GLOBAL LAW OFFICE Law Bulletin (June 2013).pdf · Case Study 33 The PRC Court ... Special Assets...

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GLOBAL LAW BULLETIN

English Version︱June 2013

LEGAL SERVICES TO CLIENTS WORLDWIDE SINCE 1984

环球律师事务所

GLOBAL LAW OFFICE

TABLE OF CONTENTS

Asset-backed Securitization

01 A Brief on Securities Companies’ Asset-backed Securitization Business Wei QIN

13 A Brief on Securitization of Credit Assets in China May Liu

Anti-monopoly

19 The Antitrust Filing of Establishment of JV Jinrong LIU/Sophia Hu

Labor Law

24 Brief Summary on Interpretation (IV) of the Supreme People’s Court of Several Issues on the Application of Law in Trial of the Labor Dispute Cases

Zhao LI/Wei CUI/Dingding LI

28 Analysis of Non-compete Clauses under the Most Updated Judicial Interpretation

Amy Dai

Case Study

33 The PRC Court Held That the Shareholders’ Right of First Refusal Shall Not Be Circumvented by Means of Indirect Share Transfers

Wu WANG

FEATURE: SECURITIES COMPANIES’ ASSET-BACKED SECURITIZATION BUSINESS

Global Law Bulletin︱June 2013

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On March 15, 2013, the China Securities Regulatory Commission (the “CSRC”) promulgated the Administrative Provisions on the Securities Companies’ Asset-backed Securitization Business, which signaled that the securities companies’ asset-backed securitization business (the “ABS Business”) under the supervision of the CSRC has shifted from the previous pilot stage to the regular supervision stage. During the pilot stage, the legal basis for the securities companies to conduct the ABS Business is the Guidance on Pilot Asset-backed Securitization of Securities Companies (For Trial) issued by the CSRC (No. [2009]224). The author has participated in the first batch of the pilot ABS Business, rendered legal opinions on the relevant ABS Business to the CSRC and the exchanges, and as a retained legal counsel, he also assisted multiple securities companies to succeed in setting up special assets management scheme (the “Special Scheme”), and issuing and listing the asset-backed security on the Shanghai Stock Exchange or the Shenzhen Stock Exchange. Currently, a number of the ABS projects for which the author is responsible are being examined by the CSRC or in preparation for approval. By this article, the author intended to brief the readers about the ABS Business from a lawyer’s angle and expected that the readers could benefit and get some enlightenment from this article. I. Overview of the ABS Business in China

The asset-backed securitization or ABS, as one kind of structured finances, means a technique or process enabling an array of assets (the “Assets” or “Underlying Assets”), which are capable of generating

predictable and stable cash flows income in the future, to be converted into certain securitization products via particular structural arrangement and coupling with corresponding credit enhancement, and which products can be traded on the financial market and possess certain credit rating. The ABS is an emerging product in the financial sector during the recent 30 years, and it evolved in the USA and developed rapidly in Europe, Japan, etc., and currently it spreads over worldwide in a quick speed. As to the ABS in China, since initially launched in 2004, it mainly consists of two systems: (i) one is the securitization of credit assets, which is originated by the banks and other financial institutions, and traded on the national inter-bank bond market upon the approval of the China Banking Regulatory Commission (the “CBRC”), and (ii) the other is the securitization of enterprises’ assets (including the state-run institutions’ assets), (the products of ) which are issued by the securities companies through a Special Scheme and in the form of ABS, and traded and listed on the Shanghai Stock Exchange or the Shenzhen Stock Exchange upon the approval of the CSRC. In addition, the insurance companies, fund management companies, trust companies and other institutions are also allowed to conduct the ABS Business in accordance with the relevant rules regulating such business in their respective sectors. Please see below a comparison between such two systems of ABS:

A Brief on Securities Companies’ Asset-backed Securitization Business

By Wei QIN



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Items CBRC System CSRC System

Applicable Rules Measures on Administration of Pilot

Credit Asset-backed Securitization

([2005] No. 7)

Administrative Provisions on the Securities Companies’

Asset-backed Securitization Business (No. [2013]16)

Originator Financial institutions Enterprise and/or state-run institutions

Issuer (SPV） Special purpose trust Special Scheme originated by the securities companies

Listing and Trading National inter-bank bond market Stock exchanges

Underlying Assets Limited to the credit assets of

financial institutions

Assets capable of generating stable cash flows, such as the

rights to claim repayment of debts and the rights to claim

proceeds generated by certain assets, etc.

Principal Investors Commercial banks, insurance

companies, etc.

Institutional investors like securities investment funds, social

security fund, securities companies, finance companies,

enterprises group, etc.

The Underlying Assets for the ABS Business include the rights to claim proceeds generated by the leases, the rights to claim highway tolls, the rights to claim receivables generated by the acquisition of assets, the rights to claim proceeds generated by the sale of electricity, the rights to claim receivables generated by the BT project of infrastructure construction, the rights to claim the proceeds generated by the disposal of urban construction sewage. The ABS can be sorted as two different types in accordance with the status of the Underlying Assets—securitization of existing assets and securitization of future assets. The securitization of existing assets lived in the form of contracts or agreements, such as various receivables, mortgage loans, etc., which reflect a

debt-credit relationship; thus, the securitization of existing assets, as a matter of fact, can be deemed to be “securitization of rights to claim repayment of debts” (or “securitization of creditor’s rights”). In contrast to the securitization of existing assets, the securitization of future assets is conditioned on certain legal rights, which could be a title or other rights to a particular property, such as the rights to claim highway tolls, thus in nature, it could be deemed to be one kind of “securitization of the rights to claim proceeds generated by a particular assets (or “securitization of rights of remuneration”). Set out below are some ABS products of securities companies issued and listed successfully up to date:

Asset-backed Security Issuer

(Originator)

Date of Issuance Total Issue Amount

(RMB/100 Million)

Maturity

(Year)

Securities Backed by Network Rental

Fees Charged by China Unicom

CDMA

China Unicom New

Space Co., Ltd.

Aug., 2005 95.00 2.7

Special Assets Management Scheme

of Dongguan-Shenzhen Highway

Rolls

Dongguan Development

Holdings Co., Ltd.

Dec., 2005 5.80 1.5

Securities Backed by China

Netcom’s Receivables

China Netcom (Group)

Co., Ltd.

Mar., 2006 103.10 4.68

Special Assets Management Scheme Far Eastern International May, 2006 4.77 2.4



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of Far Eastern’s First Tranche

Securities Backed by Leases

Leasing Co., Ltd.


of Charges for Electricity of

Huaneng Nancang River

Huaneng Nancang River

Hydropower co., Ltd.

May, 2006 20.00 5

Securities Backed by BT

Construction Project of Pudong

Shanghai Pudong

Construction Company

Limited by Shares

Jun., 2006 4.10 4

Securities Backed by Charges for

Disposal of Nanjing Urban

Construction Sewage

Nanjing Urban

Construction Holding

(Group) Co., Ltd.

Jul., 2006 7.21 4


of Securities Backed by

Nan-tong-tian Sale of Electricity

Nantong Tiansheng

Harbour Power Co., Ltd.

Aug., 2006 8.00 3


of Repurchase Price Paid on Jinagsu

Wuzhong BT Project

Jiangsu Wuzhong

International Trade

Group Co., Ltd.

Aug., 2006 15.88 5.31

Far Eastern Second Tranche Special

Assets Management Scheme

Far Eastern International

Leasing Co., Ltd.

Aug., 2011 12.79 1.90


of Securities Backed by Charges for

Disposal of Sewage

Nanjing Public Holding

(Group) Co., Ltd.

Mar., 2012 13.30 5


of Securities Backed by Overseas

Chinese Town’s Theme Park Ticket

Overseas Chinese Town

Co., Ltd.

Dec., 2012 18.5 3＋2


of ICBC Leasing

ICBC Financial Leasing

Co., Ltd.

Dec., 2012 16.3 2.25


of Minsheng Financial Leasing

Minsheng Financial

Leasing Co., Ltd.

Pending 19.02 1.75

II. Main Features of ABS Business

A. The ABS Business is one kind of direct financings but different from stock or bond, and its main features are as follows:

(a) The enterprise segregates certain profitable assets

capable of generating stable cash flows (from its total assets) and issues asset-backed security on the basis of such assets (namely, the Underlying Assets); and the investor will profit from the cash flows income generated by such Underlying Assets;

(b) The Special Scheme will purchase or use other lawful means to acquire the Underlying Assets; when the enterprise comes to bankruptcy, the Underlying Assets shall not be deemed to be the bankruptcy estate so as to achieve the “bankruptcy remote”;

(c) Different from the stock or bond, it will not

directly form a “financing relationship” between the financing enterprise and the investors. Instead, it is a pattern of structure finance, the financing enterprise will use its profitable assets to constitute the Underlying Assets and then acquire



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the funds by issuing and selling the asset-backed security to investors via the Special Scheme established by the securities companies and reimburse the principal and interest to investors from the proceeds in cash generated by the Underlying Assets;

(d) The asset-backed security has finite term and

stable rate of return and bears the nature of fixed-return products;

(e) The asset-backed security can be classified into priority classes and subprime classes so as to explicitly deliver the investors different risks v. returns. The priority class asset-backed security has the priority to participate in the distribution of the Underlying Assets.

B. Impacts of ABS on corporate accounting

Underlying Assets Creditor’s Rights Rights of Remuneration

Transfer of Risks and

Premium

The risks and premium can be transferred

to a full extent; for instance, the

originator or its mother company dose

not need to provide collateral or counter

guarantee.

The risks and premium

can be transferred to

some extent, and the

originator or its mother

company is still subject

to recourse against it.

The risks and premium

cannot be transferred.

Accounting Treatment Can be recognized as “true sale” Cannot be recognized as “true sale”

Off Balance Sheet (Y/N) Y N

Accounting record of receipt

of raised funds (not taking

into account such portion of

subprime class securities

subscribed by the originator)

Credit: Cash in bank

Debt: The item corresponding to the sale

of specific assets ( such as holding maturity investments or long-term bond

investment, accounts receivable)

Credit: Cash in bank

Debt: Long-term account payable

Main impacts on the financial ratios:

Debt/Asset Ratio 1. The debt/asset ratio will remain the

same upon the receipt of raised funds;

2. The amount of total debts and assets

will be simultaneously decreased upon

the repayment of the debts by using

the raised funds, as a result thereof,

the debt/asset ratio will be decreased

as well.

1. The amount of debts and assets will

simultaneously be increased upon the receipt of

raised funds, as a result thereof, the debt/asset

ratio will be increased as well;

2. The amount of total debts and assets will be

simultaneously decreased upon the repayment of

the debts by using the raised funds, as a result

thereof, the debt/asset ratio will be decreased as

well.

Liquidity Ratio/Quick

Assets Ratio

1. The liquidity ratio will be increased upon the receipt of raised funds;

2. The liquidity ratio will be subject to little change upon the repayment of current debts by using

the raised funds;

3. The liquidity ratio will be decreased to the original level upon the repayment of non-current

debts (on the assumption that the current assets and current debts remain unchanged).

All Capital Earnings

Ratio/Total Assets

Turnover Ratio

1. It will be decreased upon the receipt of raised funds;

2. It will be increased upon the repayment of debts by using the raised funds.



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（Note: The above dose not constitute our legal advice and professional opinions. Please refer to qualified accountants for specific advice and opinions.） III. Deal Structure of ABS Business of Securities

Companies

The deal structure of the ABS is composed of two parts: (i) transfer of assets and (ii) issuance of securities. As to the transfer of assets, the essential difference between the ABS and mortgage financing or other ways of financing is whether or not the “bankruptcy remote” can be achieved. Moreover, the true sale of the Underlying Assets and the establishment of the SPV (Special Purpose Vehicle) constitute the key point to fulfill the “bankruptcy remote”. The common steps of the ABS Business financing are as follows: (a) The securities companies set up the Special

Scheme and promote and sell the asset-backed security to domestic institutional investors;

(b) The securities companies use the funds raised

from the promotion of the asset-backed security to purchase the Underlying Assets which can generate predictable and stable cash flow (i.e., creditor’s rights or rights of remuneration) from the originator;

(c) Distribute the proceeds generated by the Underlying Assets to the asset-backed security holders.

Please see below the deal structure diagrams of (i) using the creditor’s rights as the Underlying Assets (Graphic 1) and (ii) using the rights of remuneration as the Underlying Assets (Graphic 2).

（Graphic 1: Deal Structure of Using the Creditor’s Rights as the Underlying Assets）



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(Graphic 2: Deal Structure of Using the Rights of Remuneration as the Underlying Assets)

IV. Comparisons Between Securities Company’s

ABS Business and Other Ways of Financing

The essence of the ABS is to raise funds by selling such kind of assets which are lack of liquidity but capable of generating predictable and stable cash flows, and its greatest utility is to improve profitability of the total assets, and acquire in one lump sum such

returns (i.e., cash flows) which would have been generated by the Underlying Assets in the next few years or future ten years; moreover, (under the ABS Business) the use of the raised funds is subject to less restrictions and the cost of financing is relatively low. Comparing to other ways of financing:

（Table One）

Items Medium-term

Notes

Corporate Bonds Enterprise ABS Bank Loans

Legal Basis Administrative

Measures for Debt

Financing

Instruments of

Non-Financial

Enterprises in the

Inter-bank Bond

Market

Trial Measures of

Issuance of

Corporate Bonds

Administrative

Provisions on the

Securities Companies’

Asset-backed

Securitization

Business

Measures on

Administration of Pilot

Securitization of Credit

Assets

Regulatory Agency National Association CSRC CSRC CBRC



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Items Medium-term

Notes

Corporate Bonds Enterprise ABS Bank Loans

of Financial Market

Institutional Investors

Examining and

Approving Agency

National Association

of Financial Market


CSRC CSRC Lending Bank

Time Period for

Examination and

Approval

2－3 months 2－3 months 2 months 1－2 months

Trading Market Inter-bank market Stock Exchanges Stock Exchanges /

Investors Banks, insurance

companies

Funds, insurance

companies

Securities dealers,

funds, insurance

companies

/

Cost of Financing Low Low A bit low A bit high

Issuer Financial institutions,

enterprises

Listed companies

(include companies

listed abroad)

Various enterprises Various enterprises

Scale of Issuance Shall not exceed 40%

of the net assets.

Shall not exceed 40%

of the net assets.

Per the discounted

future cash flows

Restricted by the

enterprises’ loan-deposit

ratio

Use of Proceeds Few restrictions on

use

Few restrictions on

use

Few restrictions on

use

The use of proceeds shall

be subject to national

policies and supervised by

banks.

Advantages Speedy approving

process and low

interest

The scale of issuance

dose not take into

account the amount

of short-term and

medium-term notes.

The scale of issuance

and the rating are not

subject to the entities’

credit and debt-paying

ability; the transferred

Underlying Assets can

be “off balance

sheet” under certain

conditions, and thus

the debt ratio will not

be increased.

Speedy approving process

Disadvantages The scale of issuance

is restricted.

Policies inclined to the

listed companies.

Shortfall in liquidity,

and the cost of

financing is high.

Focus on short term loans,

the cost of financing is

high, and the scale of

issuance is restricted.



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（Table Two）

Items Insurance Credit

Plan

Trust Plan Asset-backed Notes Corporate Asset-backed

Securitization

Legal Basis Interim Provisions on

the Management of

Infrastructure

Investment Plan

Administrative

Measures for

Collective Investment

Trust Schemes of

Trust Companies

Administrative

Measures for Debt

Financing

Instruments of

Non-Financial

Enterprises in the

Inter-bank Bond

Market

Administrative Provisions

on the Securities

Companies’ Asset-backed

Securitization Business

Regulatory Agencies China Insurance

Regulatory

Commission (the

“CIRC”)

CBRC People’s Bank of

China

CSRC

Examining and

Approving Agencies

CIRC CBRC’s local

counterparts

National Association

of Financial Market


Stock Exchanges and

CSRC

Approving System Examining and

approving system

Filing system Registration system Examining and approving

system

Speed of Examining

and Approving

Fast Fast Fast Fast

Trading Market Qualified financial

assets exchanges

No public market Inter-bank bond

market

Bulk trading platform of

exchanges.

Investors Insurance companies Trust companies Banks, insurance

companies, funds

Securities dealers, funds,

insurance companies

Cost of Financing Low High Low Low

Subject of Financing Assets of

infrastructure project

The entities in real

estate and city

investment companies

are restricted.

The entities in real

estate and deputy

provincial city

investment platform

are restricted.

The entities in real estate

are restricted.

Trustee Insurance assets

management

companies

Trust companies / Securities companies

Scale of Issuance No restrictions to the

ratio of net assets

No restrictions to the

ratio of net assets

No restrictions to the

ratio of net assets,

and per the

discounted future

cash flows

No restrictions to the ratio

of net assets, and per the

discounted future cash

flows

Advantages The time period for

approval is short, the

The funding cycle is

short, and the

The time period for

approval is short, and

The transferred Underlying

Assets can be “off balance



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Items Insurance Credit

Plan

Trust Plan Asset-backed Notes Corporate Asset-backed

Securitization

cost of financing is

low, and the various

fees incurred by the

issuance are borne by

the trsutor or the

trustee.

products portfolios

are flexible

the pledge, repurchase

(including buyout

repo) are permitted.

sheet” under certain

conditions, thus the debt

ratio will not be increased;

and the subjects of

financing are less

restricted.

Disadvantages The issuers are

limited—only a

portion of qualified

insurance assets

management

companies are allowed

to conduct such

business.

No liquidity, high cost

of financing, the

deduction of net

capital are strictly

controlled, and

subject to regular

policy regulations

The current deal

structure is similar to

collateral financing,

and the Underlying

Assets cannot be “off

balance sheet”

Strict approval process,

high requirement on the

legality of the Underlying

Assets and the ownership

of the cash flows.

V. Operating Process of Securities Companies’

ABS Business Here, we take the creditor’s rights to accounts receivables generated by BT project as an example to introduce the relevant operating process of ABS Business. “BT” is an abbreviation of “Build-Transfer”, to which currently there is no clear legal definition in China. Under which, the construction entity (generally, the government agencies) will invite the investment entity to invest in the construction project via a BT cooperation agreement (the “BT Agreement”), then the investment entity injects the funds to construct by itself or by using the construction contracting enterprise, after completion of the construction project, the construction entity will buy back the construction project in accordance with the BT Agreement. On Feb. 13, 2003, the Ministry of Construction of the PRC issued a document (No. [2003]30) to encourage the use of BT to operate the construction project. The financing process of the ABS of BT project is as follows:

(a) Identify and determine the Underlying Assets. The investor will have the rights to claim the payment against the government agencies in accordance with the BT Agreement, under which the government agencies must transfer and pay the repurchase price and the promised interest to the investor’s bank account on the date of maturity. Thus, the steady cash flows (i.e., the repurchase price paid by the government agencies) generated by the BT project will form the investor’s Underlying Assets. In the event that there isn’t a BT Agreement signed in advance, it can be otherwise agreed that, after the completion of the government agencies’ construction project, the government agencies can repurchase the project on installments made by the city investment companies or urban construction companies owned by the government agencies so as to form the future stable cash flows.

(b) Set up special purpose vehicle (the “SPV”). The

originator shall transfer the Underlying Assets to the SPV. And the SPV, at a position between the originator and the investors, plays a key role in the course of ABS by conducting a series of following businesses: purchasing the Underlying Assets, integrating the cash flows, dealing in the



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credit enhancement and rating, collateralizing and issuing the securities, etc. According to the CSRC’s relevant rules, it is required that the Special Scheme set up by the securities company to act as the SPV under the current mode of ABS financing.

(c) Credit Enhancement. The ABS pose certain

inherent risks to the investors as the returns on the asset-backed security are dependent on whether or not the future cash flows yielded by the Underlying Assets can be smoothly achieved. However, the credit enhancement can upgrade the credit rating, improve the issuance conditions and reduce the financing cost.

(d) Credit Rating. The credit rating agencies will evaluate the cash flows yielded by the Underlying Assets so as to evaluate the securities proposed to be issued upon the credit enhancement. The credit rating agencies shall need to do the follow-up monitoring and from time to time to make adjustment to the rating in accordance with any variation in the quality of assets credit.

(e) Sale and Issuance of Securities. The SPV, acting

as the issuer, will sell and issue the asset-backed security to the investor via various financial institutions like banks or securities underwriters, etc.

(f) Management of and service to the assets pool.

The SPV needs to manage the assets pool and accordingly have the responsibilities to collect and record the cash revenues generated by the assets pool, and transfer and deposit all such revenues into the trustee bank or special bank account designated in advance so as to pay the principal and interests to the investors on time.

(g) Liquidation. As agreed upon at the time of

issuing the securities, when the asset-backed security become mature, after the payment of the principal, interests, and various service fees from

the revenues generated by the assets pool, if there are any remaining revenues, which revenues can be distributed between the originator and the SPV.

VI. Recent Trends of CSRC’s Examination and

Approval

A. Supervising Principles adopted by the CSRC (a) Strictly control the speed of examining and

approving; the project options and the use of the raised funds shall be in line with the country’s economic policies and conforming to the characteristic and nature of ABS;

(b) The securities companies shall proceed the ABS

Business on the basis that the related risks should be assessable, controllable and sustainable; the risk control shall penetrate each step of the ABS Business; and there should be back-up plans, emergency plans and progressing monitoring;

(c) The ownership of the Underlying Assets of the

pilot project shall be clear of any doubt; the rights and obligations of each related parties shall be undisputable; the content of the relevant contracts shall be lawful and valid; and the deal structure shall be in compliance with the applicable laws, regulations and rules;

(d) The Underlying Assets should be in high-quality

and capable of generating continuous, stable, true, predictable cash flows, and cannot be the non-performing claims. The transfer of the Underlying Assets should be in compliance with the principle of “true sale” ;

(e) The project of ABS shall be equipped with

external credit enhancement measures to protect the investors’ interests to a feasible extent.

B. Application documents



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(a) A written application； (b) Draft statements on the Special Scheme； (c) Drafts of principal transaction contracts; (d) Written legal opinion; (e) The originator’s audited financial and accounting

report over the past three years (in the case that the originator has been in operation for less than three years, then the report of the past period commencing from the date of establishment will suffice); and

(f) Other materials requested by the CRSC. C. Content of legal opinion (a) The qualifications and authority of the manager,

sales institutions and the custodian; (b) The legality of the statements on the Special

Scheme, the asset transfer agreement, the custody agreement, the subscription agreement and other legal documents;

(c) The authenticity, legitimacy and validity of the Underlying Assets, their ownership and any encumbrance thereon;

(d) The legality of the transfer of the Underlying Assets;

(e) The legitimacy and effectiveness of the credit enhancement arrangements of the Special Scheme; and

(f) Opinions on other material matters that may affect the interests of the asset-backed security investors.

VII. Re-analysis of Other Legal Issues

As a creative product of structured finance, there are many legal issues as to the ABS worth discussing and analyzing. Although a lot of such issues have been resolved in practice, there still plenty of issues are not fixed yet. Since this article intended only to do a brief introduction, we will not take a long page to discuss those pending issues. A. Trust relationship and entrusting relationship

The CSRC once defined the relationships between the parties involving the ABS Business as “trust relationship” in its prior drafts for public comments, and defined the Underlying Assets as the “trust assets”. However, the above definitions are finally abandoned as they are in conflict with the existing Trust Law, Management Measure on Trust Companies, etc., also, due to the CSRC’s failure to coordinate with the CBRC. Therefore, the prevalent view as of the date hereof is that the legal relationships between the parties involving the ABS Business are “entrusting relationship plus joint ownership”. B. Legal status of SPV As the SPV in the financing structure of ABS Business is the Special Scheme established by the securities companies, its legal status is still subject to further clarification. C. True sale and bankruptcy remote The “true sale” is treated not as the same in each of legal, accounting and taxation respects. The “true sale” in accounting area refers to that “the assets sold out shall cease to be recognized in the balance sheet after the completion of the transfer, and the funds received shall be recognized as the income generated by such transfer, and the relevant loss and profit shall also be recognized, that is to say, the assets sold out shall be “off balance sheet”. To define the “true sale” in taxation area is to make judgment on whether the activities of transferring assets are taxable. With respect to the legal perspective, the “true sale” refers to the true transfer of assets occurred between two legal entities (the seller and the buyer), moreover, such transfer should not be revoked or declared to be invalid, and it should not be subject to the creditors’ recourse so as to achieve the bankruptcy remote. Up to date, there have been no breach occurred as to



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such structured finance, that is to say, there have been no dispute finally resolved by the courts. We will keep an eye on whether there will be any lawsuit adjudicated by the courts in the future.

(This article was originally written in Chinese, and the English version was translated by Mr. Wu WANG, a senior associate with Global Law Office.)

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

Tel: (86 10) 6584 6665

Fax: (86 10) 6584 6666/6677

E-mail: [email protected]

Mr. Qin Wei is a partner of Global Law Office. Mr. Qin is also an independent director of Huabei Expressway (Stock Code: 000916). Mr. Qin positions his professional service mainly in areas including M&A, restructuring, reorganization of companies (entities); equity financing (IPO, PE, etc.) and debt financing (convertible bonds, enterprise bonds, corporate bonds, short term financing bills, etc.); ABS; private equity financing, etc. Up to now, Mr. Qin has provided efficient and quality legal service to the restructuring, reorganization, private equity financing and IPO of dozens of enterprises including state-owned enterprises and institutions, collectively-owned enterprises and foreign invested enterprises. Representative cases:restructuring, reorganization and IPO of Huatai Securities (Stock Code: 601688 ); restructuring, reorganization and IPO of Changhai (Stock Code: 300196). In addition to the above, Mr. Qin also provided comprehensive legal consulting services to the bond issuance, ABS, private equity financing, M&A, reorganization, RTOand IPO of Yueyang City Construction and Investment Co., Ltd, Suzhou Amusement Land, CITIC Trust, Bank of Dalian, Huaxi Village Group, XCMG, Wuhu Yangtze River Bridge, CITIC Securities, Guolian Trust.

FEATURE: SECURITIZATION OF CREDIT ASSETS IN CHINA


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I. Types of Asset Securitization Businesses in

China

In China, there are currently existing two types of asset securitization businesses: (i) one is the securities companies’ asset-backed securitization business, which uses the special assets management scheme as the special purpose vehicle and is supervised by the China Securities Regulatory Commission (the “CSRC”) and mainly traded on the fixed income platform of Shanghai Stock Exchange and the comprehensive protocol platform of Shenzhen Stock Exchange and (ii) the other is the credit asset securitization business, which is supervised by the China Banking Regulatory Commission (the “CBRC”) and the People’s Bank of China (the “PBOC”) and mainly traded on the asset-backed commercial paper platform (which platform is under the charge of National Association of Financial Market Institutional Investors), and the trust companies play a role of trustee institutions in the course of the securitization of credit assets. II. Participating Parties to Securitization of

Credit Assets

The securitization of credit assets refers to an activity of structured finance, under which the banking financial institutions (the originator) will entrust the credit assets to the trustee institutions, and then such trustee institutions will issue and sell the beneficiary securities to the investment institutions in the form of asset-backed security (the “ABS”) and will use the cash derived from such credit assets to pay the returns on the ABS.

A. Originator (acting as the trustor): It shall be the banking financial institutions;

B. Trustee Institutions (acting as the trustee)/Issuer:

Generally, it shall be the trust companies; C. Loan Service Providers: Generally, it shall be the

originator; D. Fund Depository Institutions: Generally, it shall

be the banks, but it shall not be either the originator or the loan service providers at a same deal;

E. Securities Registration and Custodian Agencies:

it shall be the Inter-bank Market Clearing Company Limited by Shares (namely, Shanghai Clearing House);

F. Underwriters: It must be an underwriting group

and each of which must be a financial institution;

G. Investment Institutions (namely, the holders of

ABS): the following approved and qualified non-banking institutional investors are encouraged to invest in the ABS: insurance companies, securities investment funds, enterprise annuity funds, national social security fund, etc. For each single ABS product, a banking financial institution shall not, in principle, purchase or hold a percentage of ABS greater than 40% of the total ABS issued therefor.

A Brief on Securitization of Credit Assets in China

By May Liu



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III. Types of the Underlying Assets for

Securitization of Credit Assets

Financial institutions are encouraged to use the following credit assets as the underlying assets for securitization of credit assets so as to enrich the types of underlying assets for credit asset securitization: loans to major national infrastructure projects, agriculture-related loans, loans to small and medium-sized enterprises, loans to local government financing vehicles that are in compliance with the law after clean-up, loans for energy conservation and emission reduction, auto loans and other diversified credit assets that meet relevant requirements. A product of credit asset securitization shall be simple and clear in structure. Pilot programs on re-securitization and synthetic securitization are not allowed during the current round of expansion. IV. Process of Securitization of Credit Assets

A. Restructure the cash flows and assemble the securitized assets

The originator will (i) set the goal of asset securitization per its financing needs; (ii) clean up, estimate and assess its credit assets capable of generating future cash flows; (iii) conclude its primary judgment on the average degree of the whole portfolios’ cash flows; (iv) assess the borrower’s credit and the market value of the collateral for the extended loan, etc.; (v) assemble the assets of receivables and predictable cash flows; (vi) restructure the cash flows in accordance with the structure of maturities, and the rearrangement of the principal and interest or reallocation of the related risks; and (vii) identify the targeted assets per the goal of asset securitization and pool these assets. B. Set up a special purpose trust (the “SPT”) to

fulfill true sale of credit assets and achieve the bankruptcy remote

The originator will set up a SPT and transfer the

securitized assets (as the trust assets) to a trustee institution through the SPT. Then, the trustee institution will issue the ABS. C. Improve the deal structure and enhance the

credit rating [The trustee institutions will] take a series of the following steps to improve the deal structure of asset securitization: (i) conclude the loan service contract with the loan service institution for assets pool, (ii) sign the custody contract with the custodian bank, (iii) reach the revolving credit agreement with the banks for liquidity support in necessary time, (iv) enter into the underwriting agreement with the underwriter, etc. At the same time, after conducting certain risk analysis to the securitized assets, the SPT must conduct the risk restructuring for particular portfolio assets, and make up for the predictable losses by using additional source of cash flows to reduce the predictable credit risk and enhance the credit rating of the ABS. D. Credit rating of asset securitization The credit rating of the ABS serves as an investment basis for the institutional investors and thus constitutes a vital part of the asset securitization. Two duly qualified credit rating institutions shall be engaged to make the initial credit rating and the follow-up credit ratings for the issuance and trading of the ABS on the national inter-bank bond market, and pursuant to relevant rules and policies, the credit rating report shall be submitted to the financial regulatory agencies when applying for issuance of the ABS. E. Arrange for sale of securities and payment to the

originator After the enhancement of the credit and the announcement of the rating result, the underwriter shall be responsible for the sale of ABS to the institutional investors. The sale of the securities



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could be either by a firm commitment or by proxy. After the SPT receives from the underwriters the revenues generated by the sale and issuance of the securities, the SPT will pay and deliver a large part of the revenues to the originator. Thus, the originator’s financing purpose will have been achieved. For each single credit securitization scheme, the originator shall hold a certain percentage of the most junior class (or the equity class) ABS for a period not less than the term of the equity class securities, and which percentage shall be, in principle, not lower than 5% of total ABS issued for such securitization scheme. F. Listing and trading Within two months following the consummation of issuance of ABS on the national inter-bank bond market, the trustee institutions may apply for listing and trading of the ABS on the national inter-bank bond market to fulfill the liquidity of the ABS. G. Payment on time The trustee institutions will manage the assets pool and accordingly have the responsibilities to collect and record the cash revenues generated by the assets pool, and further distribute such revenues to the investors on time. V. Principal Legal Documentation

A. Trust Contract Contracting parties: (i) the originator acting as the trustor and (ii) the trustee institution acting as the trustee; Main content: (i) the originator transfers the securitized assets (as the trust assets) to the trustee institution (the trust company) and receives transfer price generated by the sale and issuance of the ABS; and (ii) the trustee institution (acting as the trustee)

shall have the right to manage, use and dispose of the trust assets, convene the meetings of the securities holders, and engage the underwriters to underwrite the securities. B. Fund Depository Contract Contracting parties: trustee institution (the trust companies) and fund depository institution (the banks); Main content: (i) the trustee institution opens a trust account (with the depositor and) in the name of SPT and delivers instructions with respect to the trust account in accordance with the Trust Contract; and (ii) the fund depository institution monitors the trustee’s instructions. C. Loan Service Contract Contracting parties: trustee institution (trust company) and loan service provider; Main content: the loan service provider (i) offers loan service and management per the trustee’s instructions, receives the principal and interest of the loan and transfers such to the trust account, and (ii) periodically provides the trustee institution with the assets management report, and puts forward solutions to the borrower’s breach of contract. D. Managing Underwriter Agreement Contracting parties: trustee institution (trust company), the originator, and the managing underwriter; Main content: (i) the trustee institution engages the underwriters to underwrite the ABS; and (ii) the managing underwriter should assist in setting up an underwriting group. E. Underwriting Group Agreement



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Contracting parties: the managing underwriter and other underwriters.

VI. A Diagram Illustrating the Deal Structure of Credit Assets Securitization

VII. Approval Procedure

A. Approval for Qualification. The trust investment company shall apply to the CBRC for SPT qualification.

B. Approval for securitization of credit assets. The

originator and the trustee institution shall submit a joint application to the CBRC for approval of the securitization of specific credit assets.

C. Approval for issuance of ABS. The trustee institution (the trust companies) shall submit an application to the PBOC for approval of the trading of ABS on national inter-bank bond market.

D. Approval for trading of ABS. Within two months following the consummation of issuance of ABS on the national inter-bank bond market, the trustee institution may apply to the CBRC for

listing and trading of the ABS on the national inter-bank bond market.

VIII. Registration and Custody The issuer shall register the ABS with the Inter-bank Market Clearing Company Limited by Shares (namely, Shanghai Clearing House). IX. Taxation

A. Stamp Tax: Exempted temporarily. B. Business Tax

(a) 5% business tax shall be levied on the entire interest income received by the trustee institution and derived from the trust project of the credit assets managed by the trustee institution.

(b) In the course of securitization of credit assets, 5%

business tax shall be levied on the following



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income: (i) the service fees received by the loan service institutions, (ii) the commissions received by the trustee institutions, (iii) the custody fees received by the fund depository institutions, (iv) the trustee fees received by the securities registration and custodian agencies, and (v) other service fees received by other institutions offering services for the trading of ABS.

C. Income Tax (a) 25% income tax will be levied on such proceeds

acquired by the originator and gained from the transfer of credit assets.

(b) As to such portion of proceeds generated from

the trust project and distributed to the institutional investors, in the trust stage, the income tax is temporarily exempted thereon;

As to such portion of proceeds generated from the trust project but not distributed to the institutional investors, in the trust stage, the income tax shall be paid by the trustee institutions in accordance with the PRC Law on Enterprise Income Tax (the “Enterprise Income Tax Law”);

As to such proceeds for which the income tax has been paid in the trust stage, when they are distributed to the institutional investors, the institutional investors shall deal with such proceeds in accordance with the provisions relating to after-tax income under the Enterprise Income Tax Law.

(c) In the course of securitization of credit assets, 25% income tax shall be levied on the following income: (i) the service fees received by the loan

service institutions, (ii) the commissions received by the trustee institutions, (iii) the custody fees received by the fund depository institutions, (iv) the trustee fees received by the securities registration and custodian agencies, and (v) other service fees received by other institutions offering services for the trading of ABS.

(d) During the exemption period [for the distributed

proceeds mentioned above in paragraph C(b)(i)], the institutional investors shall recognize such investment returns generated from the trust project as taxable income in accordance the accrue basis accounting principle, and calculate and pay the income tax in accordance with the Enterprise Income Tax Law.

The institutional investors shall calculate and pay the income tax for earnings acquired by them form the trading of ABS in accordance with the Enterprise Income Tax Law; and the losses sustained or suffered by the institutional investors by reason of the ABS trading shall be deductible in accordance with the Enterprise Income Tax Law. The institutional investors shall calculate and pay the income tax for proceeds acquired by them form the liquidation of the trust project in accordance with the Enterprise Income Tax Law; and the losses sustained or suffered by the institutional investors as a result of the liquidation of the trust project shall be deductible in accordance with the Enterprise Income Tax Law.

(This article was originally written in Chinese, and the English version was translated by Mr. Wu WANG, a senior associate with Global Law Office.)



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

Tel: (86 10) 6584 6789

Fax: (86 10) 6584 6666/6677


May Liu is a partner of Global Law Office. May Liu assisted many international and PRC companies in connection with their actives of mergers & acquisitions, foreign direct investment, general banking, international syndication, acquisition financing, project financing, trading financing, aircraft and shipping financing, real estate financing, private equity/venture capital investment and capital markets. In addition to the traditional industries such as finance, real estate, mines and energy, power, chemical, Xuemei Liu has also served companies in the new industries of telecommunications, medical, high-technology, new energy and etc.

FEATURE: ANTITRUST FILING OF ESTABLISHMENT OF JOINT VENTURE


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Currently, China’s legal system of antitrust filing has been preliminarily built up and being a progress to be more equipped. According to the statistics recently released by the Ministry of Commerce of the People’s Republic of China (the “MOFCOM”), since the implementation of Anti-Monopoly Law of the People’s Republic of China (the “Anti-Monopoly Law”) on August 1, 2008, the MOFCOM has received, in total, 698 applications for antitrust filings by the end of March 2013, among which 627 have been accepted for antitrust investigations (the “Accepted Cases”) and among the Accepted Cases, 579 cases on which the antitrust investigations have been completed (the “Closed Cases”). Further, among the Closed Cases, 562 cases were approved unconditionally, accounting for 97.1% of the total Closed Cases, 16 cases was approved conditionally, and only 1 case was not approved (to implement the concentration of undertakings). In the mean time, however, either from the law perspective or from the practice perspective, it is still not clear as to certain types of transactions on whether they are required to do the antitrust filings. And the establishment of joint venture (the “JV”) is just one of such types. This article attempted to analyze and discuss certain legal issues regarding the antitrust filing of establishment of JV based on the relevant PRC laws and regulations, our own project experiences and the interpretations made by the Anti-monopoly Bureau of MOFCOM (the “Anti-monopoly Bureau”).

I. Common Misunderstandings

In practice, to determine whether an antitrust filing with the MOFCOM will be required for a proposed transaction, we have to do the following two tests: (i) determine whether the proposed transaction constitutes a “concentration” under the Anti-monopoly Law (the “Concentration Test”) and (ii) assess whether the turnover threshold for antitrust filing is triggered (the “Turnover Test”). According to our project experiences, the common misunderstandings on the antitrust filing of establishment of JV are as follows: Misunderstanding 1: There is no need to do the antitrust filing because the establishment of JV does not constitute a “concentration” under the Anti-monopoly Law. Misunderstanding 2: There is no need to do the antitrust filing because no relevant market can be defined on the ground that there is no overlap of relevant markets between the relevant parties (e.g., a new JV established by a real estate company and a private equity investment company). Misunderstanding 3: There is no need to do the antitrust filing because the surviving period of the JV is so short that it won’t have any influence on the relevant market. Misunderstanding 4: There is no need to do the antitrust filing because the turnover threshold will not be triggered on the ground that the turnover of the JV is nil at the time of its establishment.

The Antitrust Filing of Establishment of JV

By Jinrong LIU / Sophia Hu



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II. Concentration Test

A. Relevant Rules According to Article 20 of the Anti-monopoly Law, each of the following circumstances will constitute the concentration of undertakings: (a) merger or consolidation of undertakings; (b) the undertakings obtain the control over other

undertakings by acquiring their shares or assets; and

(c) the undertakings obtain the control over other

undertakings or is capable of exercising decisive influence on other undertakings by contracts or other means.

As can be seen from the above Article 20, it is not explicitly indicated whether the establishment of JV constitutes a “concentration” under the Anti-monopoly Law. B. Our understanding and the MOFCOM’s Point

of View Though, the Anti-monopoly Law dose not specifically provide that the establishment of JV constitutes a “concentration”, we understand that if the JV is an enterprise jointly established and controlled by two or more entities1, then the establishment of which shall fall into the scenario of “the undertaking obtains the control over other undertakings by acquiring their shares or assets” in Article 20 of the Anti-monopoly Law and thus constitute a “concentration” under the Anti-monopoly Law. Needs to be addressed here that, according to the MOFCOM’s interpretations, the JV for which the antitrust filing may be required only refers to such JOINTLY CONTROLLED by two or more entities. 1 As for the definition of JV, please refer to “the definition of

full function JV based on merger European Commission Decision of merger control NO.4064/89”.

Obviously, the joint control is one of the key points to determine whether the establishment of JV will constitute the concentration of undertakings (the “Joint Control Test”). C. Joint Control Test It appears that the joint control is easily to be identified, but as there is no definition under the Anti-monopoly Law, in practice, it will still need to do multi-angle analysis to determine the joint control. In light of our multiple project experiences, currently, the legal basis for determining the “controlling position” is No.33 of the Accounting Standards for Enterprises—Consolidated Financial Statements. In addition, Mr. Zhicheng CUI, an official of the MOFCOM, interprets the “controlling position” in respect of concentration of undertakings as follows2: “Controlling position” refers to the power that can determine the strategic business activities of an undertaking, or to exercise strong and decisive influence on an undertaking’s major decisions. The scope of an actual controller is wider than that of a controlling shareholder, and the actual controller and the controlling shareholder can be different persons. “The power to exercise strong and decisive influence” includes the power to veto the strategic business activities of an undertaking. “Strategic business activities” include the appointment of investment or management officers, financial budget, business plans, major investments and other special market rights. Generally, the following factors will be taken into consideration when defining a “controlling position”: (a) The ownership structure of the controlled

undertakings; (b) The composition of shareholders’ meetings and 2 Please refer to “Antitrust filing, case-opening and

consultation written by Mr. Zhicheng Cui, official of MOFCOM published on EU competition law website.



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board of directors, matters subject to votes of shareholders’ meetings and board of directors, and voting mechanism;

(c) The nomination and appointment of officers;

and whether the shareholders constitute the “persons acting in concert”, etc. ;

(d) Veto right: Generally speaking, the minority

shareholders will not be deemed to have control over a JV if such minority shareholders only have veto rights with respect to certain “protective matters”, such as any amendment of the JV’s articles of association, any increase or decrease of the JV’s capital, etc. However, if (i) the minority shareholders have veto rights to certain matters relating to the JV’s business policies and strategic decisions, and (ii) such veto rights go beyond that commonly entitled to the minority shareholders for them to protect their financial interests in the JVs, further (iii) such veto rights relate to each aspect of the JV’s manufacturing and operation and the minority shareholders can exercise decisive influences on the JV’s manufacturing, operation and management, then such minority shareholders shall be deemed to have control over the JV. In general, a veto right with respect to the following matters will result in a joint control: appointment of directors, adoption of business plans, making important investments, approval of budget, exercise of special market rights, etc.

In conclusion, it needs to do a comprehensive evaluation to determine whether the various rights and contacts or other means, by which the minority shareholders could exercise strong and decisive influence on a JV’s major decisions, will enable the minority shareholders to be deemed to have a joint control over the JV. To sum up, the Joint Control Test is a critical point because the antitrust filing will only be trigged if the JV is jointly controlled. If the JV is solely controlled

by one business operator, this transaction does not need to do the antitrust filing, as in this scenario, the undertakings involved in this transaction are not so closely coordinated with each other that the influence of which on the relevant market will be extremely limited. III. Turnover Test

According to the footnote of the Notification Form on Anti-monopoly Review of Undertakings Concentration (as revised), promulgated and implemented by the Anti-monopoly Bureau on June 6, 2012, when a JV is proposed to be established, the undertakings which will have joint control over the JV upon its establishment (the “Joint Controller”) shall be deemed to be the participators in this concentration while the JV itself is not a participator. Thus we only need to see if the turnover of Joint Controllers exceeds the notification threshold. Particularly, the turnover of the participators shall be calculated in accordance with Article 5 of the Measures for Notification of Undertakings Concentration, which means the entire turnover of the whole group of undertakings shall be included. In practice, if some subsidiaries, sub-subsidiaries, grandson companies and SPV of large groups and multinational corporations are concentration participators, the Turnover Test shall be based on the consolidated turnover of the participators’ whole mother group, which means some minor behaviors of large undertakings may trigger antitrust filing. Therefore, if the turnover of Joint Controllers exceeds the notification threshold, the MOFCOM shall be notified of the establishment of JV. So far, there have been 3 cases in which new establishment of JVs were approved with additional restrictive conditions by the MOFCOM.



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IV. Legal liabilities of Failure to Notify the

Establishment of JV

Based on the Anti-monopoly Law and relevant regulations, the legal liabilities of failure to notify the concentration of undertakings (including the establishment of JV) are as follows: First, the undertakings shall not implement concentration before the antitrust filing has been accomplished in accordance with Article 25 of the Anti-monopoly Law. Otherwise, even if the concentration has been completed, which shall be deemed to have no legal effect. According to Article 48 of the Anti-monopoly Law, where the undertakings implement the concentration in violation of the Anti-monopoly Law, the competent authority shall instruct them to discontinue such concentration, and within a specified time period to dispose of their shares or assets, transfer the business and take other necessary measures to return to the state prior to the concentration, and it may impose on them a fine of not more than RMB500,000. Although there are no heavy fines here, the authority still has the power to force the participating undertakings to return to the state prior to the concentration and thus the parties’ interest of the transaction may face great uncertainties once the failure of antitrust filing. Second, on December 30, 2011, the Interim Measures for the Investigation and Handling of the Failure to Notify Concentration of Undertakings in Accordance with the Law was promulgated and it stressed and reaffirmed the punishments for not notifying concentration of undertakings in compliance with the law. The specific measures are as follows: (i) the MOFCOM shall initiate a case investigation if it suspects that the undertakings fail to notify concentration in compliance with the law; and (ii) where the investigation finds that the undertakings under investigation have executed concentration without making a notification in accordance with the law, the MOFCOM may impose a fine of no more than RMB 500,000 on the undertakings under investigation, and

may order the same to take the following measures to restore to the pre-concentration status: stop the execution of concentration; dispose of shares or assets by a specified deadline; transfer certain business operations by a specified deadline; and/or take other necessary measures. Third, according to our experiences in several related projects, the MOFCOM paid special attention to (i) the notifying parties’ recent-year performance in relevant market and (ii) the legality of notifying parties’ presence in China. When the undertakings notify the MOFCOM of a proposed concentration other than an establishment of JV, the MOFCOM may ask the notifying parties to provide certain information regarding such JVs previously established in China by the notifying parties, including but not limited to the establishment time of the JVs, whether or not the notification has been made for the JVs in compliance with the law, etc. Thus, if the notifying parties did not make the antitrust filing for any specific deal in compliance with the relevant laws, there is a likelihood that the notifying parties may suffer punishments once the MOFCOM or its local counterparts dig out that in the future in the process of examining and approving the project of foreign investment and the project of undertakings concentration in connection with such notifying parties, and which case will have an adverse effect for the notifying parties’ on-going project, which needs to be approved by the MOFCOM or its local counterparts. V. Conclusion

In conclusion, it is advisable for the concerned parties to be cautious in dealing with the antitrust filing for the establishment of JV. In addition, from the above analysis, it can be concluded that the notification of establishment of JV shall be made only if it is jointly controlled and the turnover of Joint Controllers exceeds notification threshold. If the JV is solely controlled by one party,



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there will be no change of control as it only amounts to establishing a subsidiary with several other shareholders.

(This article was originally written in Chinese, and the English version is a translation.)

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

Tel: (86 10) 6584 6699

Fax: (86 10) 6584 6666/6677


Mr. Liu is the managing partner of Global Law office and a member of Beijing Municipal Committee of Chinese People’s Political Consultative Conference. Mr. Liu specialized in capital markets, M&A, PE/VC and taxation. Mr. Liu has advised on more than 50 equity and debt offerings on both domestic and overseas capital markets (Hong Kong Stock Exchange, NASDAQ, New York Stock Exchange, Singapore Exchange, London Exchange and Toronto Stock Exchange). Industries in which he has been involved include manufacturing, Internet, hi-tech, energy, resources, telecom, financial services, shipping, real estate, retail, media, infrastructure, utilities and pharmaceutical, etc.

Tel: (86 10) 6584 6702

Fax: (86 10) 6584 6666/6677


Sophia Hu is a competition lawyer in Global Law Office ever since 2011 and graduated from China University of Political Science and Law, majored in economic law.

FEATURE: NEW INTERPRETATION ON APPLICATION OF LAW IN TRIAL OF THE LABOR DISPUTE CASES


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On 1st February, 2013, Interpretation (IV) of the Supreme People’s Court of Several Issues on the Application of Law in Trial of the Labor Dispute Cases (the “Interpretations (IV)”) became effective. The provisions thereunder mainly cover the following aspects: (i) labor dispute mediation and arbitration, (ii) consolidation of the former employment term, (iii) non-compete covenant, (iv) oral modification on labor contract, (v) procedural requirement on labor contract termination, (vi) severance pay and (vii) expatriates employment, etc., among which some new changes are introduced. I. The Consolidation of Former Employment

Term

In practice, some group companies commonly assign or transfer their employees from one employing unit to another for management purpose. Under such circumstance, (i) the employment contract between the employee and the former employer would be terminated and (ii) a new employment contract between such employee and the new employer would be signed. For those employees assigned to another employing unit, Article 10 of the Regulations on Implementation of the Labor Contact Law of the People’s Republic of China (the “Regulation on Implementation”) has already provided for the payment of the severance pay and the method of calculating the employment term:“[w]here an employee is transferred to a new employer for the reason(s) not attributable to the employee, the number of the years the employee has worked with the former employer shall be consolidated into his/her employment period with the new employer. If the former employer has paid the severance pay to the employee for the transfer, the new employer shall not be required to consolidate

the employee’s employment period into that with the former employer when calculating the severance pay for the employee at the termination or expiration of the labor contract.” This time, Article 5 of the Interpretations (IV) made some supplementary contents to the above-mentioned Article 10 of the Regulations on Implementation. Firstly, Article 5 of the Interpretations (IV) specifies that each of the following circumstances shall be deemed to be “an employee is transferred to a new employer for the reason(s) not attributable to the employee”: (1) Where the employee continues to work in the

original workplace or job position, but the hiring party is changed from the current employer to a new employer;

(2) Where the former employer changes the

workplace or job position of the employee in the form of organizational delegation or appointment;

(3) Where the employee undergoes changes in

his/her job due to merger or split-up of the employer or other reasons;

(4) Where the employer and its affiliated enterprises

take turns to conclude labor contracts with the employee; or

(5) Where there are any other reasonable

circumstances. Secondly, to combine Article 5 of the Interpretations (IV) and Article 10 of the Regulations on Implementation,

Brief Summary on Interpretation (IV) of the Supreme People’s Court of Several Issues on the Application of Law in Trial of the Labor Dispute Cases

By Zhao LI/Wei CUI/Dingding LI



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in the case of any circumstances which constitute “an employee transferred to a new employer for the reason(s) not attributable to the employee”, (i) if the former employer has paid the severance pay, the new employer will not be required to pay for the former employment term when the new employer is required to pay the severance pay or damages to the employee; and (ii) if the former employer has not paid the severance pay, the new employer shall consolidate the former employment term when it pays severance pay or damages to the employee. II. Non-compete Covenant

A. The compensation standard for the non-compete covenant

Before promulgation of the Interpretations (IV), according to the Labor Contract Law of the People’s Republic of China (the “Labor Contract Law”), the employer shall pay certain amount of economic compensation (the “Non-compete Compensation”) to the employee if the latter performs the non-compete obligation after the termination or expiration of the labor contract. However, the Labor Contract Law dose not provide for the compensation standard and which is then subject to the discretionary agreement between the employer and the employee. In practice, if there is no such standard stipulated in the labor contract, the compensation standards are varied in different places, for example, 20%-60% of monthly salary in Beijing, and 20%-50% monthly salary in Shanghai. This time, the Interpretations (IV) has provided for the compensation standard for non-compete covenant. According to Article 6 of the Interpretations (IV), when there is no compensation standard agreed by the parties to the labor contract and the employee has performed the non-compete obligation, the employee is entitled a 30% monthly average salary of 12 months before the termination or expiration of the labor contract but which shall be no less than the local minimum wage standard.

B. The performance of the non-compete covenant As to the performance of the non-compete covenant, Article 7 of the Interpretations (IV) provides that when an employer and an employee have agreed upon a non-compete covenant in the labor contract, in the event of termination of the labor contract, unless otherwise agreed upon, the employee shall perform the non-compete obligation and the employer shall compensate such employee for his/her performance. Please note that “the termination of the labor contract” includes both legal termination by the parties and illegal termination by the employer. Furthermore, Article 10 of the Interpretations (IV) provides that the employee shall continue to perform the non-compete obligation agreed in the labor contract even if the employee has paid penalty for his/her breach of the non-compete covenant. C. The termination of the non-compete covenant As to the termination of the non-compete covenant, Article 8 of the Interpretations (IV) provides that when the non-compete covenant becomes effective, the employee could terminate the non-compete covenant if the employer has not paid any Non-compete Compensation for three months due to its own reasons. Meanwhile, Article 9 of the Interpretations (IV) provides that the employer could also terminate the non-compete covenant with extra 3-month Non-compete Compensation paid to the employee. III. Oral Modifications of an Existing Labor

Contract

In practice, some modifications of an existing labor contract, such as changes in position, salary or work place, are commonly made by oral agreement between the employer and the employee. However, according to the Labor Contract Law, modifications of labor contract shall be made in writing1. As a result, there is a risk that some of the oral modifications

1 The Labor Contract Law of the People’s Republic of China,

Article 35.1



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might be invalid, especially when there is a dispute between the parties to the labor contract. However, Article 11 of the Interpretations (IV) allows such oral modifications and accordingly provides that if such oral modifications have been performed as a matter of fact for more than one month and such modifications do not violate the laws, regulations, state policies or public interests, then the parties shall not claim the modified labor contract to be invalid. Please note that the pre-condition to validate the modified labor contract, as stipulated in the Article 35 of the Labor Contract Law, is both parties’ consensus and without which such oral modifications are still deemed to be invalid. IV. Notification to the Labor Union upon

Termination of Labor Contract

According to Article 43 of the Labor Contract Law, the employer shall notify the labor union before it unilaterally terminates a labor contract. However, in the past judicial practice (even after the implementation of the Labor Contract Law), the consequences of a failure to deliver such notification were varied in different places2. Article 12 of the Interpretations (IV) specifically provides that “[t]he people’s court shall uphold the employee’s request for payment of damages on the ground of illegal termination of the labor contract by the employer, unless the employer has rectified the relevant procedures before the employee files the lawsuit.” Therefore, after implementation of the Interpretations (IV), a unilateral termination of the labor contract by the employer without an advanced notification (to the labor union) will be deemed to be an illegal termination and thus entitles the employee a 2 In the event of a unilateral labor contract revocation by the

employer without an advanced notification to the labor union, in Beijing, there is a difference of salary standard during the dispute period. For procedural flaw of law, the employer shall pay the salary in accordance with the minimum wage standard; in Shanghai, a revocation with procedural flaw of law is not deemed as an illegal one in practice; in Shenzhen, there is a specific provision by which such revocation is not illegal.

payment of damages. But for the above procedural flaw of law, the employer could rectify it with an “after notification” to the labor union before the employee files a lawsuit. Please note that, in Article 12 of the Interpretations (IV), the time condition (for the employer to rectify) is “before the employee files the lawsuit” by which means such rectification can be made before either the labor arbitration or the lawsuit. V. The Employment Process for Expatriates

According to Article 14 of the Interpretations (IV), it is required for a foreign national, a stateless person, a Taiwan resident or a resident of the Hong Kong Special Administrative Region (“Hong Kong”) or Macau Special Administrative Region (“Macau”) (collectively, the “Expatriate Employees”) to acquire related employment certificate before their labor relations with the mainland employer are established.3 According to the Provisions on the Administration of Employment of the Foreigners in China and the Administrative Regulations on the Employment of Taiwan, Hong Kong and Macau Residents in Mainland, the mainland employer shall apply employment permission for the Expatriate Employees to be employed. However, in practice, some mainland employers hired the Expatriate Employees but did not obtain the required certificates. For such circumstance, according to Article 14 of the Interpretations (IV), it will be deemed that there is no labor relationship between the employer and the Expatriate Employee. (This article was originally written in Chinese, and the English version is a translation.)

3 The Administration of Employment of the Foreigners in

China, Article 5 and The Administrative Regulations on the Employment of Taiwan, Hong Kong and Macau Residents in Mainland



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

Tel: (86 10) 6584 6668

Fax: (86 10) 6584 6666/6677


Mr. Li Zhao is a partner of Global Law Office. He worked at court for trials for several years in Beijing. Before his joining Global Law Office, Mr. Li worked as a full-time lawyer and partner in Beijing Zhong Lun Law Firm and Beijing Commerce & Finance Law Offices. Mr. Li is specialized in providing legal services in corporation, intellectual property rights, labor law and dispute resolution, etc. He has represented his clients in hundreds of various commercial disputes accepted by the Supreme People’s Court, high people’s courts and local people’s courts in Beijing, Shanghai, Tianjin, Chongqing, Guangdong, Jiangsu, Shandong, Hainan, Sichuan, Yunnan, Shanxi, Jilin, etc., as well as China International Economic and Trade Arbitration Commission and Beijing Arbitration Commission. Mr. Li represented for Multi-national Corporations and their Chinese Branches, state-owned key enterprises and their affiliates, financial institutes and other overseas listed enterprises and private enterprises.

Mr. Cui Wei

Mr. Cui Wei worked at Beijing Commerce & Financial Law Offices before his joining Global Law Office in 2012. He graduated from University of International Business and Economics with an LLB degree. Tel: (86 10) 6584 6582

Fax: (86 10) 6584 6666/6677


Mr. Li Dingding Mr. Li Dingding joined Global Law Office in 2012. He graduated from

Xiamen University as a Bachelor of Economics and University of Melbourne as a Master of Commercial Law. Tel: (86 10) 6584 6762

Fax: (86 10) 6584 6666/6677


FEATURE: NON-COMPETE COVENANT UNDER NEW JUDICIAL INTERRETATION


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The Interpretation (IV) of the Supreme People’s Court of Several Issues on the Application of Law in Trial of the Labor Dispute Cases (the “Interpretations (IV)”) became effective as of February 1, 2013. There are 15 clauses provided under the Interpretations (IV), among which 5 clauses are related to non-compete covenant. This article, based on the Interpretations (IV), is going to look into and analyze certain hot issues concerning the non-compete covenant in practice. The non-compete mechanism is designed to protect the employer’s trade secrets, for which it is provided that: (A) on the one hand, within a certain period following the termination or expiration of a labor contract (and which period shall not exceed two years in accordance with the relevant PRC labor-related laws) (the “Non-compete Period”), an employee who bears confidentiality obligation (the “Quit Employee”) shall not (a) work for a person who (i) competes with his/her former employer and (ii) produces or trades in such products or engages in such business as his/her former employer does, or (b) establishes his own business to produce or trade in such products or engages in such business as his/her former employer does 1 ; and (B) on the other hand, the former employer shall provide the Quit Employee with certain amount of economic compensation (the “Non-compete Compensation”) for the employee’s observance of the non-compete covenant. Thus, under the non-compete mechanism, the Quit Employee shall enjoy and assume certain rights and obligations as to his/her former employer, and vice versa. 1 Please refer to Article 23 and Article 24 in the Labor Contract

Law of the People’s Republic of China (2008) (“Labor Contract Law”)

I. Where the Non-compete Compensation is

not specifically provided under the

non-compete agreement, shall the

non-compete agreement be still valid?

In Practice. In order to protect their own trade secrets to the fullest extent, many employers, in practice, required the Quit Employees to enter into the non-compete agreements with such employers, respectively; while on the other hand, such employers are not willing to specify the exact amount of Non-compete Compensation for the cost-effective purpose. The arising issue is that whether or note the non-compete agreement is valid under such circumstance. Before promulgation of the Interpretations (IV), judicial authorities of different places held different views. For example, (i) the competent authorities in Shanghai and Beijing opined that the non-compete agreement shall be valid regardless of whether or not the exact amount of Non-compete Compensation is specified thereunder; while (ii) the competent authorities in Guangdong province held that the non-compete clauses shall have no binding effect as to the Quit Employee (in the case that the exact amount of Non-compete Compensation is not specified thereunder); and (iii) the competent authorities in Jiangsu province adopted the concept of “relatively invalid”, which means that (if the exact amount of Non-compete Compensation is not specified thereunder) the non-compete agreement shall have no binding effect as to the Quit Employee, but once the Quit Employee observes the non-compete covenant, such Quit Employee shall have the right to require the former employer to pay the Non-compete Compensation.

Analysis of Non-compete Clauses under the Most Updated Judicial Interpretation

By Amy Dai



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New Rules. It is clearly prescribed in the Interpretations (IV) that the Non-compete Compensation provision is not a requisite for the validity of the non-compete agreement, namely the lack of Non-compete Compensation provision would not certainly affect the validity of the non-compete agreement2. Analysis. The reason why Interpretations (IV) prescribed as such is that it would be unfair to the Quit Employee if the whole non-compete agreement is held invalid for the lack of Non-compete Compensation provisions while the Quit Employee has observed his/her non-compete covenant. On the other hand, once a non-compete agreement was entered into by and between the Quit Employee and his/her former employer, the Quit Employee shall have the obligation to perform the non-compete covenant regardless of whether or not the Non-compete Compensation was provided. In other words, the Quit Employee cannot claim that he/she is not subject to the non-compete agreement merely due to the lack of Non-compete Compensation provision. Attention/Suggestion. Both the employer and employee should be cautious on non-compete agreement, once it has been signed, neither party could claim invalidation merely due to the lack of Non-compete Compensation provision. Furthermore, both parties should do their best to specify the amount of Non-compete Compensation; otherwise, a mandatory amount of Non-compete Compensation per month shall be imposed, which 2 Article 6 of the Interpretation(IV) prescribes that: “Where an

employer and an employee have agreed upon a non-compete clause in the labor contract or confidentiality agreement, but have not agreed upon the payment of Non-compete Compensation to the employee in the event of the termination or expiration of the labor contract, the relevant people's court shall uphold the employee's request for monthly payment of Non-compete Compensation by the employer in an amount equal to 30% of his/her average salary over the twelve-month period preceding the termination or expiration of the labor contract if the employee has fulfilled the obligations under the non-compete clause. If the amount of 30% of the average monthly salary as prescribed in the preceding paragraph is lower than the minimum wage standard applicable in the place where the labor contract is performed, the said minimum wage standard shall prevail.”

amount shall be equal to 30% of the employee’s average salary over the twelve-month period preceding the termination or expiration of the labor contract3. If a specific amount of the Non-compete Compensation is provided thereunder, such specific amount shall prevail, but if such amount is far too low, it may be subject to adjustment made by the competent courts or arbitration tribunals. II. Could Non-compete Compensation be

included in the paid salaries?

In practice. Under many existing non-compete agreements, the Non-compete Compensation is provided as follows: “the salaries paid to the employee has taken into account the Non-compete Compensation”. Then, is such clause viable? New rules. “Non-compete Compensation cannot be included in Quit Employee’s paid salaries, and it should be paid to the employee on a monthly basis during the Non-compete Period.” 4 The Labor Contract Law has already provided the foregoing, and the Interpretations (IV) reaffirmed it this time. Attention/Suggestion. Where an employer requires the Quit Employee to perform the non-compete obligation by claiming that the Non-compete Compensation has been included in the Quit Employee’s paid salaries, such request could be hardly upheld by the competent court. Therefore, if the employing unit ascertains which employees need to

3 Before the promulgation of the Interpretations (IV), judicial

authorities of different places held different views. For example, (i) the competent authorities in Shanghai held that, pursuant to the Shanghai High Court on Several Issues the Application of the Labor Contract Law the non-compete covenant shall be valid even if the Non-compete Compensation is not stipulated thereunder and the amount of Non-compete Compensation shall be 20%-30% of the salary; (ii) the competent authorities in Beijing held that, pursuant to the Minutes of the Seminar of Beijing High Court on the Several Issues on the Application of Law in Trial of the Labor Dispute Cases, the Non-compete Compensation shall be 20%-30% of the annual salary.

4 Abstract from the Handling Labor Dispute Cases Correctly To Build Harmonious Labor Relationship According To Law-- Answer To Reporters' Request Of The Person In Charge Of Court of Civil Jurisdiction No. 1, The Supreme People's Court (“Answer to Reporters' Request”)



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perform the non-compete obligation after termination or expiration of the labor contract, it would be advisable for the employer to pay the Non-compete Compensation on a monthly basis (during the Non-compete Period) rather than pay it as a part of salary. III. Whether the validity of the non-compete

covenant will be affected by the employer’s

failure to pay the Non-compete

Compensation?

In Practice. Before promulgation of the Interpretations (IV), many people held the views that the non-compete agreement would be invalid if the employer fails to pay the employee the Non-compete Compensation during the Non-compete Period. New Rules. According to Article 7 and Article 8 of the Interpretations (IV), where an employer and an employee have agreed upon both non-compete clauses and Non-compete Compensation matters, unless otherwise agreed upon, the employee shall perform the non-compete obligation during the Non-compete Period. Non-compete obligation is deemed as “simultaneous obligation”, which means one party can terminate the contract if the other party fundamentally breaches the contract pursuant to the PRC Contract Law. Therefore, if the employer has not paid any Non-compete Compensation for three months due to its own reasons, the Quit Employee shall be entitled to terminate the non-compete agreement and require the employer to pay the Non-compete Compensation for the period he/she has fulfilled the non-compete obligation. Notably, the Quit Employee could exercise such termination right only when the failure of compensation payment is “due to the employer’s own reasons”. Where the employer has no fault (for example, the Quit Employee viciously rejects the Non-compete Compensation paid by the employer), the Quit Employee shall have no right to terminate the non-compete agreement and shall be bound by the competition restriction therein. On the contrary, if

the Quit Employee breaches the non-compete covenant, the employer may require the Quit Employee to pay the penalty and further require him/her to continue to perform the obligations under the non-compete covenant. Attention/Suggestion. If an employer cannot determine the list of employees who should bear non-compete obligation, the employer could still enter into the non-compete covenants with employees as many as practicable. However, the execution of the contract shall be designed as not a requisite for the effectiveness of such non-compete covenants. Instead, it shall be explicitly stipulated in the non-compete covenant that the contract only comes into effect upon “receipt of the performing non-compete covenant obligation notice from the employer”, thus the employer has the opportunity to choose whether or not to effect the non-compete covenant. Additionally, it might become more difficult and problematic for competing employers to hire the Quit Employee, because the former employer can require the Quit Employee to perform the non-compete obligation even if he/she has paid the penalty (for the breach of non-compete covenant). IV. The right to terminate the non-compete

agreement

The third issue discussed above has mentioned that the Quit Employee has the right to terminate the non-compete agreement under certain circumstances. According to the Interpretations (IV), the employer also enjoys the right to terminate the non-compete agreement. In Practice. In the case that the non-compete agreement has been executed by the employer and the Quit Employee, during the Non-compete Period, if the employer no longer requires the employee to perform the non-compete obligation due to various reasons, the employer shall have the right to terminate the non-compete agreement by paying a certain amount of Non-compete Compensation.



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New Rules. According to Article 9 of the Interpretations (IV), the people’s court shall uphold the request of an employer for terminating the non-compete agreement during the Non-compete Period. Meanwhile, the people’s court will also uphold the request of the Quit Employee for payment of an extra three-month Non-compete Compensation upon the termination or expiration of non-compete agreement. Attention/Suggestion. As parties of the non-compete covenant, both the employer and the Quit Employee have right to terminate the non-compete agreement. The Quit Employee’s termination right is based on the employer’s failure to perform the payment obligation, while the employer may terminate the non-compete agreement at any time by paying extra Non-compete Compensation. V. Whether the termination of the labor contract

will affect the validity of the non-compete

agreement?

In Practice. In practice, some employer signed the non-compete agreement with the employee but terminated the labor contract (not the non-compete agreement) illegally thereafter. Under such circumstances, shall the Quit Employee still need to undertake the non-compete obligation? New Rules. According to Article 7 of Interpretations (IV), if an employer and an employee have agreed upon the non-compete clauses and Non-compete Compensation matters in the labor contract or confidentiality agreement, both parties shall, in the event of termination of the labor contract, perform the non-compete obligation, unless otherwise agreed. The separation of the validity of the non-compete covenant and the termination of the labor contract under the Interpretations (IV) is propitious to handle the relationship between them properly. Analysis. The termination of the labor contract shall be subject to the statutory provisions while the

non-compete covenant is subject to both parties’ discretionary agreements. The legislative purpose of the non-compete covenant is to protect the employer’s trade secrets. The Quit Employee therein undertakes passive obligations that shall not be changed as a result of the termination of the labor contract. In other words, the non-compete covenant shall be a relatively independent agreement and have no causality with the termination of the labor contract. If the employer terminates the labor contract illegally, the Quit Employee may claim his/her rights against the employer pursuant to the Labor Contract Law, the Labor Law or other relevant laws and regulations. However, the validity of the non-compete agreement shall not be affected by the termination of the labor contract. “Such provisions are also beneficial to the protection of employer’s trade secrets. Otherwise, the fairness, order and competitiveness of the market will be influenced if the Quit Employee engages in the business which is competitive with his/her former employer”. 5 Attention/Suggestion. Neither the employer nor the Quit Employee can refuse to undertake the obligations under the non-compete agreement on the grounds that the labor contract is terminated or terminated illegally. Instead, both of them shall claim their rights according to the relevant laws and regulations.

VI. Conclusion

Labor relation is one of the most important social relations in modern economic society. The Interpretations (IV) is issued under the background of high rate of labor disputes in recent years. With regard to the legal relationship under the non-compete covenant, the Interpretations (IV) attempts to protect the employees more favorably on the one hand and protect the trade secrets of enterprises on the other hand, thereby balancing the benefits of both parties. Based on the fully understanding of the Interpretations (IV), the employer

5 Abstracted from Answer to Reporters' Request.



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and the employee shall be cautious with the non-compete covenant.


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Tel: (86 21) 6275 6722 # 8602

Fax: (86 21) 6375 6723


Amy Dai is a counsel with Global’s Shanghai office. Prior to joining Global, Amy Dai worked with AllBright Law Offices as an associate. She started her legal practice in AllBright Law Offices since July, 2007. Amy Dai has involved in multiple foreign direct investment and M&A deals which relate to various kinds of employment legal services, including: providing legal advice on employment termination and compensation payment; representing the purchaser to negotiate with the staff and assist the purchaser with all staff placement; dealing with housing fund dispute etc.; reviewing the labor contract, severance agreement and staff manual etc. for the client. Amy Dai also has rich experience in providing legal services for capital market, including fund formation, fund investment and fund exit.

FEATURE: RIGHT OF FIRST REFUSAL UNDER INDIRECT SHARE TRANSFERS


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On April 23, 2013, the No.1 Intermediate People’s Court of Shanghai (the “First Instance Court”) made its judgment (the “First Instance Judgment”) with respect to a case well-known as “Shanghai Bund Land Case”, which judgment ruled that the indirect share transfers taken by SOHO China with the purpose of circumventing other shareholders’ right of first refusal shall be invalid. As it was reported that SOHO China has lodged an appeal against the First Instance Judgment, the result of this case may still be subject to the final judgment. I. Case Overview

In order to invest into the development and operation of the project on the “Bund Land 8-1”, Zhejiang Fu Xing Commerce Development Co., Ltd. (“Zhejiang Fu Xing”) and certain other entities (the “Minority Shareholders”) set up a company named Shanghai Haizhimen Real Estate Investment Co., Ltd. (“Haizhimen Company”), which subsequently acquired the “Bund Land 8-1” through a vehicle company (the “Project Company”). After that, the Minority Shareholders intended to exit from Haizhimen Company by selling all of their equity interests in Haizhimen Company to SOHO China (which aggregated 50%, and the remaining 50% was owned by Zhejiang Fuxing). However, if the Minority Shareholders directly transfer their equity interests in Haizhimen Company to SOHO China, Zhejiang Fuxing would have a statutory right of first refusal with respect to such transfer, which was not desired by the prospective buyer—SOHO China.

Therefore, in order to circumvent Zhejiang Fuxing’s right of first refusal, it was at last not the Minority Shareholders directly transferred their equity interests in Haizhimen Company to SOHO China, but the owner of the Minority Shareholders transferred all of their equity interests in the Minority Shareholders to SOHO China (the “Indirect Share Transfers”). As such, SOHO China became the owner of the Minority Shareholders while which remained to be the shareholders of Haizhimen Company. Subsequently, Zhejiang Fuxing claimed that the Indirect Share Transfers infringed upon its right of first refusal and brought a lawsuit before the First Instance Court on May 30, 2012. II. Relevant Rules

With respect to the shareholders’ right of first refusal, Article 72 of the PRC Company Law (2006) provided that: “The shareholders of a limited liability company may transfer all or a portion of their equity interests among themselves. The proposed transfer of equity interests by a shareholder to any non-shareholder party shall be subject to the consent of more than half of the other shareholders. The transferring shareholder shall notify the other shareholders in writing of the matters on the proposed equity transfer for their consent. Failure to reply by any of the other shareholders within 30 days upon receipt of the written notice shall be deemed to be consent to the proposed transfer. Where more than half of the other shareholders do

The PRC Court Held That the Shareholders’ Right of First Refusal Shall Not Be Circumvented by Means of Indirect Share Transfers

By Wu WANG



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not consent to the proposed transfer, such non-consenting shareholders shall purchase the equity interests to be transferred; failure to purchase the equity interests shall be deemed to be consent to the proposed transfer. With respect to any equity interests to be transferred with the consent of the shareholders, those shareholders other than the transferring party shall have the preemptive right under the same conditions. Where two or more shareholders claim to exercise their preemptive right, they shall determine the proportional ratio for purchase through consultation. Where the consultation fails, the preemptive right shall be exercised in proportion to their respective capital contribution at the time of the transfer. The provisions on equity transfer otherwise provided under the articles of association of a company shall prevail.” However, the above Article 72 only provides for the shareholders’ right of first refusal with respect to the “direct share transfers” and dose not provide for “whether or not the shareholders shall have the right of first refusal with respect to the Indirect Share Transfers.” III. Comments on First Instance Judgment

Though, there are no specific rules can be directly applied to this case, the First Instance Court is of the opinion that: (A) The Indirect Share Transfers taken by SOHO

China to acquire 50% equity interests of Haizhimen Company, “though, from the perspective of form, did not directly jeopardize the equity interests currently held by the plaintiff (namely, Zhejiang Fuxing) in Haizhimen Company, it substantially deprived the plaintiff of the right of first refusal with respect to the other 50% equity interests of Haizhimen Company”;

(B) “From the perspective of substance, the Indirect Share Transfers caused the same effect, and the result thereof directly harmed the plaintiff’s benefits and interests, in other words, the plaintiff’s controlling position in Haizhimen Company has been materially affected and damaged, and the “personal nature” and the internal reliance relationship among the original shareholders of Haizhimen Company has been destroyed fundamentally”; and

(C) “The consequences of the above-mentioned

transactions will do harm to the operation and management of Haizhimen Company and the Project Company; also, it will be hard to ensure the due development of the construction project on Bund Land 8-1.”

Therefore, the First Instance Court held that the share transfer agreements entered into for the Indirect Share Transfers shall be null and void in accordance with Article 52 of the PRC Contract Law, which provides that “[t]he contract shall be null and void under any of the following circumstances:…(iii) concealing illegal purposes under the disguise of legitimate forms.” When the relevant PRC laws are silent on whether or not the Indirect Share Transfers violate the other shareholders’ right of first refusal, it can be seen from the First Instance Judgment that the judge took a view of “Substance Over Form” and adopted the following notion when considering the order of legal values such as justice, efficiency and safety, etc.:“when hearing a dispute concerning shareholders’ right of first refusal…the maintenance of the internal reliance relationship shall be given first priority, the second is to consider the degree of restrictions as to the principle of “shares can be transferred at discretion”, and the third is to protect the safety and stabilization of the transactions…” (Please note that the above notion was quoted from a book written by the First Instance Court, which heard this case.)



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In addition, please note that China is not a case law county, as such, different judges may have different understandings and opinions to an identical issue. However, the First Instance Judgment of this case may send a message to the other courts and affect the judge’s understanding on the issue discussed herein. IV. Practice Overview

In practice, to fully protect the shareholders’ right of first refusal, the relevant parties will agree to provide for certain restrictions on the indirect share transfers. Set forth below are some exemplary language for reference: “In the case that any shareholder is an entity, and in the event that (i) such shareholder proposes to sell or issue to any other persons any of its equity interests, (ii) such shareholder proposes to redeem or repurchase any of its equity interests, or (iii) any equity holder of such shareholder proposes to transfer to any other person its/his/her equity interests in such shareholder, then, the abovementioned sale, issuance, redemption, repurchase, transfer, or the like, shall constitute the transfer of equity interests of the Company by such shareholder, and shall thus be subject to all requirements and restrictions provided herein on the transfer of equity interests of the Company by the shareholders.”

V. Suggestions

(A) When there are no specific rules can be applied, the legality of the proposed transactions may need to be considered prudently from the perspective of “Substance Over Form”.

(B) As the provisions regarding the shareholders’

right of first refusal under the PRC Company Law do not cover all possible situations in real life, for the purpose of avoiding any possible disputes caused by the absence, vagueness or ambiguity of the relevant provisions, the concerned parties may need to consider providing for the shareholders’ right of first refusal in detail to the full extent possible. In practice, some particular “share transfers” caused by donation, inheritance, share swap, etc. may also need to be taken into consideration.

(C) Not to establish a shareholding structure which

may lead to a company deadlock, especially for those persons who desire to control a company. Assuming that Zhejiang Fuxing held 51% or more equity interests (not 50% in this case) in Haizhimen Company, let SOHO China acquire all of the remaining equity interests, it will still be hard for SOHO China to exercise decisive influences on the operation and management of Haizhimen Company.


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Mr. Wu WANG is a senior associate with Global’s Beijing office who specializes in merger & acquisition, private equity investment, venture capital investment, foreign direct investment, corporate financing, and corporate public offering and listing. Direct: (86 10) 6584 6650 Fax: (86 10) 6584 6688 E-mail: [email protected]


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