Foreign investors eyeing production enterprises need to tread carefully

The establishment of greenfield production enterprises involves complicated project approval procedures, with relatively long construction periods and low economic benefits. Accordingly, foreign investors frequently make their investments by acquiring PRC domestic enterprises that already exist, or are in the course of being formed, and utilise the existing production enterprise resources to rapidly gain market share. This column will analyse the major legal issues involved in this kind of investment.

Form of transactions

Pursuant to Order No. 6 of 2009 of the Ministry of Commerce, foreign investors may acquire domestic enterprises by equity acquisition or asset acquisition. If acquisition of the target company involves the disposal of state-owned assets or equity, the Law on the State-owned Assets of Enterprises, the Provisional Measures for the Administration of the Transfer of the State-owned Property Rights of Enterprises, the Provisional Regulations for Oversight of the State-owned Assets of Enterprises, etc., need to be complied with when carrying out asset appraisal and recordal procedures, as well as effecting transfer of title to state-owned assets.

The 2007 Property Law permits an enterprise to create a floating mortgage over its existing or soon to be acquired production equipment, raw materials, etc. Should the enterprise be unable to perform a due and payable debt obligation, the creditor has the right to preferential repayment from the mortgaged movables. As the large pieces of production equipment owned by a target company account for a relatively large percentage of its assets, they will have a material impact on the enterprise’s production and operation. Accordingly, it is important to check and note the encumbrance conditions of such equipment in the due diligence.

Dorothy Xing and Tina Tang are partners at Concord & Partners