In China, acquisitions of state-owned enterprises (SOEs) are complicated because the deal is compulsorily required to go through a public listing and auction process, whether it is structured as an equity or asset transaction. The related rules also apply to the sale of non-SOE entities (including Sino-foreign joint ventures) if state assets are involved.

The auction is required to be conducted by a local Property Rights Exchange (PRE). A seller starts the process by providing the PRE with information regarding the target company, minimum price and payment terms, as well as any qualification requirements for a potential bidder or buyer to participate in the auction. The PRE will then publish the proposed sale on its website and a designated newspaper with provincial or national circulation. The legally-required open bidding period is 20 working days, which can be extended for one or more weeks if there is only one bidder at the close of the initial open bidding period. If the open bidding results in two or more qualified bidders, the PRE will organise an auction in which the highest bidder will normally win. Because all bidders are required to use the same PRE form contract, transaction terms resulting from the parties’ negotiations will lose their operative effect unless substantially aligned with the standard terms of the PRE form contract.

China law allows a seller to impose capitalisation, management skill and other qualification requirements for potential bidders. A seller may also specify requirements in relation to price, payment schedule, job retention, debt settlement, etc. Friendly buyers should make good use of these rules and work with the seller to prescribe requirements which are “objective” but also capable of narrowing the pool of potential competing bidders.

For a friendly buyer, it is crucial to work closely with the seller, which in turn maintains constant communication with the PRE. For one thing, the PRE has substantial discretion, within applicable legal requirements, to determine whether the conditions proposed by the seller are acceptable and not overly in favour of any particular buyer. Also, when competing bids are submitted, the PRE has discretion to determine whether sufficient evidence has been shown to establish qualifications for competing bidders. While a friendly buyer could work with the seller to protect the deal, its success is not guaranteed, particularly when the potential competing buyer is well-prepared, and the target company or the seller is not 100% aligned with the intended buyer.

No buyer would want to pay any money before closing, but this appears to be impossible as PREs normally require a deposit (ranging from 10% to 30% of the listing price in different locations) before allowing a potential buyer to participate in the bidding. PREs also charge a commission on the bidder and seller. To minimise the risks arising from these payment obligations, a buyer must fully utilise all possible flexibilities in applicable rules and devise a realistic and practical strategy on the basis of the relative bargaining power of itself, the seller and the PRE.

In addition to representing a substantial amount of money, a deposit imposes a pre-signing payment obligation on a potential buyer, which is undesirable under any circumstances. At a starting point, a buyer, especially one with strong bargaining power, should try to push it back as there is no clear legal requirement for a deposit, at least at the national level. In theory, the seller has the right to require a deposit, as this is designed to protect the seller if a bidder walks away without a good reason. For the same reason, the seller should be able to waive this requirement. While it is extremely difficult to obtain a waiver, a sophisticated buyer should at least try to negotiate a lower amount.

Where the buyer is an offshore entity, it needs to obtain approval from the State Administration of Foreign Exchange (Safe) to remit funds to the PRE to pay a deposit. This procedure can be lengthy and complicated. One way to avoid this is to offer a bank guarantee to the PRE, covering the same amount of the deposit. If the buyer has strong bargaining position, it may also be able to negotiate some restrictions in favour of the buyer. In one extreme case, a buyer was successful in setting out conditions to the extent that no money could be drawn down without the buyer’s prior written approval.

With respect to the PRE commission, a buyer should closely align with the seller to negotiate the amount and, more importantly, to postpone the payment until closing, by way of contracts with the PRE.

In regards to deal documentation, a foreign buyer needs to synchronise the terms of the form documents used or imposed by the PRE and those of the actual sales and purchase agreement (SPA) resulting from the commercial negotiation with the seller. The PRE form documents normally include a Purchase Contract, an Engagement Contract between the PRE and the seller, an Engagement Contract between the PRE and the buyer, the Buyer’s Application to Accept Bid, etc. All these documents must be filed with the PRE prior to the listing process.