On July 16, 2020, the State Administration for Market Regulation (“SAMR") unconditionally cleared the establishment of a joint venture between Shanghai Ming Cha Ze Gang Management Consulting Co., Ltd. (an affiliate of Mininglamp) and Huansheng Information Technology (Shanghai) Co., Ltd. (an affiliate of Yum China) (“M/H Case").  This is the first case involving VIE structure that has been formally docketed and unconditionally cleared by the Chinese antitrust authority, since its conditional clearance of Walmart’s acquisition of Yihaodian in 2012 (“Walmart/Yihaodian Case").[1]  Based on our first-hand experience and observation,[2] we would like to discuss certain key issues in a merger filing involving VIE structure. 

VIE (Variable Interest Entity) structure, as a type of “contractual control", refers to the corporate structure that the actual controlling party does not own shares of the operating entity (i.e., VIE), but achieves de facto control on business operation and financial consolidation of such entity through a series of agreements (i.e. VIE agreements).  In a typical VIE structure, the controlling entity is usually incorporated overseas for financing and tax planning purposes, while the controlled operating entity is a domestic company and can carry out business in the sectors not (fully) open to foreign investors.  Such structure is believed to be first introduced in the overseas IPO of Sina.com (also known as “Sina Model") and later widely adopted in many emerging sectors, particularly in internet-related businesses.

In practice, uncertainty remains for merger filing of transactions involving VIE structure.  Under the Anti-Monopoly Law (“AML"), “the acquisition of control over other undertakings or the ability to impose decisive influence on other undertakings through agreements or other methods" constitutes a concentration of undertakings, and transactions involving VIE structure are often captured by this scope.  Accordingly, if the filing threshold is met, there appears to be no legal grounds to exempt such transactions from a mandatory merger filing in China.  Indeed, the Chinese antitrust authority has never expressly affirmed that merger filing obligations do not apply or that they will not accept merger filing involving VIE structure.  Nevertheless, since Walmart/Yihaodian Case in 2012, we are not aware of any merger filing involving VIE structure docketed or cleared by the Chinese antitrust authority until the recent M/H Case.  It was reported that the failure of Sina’s proposed acquisition of Focus Media in 2009 was partially due to the unsuccessful attempt in docketing China merger filing.[3]

Even for the Walmart/Yihaodian Case, it should be noted that MOFCOM (the merger control authority at the time) docketed and cleared the case subject to conditions, among others, that Walmart shall not engage in, through VIE arrangement, the value-added telecommunication business operated by Yihaodian, which was not fully open to foreign investors at the time.[4]  Thus, Walmart/Yihaodian Case provided limited guidance on some key questions, such as whether the VIE structure will impact the Chinese authority’s acceptance and review of the filing, and if the filing is docketed, how the VIE will impact its review approach and outcome, or how the “negative list" for foreign investment interplays with the merger review.

The acceptance and unconditional clearance of the M/H Case shed some valuable lights on merger filings involving VIE structure.  Specifically,

1) The M/H Case has reaffirmed that contractual control through VIE agreements falls within the scope of “control" under the AML.  According to the public announcement form of the M/H Case, the Chinese party’s ultimate controlling person controls the Chinese party “through its affiliates based on a series of contractual arrangement", which suggests that VIE structure within one party’s group is deemed as a kind of “control" under the AML[5], and the turnover and competitive analysis shall trace through the VIE structure up to the ultimate controlling person.

Following this approach, typical VIE arrangements in M&As in internet sector such as concluding proxy agreements, acquiring WFOEs that control domestic operating entities will likely be deemed as “acquiring control over other undertakings",[6] and will trigger the mandatory ex ante merger filing obligation if the filing thresholds are met.

2) The M/H Case shows that SAMR is actively exploring merger review of transactions involving VIE structure. Some are of the view that the Chinese antitrust authority (in particular former MOFCOM) has adopted a “passive" stance on transactions involving VIE structure that meet the filing thresholds – while not taking the position that those transactions are not subject to merger review, it does not appear to have docketed their merger filings.

The successful docketing and clearance of M/H Case shows that SAMR is becoming more proactive on such merger fillings.  In this case, while the parties disclosed the VIE part involved in the transaction structure, SAMR decided to focus on impact on the market competition, and unconditionally cleared the case based on its thorough review of market data and competition analysis.  This clearance demonstrates SAMR’s expertise and independent exercise of its function as competition authority, and provides significant guidance on future merger filings involving VIE structure.

3) The prevailing practice of keeping a notifiable deal involving VIE structure off the competition review radar will face heightened antitrust risk exposures. It has been an often-adopted tactic to keep a notifiable transaction involving VIE structure off the competition review radar.  However, with the clearance of M/H Case, such tactic will more likely run into significant antitrust risk.  Considering that the draft Amendment to the AML released earlier this year proposes to significantly increase the upper limit of the penalty against failure to notify (from RMB500,000 to 10% of one undertaking’s group-level turnover in the preceding year), the legal consequences and non-compliance exposure will become much more severe[7].  Especially for big internet players involving VIE structure, even a fine based on a low single digital percent of group revenues could imply billions of dollars at stake.

SAMR’s review of merger filing involving VIE structure may still evolve on case-specific basis, as the M/H Case is just one single example.  But this case has demonstrated that VIE structure is not an untouchable area in China’s merger control or even in other antitrust enforcement activities.  VIE-structured firms or those who plan to introduce a VIE structure should be vigilant about antitrust compliance in their M&A transactions.

For a transactions involving VIE structure (including establishing a VIE structure), to manage the process, it is recommended for the parties to conduct antitrust assessment during early stage and, where a merger filing is required, to formulate and implement a proper strategy to mitigate uncertainty during merger review process.  Specifically,

1) working with antitrust counsel at early stage to run substantive assessment, discuss and formulate filing strategies and plans, and, if necessary, proactively approach SAMR for guidance, instead of failing to make a merger filing simply based on the misconception that SAMR will not accept the merger filing involving VIE structure or intentionally circumventing the filing obligations;

2) if, upon assessment, filing obligation will likely be triggered, planning a more flexible timetable for the merger filing to cope with the unexpected circumstances during review process;

3) proactively communicating with SAMR and the parties and properly responding to the information request to ensure smooth process;

4) for any historical non-compliance issues, establishing a task force or engaging antitrust counsel to conduct self-review and develop proper response strategy (based on communication with SAMR, if needed).

[4] According to the Announcement of MOFCOM on Removal of Restrictive Conditions on the Concentration of Undertakings of Wal-mart Stores, Inc.’s Acquisition of 33.6% Equity in Niuhai Holding Ltd., MOFCOM has removed the restricted conditions imposed on Walmart/Yihaodian Case on May 30, 2016.  In fact, since June 19, 2015, the Ministry of Industry and Information Technology (MIIT) has lifted the shareholding percentage restriction on foreign investment in the area of Electronic Data Interchange (e-commerce) at the national level and foreign investors are allowed to hold up to 100% equity of the operating company of such value-added telecommunication services.  Therefore, the restrictive condition related to the VIE structure has been of no practical meaning since then.

[5]  See Article 6 of the Guiding Opinions on Notification of Concentration of Undertakings.

[6] See Article 20 of the AML.

[7] See our highlights on the draft Amendment to the AML at http://www.zhonglun.com/Content/2020/02-09/1955422055.html (in English) and at http://www.zhonglun.com/Content/2020/01-08/1626562985.html (in Chinese).