer and product safety;
  • Oversee corporate strategy (including purpose and culture) and the communication of that strategy to investors, keeping in mind that investors want to be assured not just about current risks and problems, but threats to long-term strategy from global, political, social, and technological developments;
  • Work with management to review the corporation’s strategy, and related disclosures, in light of the annual letters to CEOs and directors, or other communications, from BlackRock, State Street, Vanguard, and other investors, describing the investors’ expectations with respect to corporate strategy and how it is communicated;
  • Set the “tone at the top” to create a corporate culture that gives priority to ethical standards, professionalism, integrity and compliance in setting and implementing both operating and strategic goals;
  • Choose the CEO, monitor the CEO’s and management’s performance and develop and keep current a succession plan;
  • Have a lead independent director or a non-executive chair of the board who can facilitate the functioning of the board and assist management in engaging with investors;
  • Together with the lead independent director or the non-executive chair, determine the agendas for board and committee meetings and work with management to ensure that appropriate information and sufficient time are available for full consideration of all matters;
  • Determine the appropriate level of executive compensation and incentive structures, with awareness of the potential impact of compensation structures on business priorities and risk-taking, as well as investor and proxy advisor views on compensation;
  • Develop a working partnership with the CEO and management and serve as a resource for management in charting the appropriate course for the corporation;
  • Oversee and understand the corporation’s risk management and compliance efforts and how risk is taken into account in the corporation’s business decision-making; respond to red flags if and when they arise;
  • Monitor and participate, as appropriate, in shareholder engagement efforts, evaluate corporate governance proposals, and work with management to anticipate possible takeover attempts and activist attacks in order to be able to address them more effectively, if they should occur;
  • Meet at least annually with the team of company executives and outside advisors that will advise the corporation in the event of a takeover proposal or an activist attack;
  • Be open to management inviting an activist to meet with the board to present the activist’s opinion of the strategy and management of the corporation;
  • Evaluate the individual director’s, board’s and committees’ performance on a regular basis and consider the optimal board and committee composition and structure, including board refreshment, expertise and skill sets, independence and diversity, as well as the best way to communicate with investors regarding these issues;
  • Review corporate governance guidelines and committee workloads and charters and tailor them to promote effective board and committee functioning;
  • Be prepared to deal with crises; and
  • Be prepared to take an active role in matters where the CEO may have a real or perceived conflict, including takeovers and attacks by activist hedge funds focused on the CEO.

To meet these expectations, major public companies should seek to:

  • Have a sufficient number of directors to staff the requisite standing and special committees and to meet investor expectations for experience, expertise, diversity, and periodic refreshment;
  • Compensate directors commensurate with the time and effort that they are required to devote and the responsibility that they assume;
  • Have directors who have knowledge of, and experience with, the corporation’s businesses and with the geopolitics developments that affect it, even if this results in the board having more than one director who is not “independent”;
  • Have directors who are able to devote sufficient time to preparing for and attending board and committee meetings and engaging with investors;
  • Provide the directors with the data that is critical to making sound decisions on strategy, compensation and capital allocation;
  • Provide the directors with regular tutorials by internal and external experts as part of expanded director education and to assure that in complicated, multi-industry and new-technology corporations, the directors have the information and expertise they need to respond to disruption, evaluate current strategy and strategize beyond the horizon; and
  • Maintain a truly collegial relationship among and between the company’s senior executives and the members of the board that facilitates frank and vigorous discussion and enhances the board’s role as strategic partner, evaluator, and monitor.

Martin Lipton

 

The views expressed herein are solely those of the author and have not been endorsed, confirmed, or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

U.S. UPDATE – 2019 Checklist for Successful Acquisitions in the United States

Editors’ Note: This submission updates a checklist co-authored by Messrs. Emmerich and Panovka, members of XBMA’s Legal Roundtable, with their colleagues at Wachtell Lipton, Jodi J. Schwartz, Scott K. Charles, David A. Katz, Andrew J. Nussbaum, Ilene Knable Gotts, Mark Gordon, Joshua R. Cammaker, William Savitt, Andrea K. Wahlquist, Karessa L. Cain, T. Eiko Stange, Joshua M. Holmes, Eric M. Rosof, Gordon S. Moodie, Emil A. Kleinhaus, Edward J. Lee, Raaj S. Narayan and Matthew T. Carpenter.

Cross-Border M&A –
2019 Checklist for Successful Acquisitions in the United States

M&A in 2018 began with a bang, with more than $350 billion of deals in January 2018 – a January level not seen since 2000 – and much chatter that M&A volume for the year could hit an all-time record. As it turned out, 2018 was a tale of two cities, with M&A continuing at a torrid pace during the first half of the year, and falling off markedly during a second half of geopolitical tension and market volatility. Overall, M&A volume for 2018 reached a very robust $4 trillion, but fell short of overtaking deal volume in 2007 and 2015. M&A being lumpy and unpredictable as ever, 2019 has opened with a number of notable deals, not least the sale of Celgene to Bristol-Myers Squibb for $95 billion, somewhat defying gloomy predictions for the year.

As for cross-border deals, interestingly, a record $1.6 trillion (39%) of last year’s deals (including six of the 10 largest deals) was cross-border M&A, despite growing trade tensions and anti-globalist rhetoric.

Acquisitions of U.S. companies continued to dominate the global M&A market in 2018, representing 43% of global M&A volume ($1.7 trillion), higher than the average over the last decade. Approximately 16% of U.S. deals involved non-U.S. acquirors. German, French, Canadian, Japanese and U.K. acquirors accounted for approximately 60% of the volume of cross-border deals involving U.S. targets, and acquirors from China, India and other emerging economies accounted for approximately 10%.

Whatever 2019 does bring – in addition to trade tensions and protectionist rhetoric, cyber insecurity, slowdowns in China and a number of other emerging economies, gloom about the interest rate and debt financing pictures in the U.S., geopolitical risks all around the world, and inevitable but as-yet-unknown curve balls from politicians – we expect the pace of cross-border deals into the U.S. to remain strong. And, as always, transacting parties who are smart and well prepared – particularly when engaging in cross-border deals with all of their cultural, political and technical complexity – will do better. Advance preparation, strategic implementation and deal structures calibrated to anticipate likely concerns will continue to be critical to successful acquisitions in the U.S. In light of the recent changes to the CFIUS regime (discussed below), careful attention to CFIUS, well in advance of any potential acquisition, is obviously essential.

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The views expressed herein are solely those of the author and have not been endorsed, confirmed, or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

Dealing with Activist Hedge Funds and Other Activist Investors

Editors’ Note: This article was co-authored by Martin Lipton, Steven A. Rosenblum, Karessa L. Cain and Sabastian V. Niles of Wachtell, Lipton, Rosen & Katz.

Dealing with Activist Hedge Funds and Other Activist Investors

Introduction

Regardless of industry, size or performance, no company should consider itself immune from hedge fund activism. No company is too large, too popular, too new or too successful. Even companies that are respected industry leaders and have outperformed the market and their peers have come under fire. Activists set new records in 2018, targeting the largest number of companies (nearly 300), deploying more capital and winning a greater number of board seats (161) than ever before.

Campaigns by the most well-known activist hedge funds are surging, and there are more than 100 hedge funds currently engaged in activism. Activist hedge funds have significantly more than $100 billion of assets under management, and remain an “asset class” that attracts investment from major traditional institutional investors.

Although a number of institutional investors are beginning to question whether hedge fund activism should be supported or resisted, and will act independently of activists, the relationships between activists and more traditional investors in recent years have encouraged increasingly frequent and aggressive activist attacks. Several mutual funds and other institutional investors have on occasion also deployed the same kinds of tactics and campaigns as the dedicated activist funds. A number of hedge funds have also sought to export American-style activism abroad, with companies throughout the world now facing classic activist attacks. Many activist attacks continue to be designed to force a takeover, sale or breakup of the target, or a change in management, either immediately or over time.

Elliott Management was the most active and, in many cases, aggressive activist of 2018. The Wall Street Journal noted that Elliott publicly targeted 24 companies in 2018, with Carl Icahn and Starboard runners-up with nine public targets each. These numbers do not include the increasing number of non-disclosed activist situations against major companies. The New Yorker published a lengthy profile of Paul Singer and Elliott in August, “Paul Singer, Doomsday Investor,” noting “Singer has excelled in this field in part because of a canny ability to discern his opponents’ weaknesses and a seeming imperviousness to public disapproval.”

It has become increasingly evident that the activism-driven corporate world is relatively fragile and is proving to be unsustainable, particularly when viewed in the broader context of rapidly changing political and social norms and increasing divisiveness across many planes of the social contract. A number of initiatives have been underway to establish a modern corporate governance framework that is calibrated to the current environment. For our part, at the request of the World Economic Forum, we prepared a paper titled, The New Paradigm: A Roadmap for an Implicit Corporate Governance Partnership Between Corporations and Investors to Achieve Sustainable Long-Term Investment and Growth, which was issued in September 2016. We updated The New Paradigm and discussed it in our memo, Some Thoughts for Boards of Directors in 2019.

In essence, The New Paradigm conceives of corporate governance as a collaboration among corporations, shareholders and other stakeholders working together to achieve long-term value and resist short-termism. While we have seen considerable interest in The New Paradigm and similar initiatives from major institutional investors and other key stakeholders (for example, the Investor Stewardship Group), until such a framework is widely adopted and in the absence of legislation, it is unlikely that there will be any significant decrease in activism. Accordingly, companies should regularly review and adjust their plans to avoid an activist attack and to successfully deal with an activist attack if one should occur. Effective engagement with major shareholders is the essential element of activist defense, and the support of major investors, including the largest index funds, cannot be taken for granted.

The Attack Devices Used by Activists

  • Aggressively criticizing a company’s governance, management, business and strategy and presenting the activist’s own recommendations and business plan.
  • Proposing a precatory proxy resolution for specific actions prescribed by the activist or the creation of a special committee of independent directors to undertake a strategic review for the purpose of “maximizing shareholder value.”
  • Recruiting candidates with industry experience (including retired CEOs of major companies or even former executives of the target) to serve on dissident slates, and conducting (or threatening to conduct) a proxy fight to get board representation at an annual or special meeting or through action by written consent (solicitation for a short slate is very often supported by ISS and, if supported, is often, though not always, successful, in whole or in part).
  • Orchestrating a “withhold the vote” campaign.
  • Seeking to force a sale by leaking or initiating rumors of an unsolicited approach, publicly calling for a sale, acting as an (unauthorized) intermediary with strategic acquirers and private equity funds, taking positions in both the target and the acquirer, making their own “stalking-horse” bid or partnering with a hostile acquirer to build substantial stock positions in the target to facilitate a takeover.
  • Rallying institutional investors and sell-side research analysts to support the activist’s arguments.
  • Using stock loans, options, derivatives and other devices to accumulate positions secretly or increase voting power beyond the activist’s economic equity investment.
  • Using sophisticated public relations, social media and traditional media campaigns to advance the activist’s arguments.
  • Investing in significant diligence and third-party consulting services to analyze the target’s business.
  • Seeking to create divisions within the boardroom or between the board and management.
  • Reaching a company’s retail shareholders with weekly mailings, telephonic outreach, local newspaper advertisements and user-friendly infographics.
  • Hiring private investigators to create dossiers on directors, management and key employees and otherwise conducting aggressive “diligence.”
  • Litigation.

Current SEC rules do not prevent an activist from secretly accumulating a more than 5% position before being required to make public disclosure and do not prevent activists and institutional investors from privately communicating and cooperating.

Prevention of, or response to, an activist attack is an art, not a science. There is no substitute for preparation. The issues, tactics, team and approaches to an activist challenge will vary depending on the company, the industry, the activist and the substantive business and governance issues in play. To forestall an attack, a company should regularly review its business portfolio and strategy and its governance and executive compensation issues. In addition to a program of advance engagement with investors, it is essential to be able to mount a defense quickly and to be agile in responding to changing tactics. A well-managed corporation executing clearly articulated strategies can still prevail against an activist, even when the major proxy advisory firms support the activist.

Given the risks and potential harm of a full-blown battle, in certain situations the best response to an activist approach may be to seek to negotiate with the activist and reach a settlement on acceptable terms, if such a settlement is feasible, even if the company believes it could win a proxy fight. However, when a negotiated resolution is not achievable on acceptable terms, whether because the activist’s proposals are inimical to the company’s business goals and strategy or because the activist is unwilling to be reasonable in its negotiation, the ability to wage an effective campaign will depend on advance preparation, proactive action, good judgment and effective relationships and engagement with shareholders. This outline provides a checklist of matters to be considered in putting a company in the best possible position to prevent, respond to or resolve a hedge fund activist attack.

Advance Preparation

Create Team to Deal with Hedge Fund Activism:

  • A small group of key officers plus legal counsel, investment banker, proxy soliciting firm, and public relations firm.
  • Continuing contact and periodic meetings of the team are important.
  • A periodic fire drill with the team is the best way to maintain a state of preparedness; the team should be familiar with the hedge funds and other investors that have made activist approaches generally and be particularly focused on those that have approached other companies in the same industry and the tactics each fund has used; the team should also use that familiarity to be alert to any contacts or interest shown by known activists.
  • Periodic updates to the company’s board of directors.

Shareholder Relations:

  • The investor relations officer is critical in assessing exposure to an activist attack and in a proxy solicitation. The credibility the investor relations officer has with the institutional shareholders has been determinative in a number of proxy solicitations. Candid assessment of shareholder sentiment should be appropriately communicated to senior management, with periodic briefings provided to the board.
  • Review capital return policy (dividends and buybacks), broader capital allocation framework, analyst and investor presentations and other financial public relations matters (including disclosed metrics and guidance).
  • Monitor peer group, sell-side analysts, proxy advisors, active asset managers, and internet commentary and media reports for opinions or facts that will attract the attention of activists.
  • Be consistent with the company’s basic strategic message while updating the strategy as circumstances warrant.
  • Objectively assess input from shareholders and whether the company is receiving candid feedback. The company should make sure that major investors feel comfortable expressing their views to the company and believe that the company honestly wants to hear any concerns or thoughts they have.
  • Proactively address reasons for any shortfall versus peer benchmarks. Anticipate key questions and challenges from analysts and activists, and be prepared with answers. Monitor peer activity and the changes peers are making to their businesses, as well as key industry trends.
  • Build credibility with shareholders and analysts before activists surface.
  • Monitor changes in hedge fund and institutional shareholder holdings on a regular basis; understand the shareholder base, including, to the extent practical, relationships among holders. Pay close attention to activist funds that commonly act together or with an institutional investor.
  • Maintain regular contact with major institutional investors, including both portfolio managers and proxy voting/governance departments; CEO, CFO and independent director participation is very important. Consider engagement with proxy advisory firms.
  • Major institutional investors, including BlackRock, Capital, Fidelity, State Street, TIAA, T. Rowe Price, Vanguard and Wellington, have established significant proxy departments that make decisions independent of ISS. It is important for a company to know the voting policies and guidelines of its major investors, who the key decision-makers and point-persons are and how best to reach them. It may be possible to defeat an activist attack supported by ISS by gaining the support of major institutional shareholders.
  • Consider whether enhancements to company disclosures or changes to governance practices are appropriate in light of evolving shareholder expectations.
  • Monitor third-party governance ratings and reports and seek to correct inaccuracies.
  • Maintain up-to-date plans for contacts with media, regulatory agencies, political bodies and industry leaders and refresh relationships.
  • Monitor investor conference call participants, one-on-one requests and transcript downloads.

Prepare the Board of Directors to Deal with the Activist Situation:

  • Maintaining a unified board consensus on key strategic issues is essential to success in the face of an activist attack; in large measure, an attack by an activist hedge fund is an attempt to drive a wedge between the board and management by raising doubts about strategy and management performance and to create divisions on the board, which may include advocating that a special committee be formed.
  • Keep the board informed of options and alternatives analyzed by management, and review with the board basic strategy, capital allocation and the portfolio of businesses in light of possible arguments for spinoffs, share buybacks, increased leverage, special dividends, sale of the company or other structural or business changes.
  • Schedule periodic presentations by the legal counsel and the investment banker to familiarize directors with the current activist environment and the company’s preparation.
  • Directors should guard against subversion of the responsibilities of the full board by the activists or related parties, and should refer all approaches to the CEO.
  • Boardroom debates over business strategy, direction and other matters should be open and vigorous but stay confidential and be kept within the boardroom.
  • Recognize that psychological and perception factors may be more important than legal and financial factors in avoiding being singled out as a target.
  • Scrutiny of board composition is increasing, and boards should self-assess regularly. In a contested proxy solicitation, institutional investors may particularly question the “independence” of directors who are older than 75 or who have lengthy tenures, especially where the board has not recently appointed new directors, in addition to more broadly assessing director expertise and attributes. Directors may also be criticized for “overboarding” or attendance issues. Meaningful director evaluation is now a key objective of institutional investors, and a corporation is well advised to undertake it and talk to investors about it. Regular board renewal and refreshment, and having longer-term board development and succession plans, can be important evidence of meaningful evaluation.
  • A company should not wait until it is involved in a contested proxy solicitation to offer its key institutional shareholders the opportunity to meet with its independent directors. Many major institutional investors have recommended that companies offer scheduled meetings with some (or in unusual circumstances even all) of a company’s independent directors. A disciplined, thoughtful program for periodic meetings and other engagement initiatives is advisable. See Shareholder Engagement: Succeeding in the New Paradigm for Corporate Governance.

Monitor Trading, Volume and Other Indicia of Activity:

  • Employ stock watch service and monitor Schedule 13F filings.
  • Monitor Schedule 13D and Schedule 13G and Hart-Scott-Rodino Act filings.
  • Monitor parallel trading and group activity (the activist “wolf pack”).
  • Monitor activity in options, derivatives, corporate debt and other non-equity securities.
  • Monitor attendance at analyst conferences, requests for one-on-one sessions and other contacts from known activists.

The Activist White Paper:

The activist may approach a company with an extensive, and in many cases high-quality, analysis of the company’s business and strategy that supports the activist’s recommendations (demands) for:

  • Return of capital to shareholders through share repurchase or special dividend.
  • Change in capital structure (leverage).
  • Sale or spin-off of a division.
  • Change in business strategy, including ESG.
  • Change in cost structures.
  • Improvement of management performance or replacement of management (e.g., replace CEO).
  • Change in executive compensation.
  • Merger or sale of the company.
  • Change in governance: add new directors designated by the activist, separate the positions of CEO and Chair, declassify the board, remove poison pill and other takeover defenses, permit shareholders to call a special meeting (or lower thresholds for same) and act by written consent.

Responding to an Activist Approach

Response to Non-Public Communication:

  • Assemble team quickly and determine initial strategy. Response is an art, not a science.
  • No duty to respond, but failure to respond may have negative consequences, and in most cases response is desirable.
  • No duty to discuss or negotiate, but usually advisable to meet with the activist and discuss the activist’s criticisms and proposals (company participants in any such meeting should prepare carefully with the company’s activist response team); no outright rejection absent study, try to learn as much as possible by listening and keep in mind that it may be desirable to at some point negotiate with the activist and that developing a framework for private communication may avoid escalation.
  • Generally no immediate duty to disclose; determine when disclosure may be required, or desirable.
  • Response to any particular approach must be specially structured; team should confer to decide proper response. Consider whether the activist’s claims or demands have merit and/or are consistent with the company’s own pending or proposed initiatives.
  • Keep board advised; in some cases it may be advisable to arrange for the activist to present its white paper to the board or a committee or subset of the directors.
  • Be prepared for public disclosure by activist and have public response contingencies ready in the event of any disclosure.
  • Be prepared for the activist to try to contact directors, shareholders, sell-side analysts, business partners, employees and key corporate constituencies. Make sure directors understand that any contacts should be referred to CEO or other designated officer.
  • Assess whether there are sensible business actions that can be taken or accelerated to preempt or undercut the activist attack and the extent to which the activist may attempt to publicly claim credit for such actions.
  • Consider whether negotiations with the activist and settlement should be pursued and at what point in time.

Response to Public Communication:

  • Initially, no response other than “the board will consider and welcomes input from its shareholders.”
  • Assemble team; inform directors.
  • Call special board meeting to meet with team and consider the communication.
  • Determine board’s response and whether to meet with activist. Even in public situations, consider pursuing disciplined engagement with the activist. Failure to meet may also be viewed negatively by institutional investors. Recognize that the activist may mischaracterize what occurs in meetings.
  • If the activist includes a demand – e.g., replace the Chair or CEO – that the board finds unacceptable or non-negotiable, it may be advisable to make the board’s position on that item clear earlier rather than later, even if there is willingness to consider and negotiate other aspects of the activist’s platform.
  • Avoid mixed messages and preserve the credibility of the board and management.
  • Continuously gauge whether the best outcome is to agree upon board change and/or strategic, business or other action in order to avoid (or resolve) a proxy fight.
  • Be prepared and willing to defend vigorously.
  • Recognize that a proxy fight will entail a meaningful time commitment from both management and directors, and work in advance to coordinate availability for key meetings with shareholders and proxy advisory firms.
  • Engage with other shareholders, not only the activist, to take investor temperature, solicit feedback and assess whether actions may (should) be taken by the company to secure support (if an activist identifies a legitimate issue, the company may propose its own plan for resolving any shortcomings that is distinct from the activist’s solutions).
  • Appreciate that the public dialogue is often asymmetrical; activists may make personal attacks and use aggressive language, but the company should not respond in kind.
  • Remain focused on the business; activist approaches can be very distracting, but strong business performance, though not an absolute defense, is one of the best defenses. When business challenges inevitably arise, act in a manner that preserves and builds credibility with shareholders. Maintain the confidence and morale of employees, partners and constituencies.
  • A significant number of major institutional investors are increasingly skeptical of activists and activist platforms even as they closely scrutinize targeted companies as well. Investors can be persuaded not to blindly follow the recommendations of ISS in support of a dissident’s proxy solicitation. When presented with a well-articulated and compelling plan for the long-term success of a company, investors are able to cut through the cacophony of short-sighted gains promised by activists touting short-term strategies. As a result, when a company’s management and directors work together to clearly present a compelling long-term strategy for value creation, investors will listen.

Martin Lipton
Steven A. Rosenblum
Karessa L. Cain
Sabastian V. Niles

 

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