1. ©2012 Foley & Lardner LLP
CITE 12th
Annual Conference
Legal Aspects of Mergers,
Acquisitions and Reorganizations
James C. Chapman, Partner
Foley & Lardner LLP
March 19-20, 2012
EYE ON CHINA SERIES

2. ©2012 Foley & Lardner LLP
Key Rules for M&A in
China
Rule #1 – “In China everything is possible but nothing is
easy.”
Rule #2 – See Rule #1.

3. ©2012 Foley & Lardner LLP
Level of M&a Activity in
China
2011 Middle-Market Deal Volume.
– 1st half – 371 transactions – $30.3 billion.
– 2nd half – 309 transactions – $20.4 billion.
2012 Middle-Market Deal Volume.
– Feb. 2012 – M&A activity increased 19.77%
from January.
– 2012 and 28.37% from activity over February
of 2011.

4. ©2012 Foley & Lardner LLP
Factors Driving M&A
Activity
Continued growth in China.
Desire of foreign companies to enter the China market.
Desire for foreign companies to gain market share.
Consolidation of key industries – auto parts, cement and
metals.
Activity in high technology, clean technology
and sectors oriented toward Chinese consumer spending.

5. ©2012 Foley & Lardner LLP
Goals of Chinese
Companies
Chinese companies desire technology, managerial
experience and new markets.
Chinese companies offer resources, relationships and
knowledge on how to succeed in the domestic market
characterized by:
– Intense competition.
– Bureaucratic complexity.
– Diverse regulations.
– Varied consumer preferences.

6. ©2012 Foley & Lardner LLP
Current M&A Environment
A recent survey by the American Chamber of Commerce
– 2010-2011 China Business Report concluded:
– China remains a top destination for investment including
M&A.
– 2/3 of respondents characterized the regulatory
environment as either “not changing” or “deteriorating.”

7. ©2012 Foley & Lardner LLP
Recent Regulatory
Changes Affecting M&A
Circular 59 – Issued by Ministry of Finance and State
Administration of Taxation to address special tax
treatment of certain corporate restructuring transactions
in light of China’s Enterprise Income tax law adopted in
2008 which was silent on the issue.
Notice No. 13 – SAT clarified tax treatment for asset
restructuring transactions (March 2011).

8. ©2012 Foley & Lardner LLP
Recent Regulatory
Changes Affecting M&A
(cont.)
Notice No. 51 – SAT business tax treatment for asset
restructuring addresses restructuring transactions such as
mergers, spin-offs, sale or swap of assets involving all or
part of certain “qualified assets” (October 2011).
Notice of the General Office of the State Council on
Establishing the Security Review Mechanism for Merger
with the Acquisition of Domestic Enterprise by Foreign
Investors – establishes a review mechanism concerning
national security issues. (March 2011).

9. ©2012 Foley & Lardner LLP
Roadmap for
Completing a Deal
Acquisition of a Chinese company is a long, multi-step
process often taking 18 months to complete.
Critical Steps:
1. Selection of Target.
Substantial research for potential targets must be conducted
including governmental policies in the target industry.

10. ©2012 Foley & Lardner LLP
Roadmap for
Completing a Deal
(cont.)
2. Relationship Building.
From the initial contact, foreign buyers should work to establish a
friendly relationship with the selected Chinese target. Foreign
buyers are encouraged to not only do business with Chinese
partner from a pure money-making perspective, but also work on
“jiao pengyou” or making true friends.
Role of “mian zi” or “face” – Very important and the Chinese
feel embarrassed in taking advantage of a true friend. Foreigners
are fair game.
Trust – A good relationship helps a foreign buyer win the Chinese
target’s trust (to the extent possible), which makes business in
China much easier.

11. ©2012 Foley & Lardner LLP
Roadmap for
Completing a Deal
(cont.)
3. Preliminary Due Diligence.
Target’s value and market positions. Request and analyze
information from the Chinese target and comparing such
information with the buyer’s own independent research.
4. Letter of Intent.
In Chinese deals, the letter of intent should be more detailed
than in U.S. deals.
5. Complete Financial and Operational Due Diligence.
A thorough due diligence includes, but not limited to the
following (which is not intended to be an exhaustive list): (i)
Assessing Financial Statements and Audits; (ii) Taxes and Filings;
and (iii) Human Resources.

12. ©2012 Foley & Lardner LLP
Roadmap for
Completing a Deal
(cont.)
6. Complete Legal Due Diligence.
7. Acquisition Agreement and Related Documents.
The period starting from the execution of relevant acquisition
agreements to the closing of the deal is a sensitive stage for
both parties. At this stage, the foreign buyer is not the legal
owner of the target and has no control over the target’s
business operation as the proposed deal is pending approval of
the applicable Chinese government authorities.

13. ©2012 Foley & Lardner LLP
Roadmap for
Completing a Deal
(cont.)
8. Government Approvals.
Unlike the United States, Chinese government agencies are
active in every transaction. Every acquisition must go through
various examination and approval procedures to consummate
the deal.
9. Co-Management of the Target’s Corporate Seals.
The procurement of the government approvals takes time.
Buyer should consider negotiating a “co-management”
agreement whereby the target will need the agreement of both
parties to use the target’s corporate seals.

14. ©2012 Foley & Lardner LLP
Roadmap for
Completing a Deal
(cont.)
10. Closing.
After the documents are signed and government approvals
obtained, the parties may finally close the transaction.
11. Conversion of the Chinese Target to an FIE.
After the closing, the target will be converted to either a
wholly foreign owned enterprise or an equity joint venture.

15. ©2012 Foley & Lardner LLP
Due Diligence
“Where are the bodies
buried”
Key Problem Areas.
1. Ownership of the Target – practice of holding ownership
in the names of others.
2. Financial records – 2 or 3 sets of books.
3. Permits/licenses – many companies operate outside of the scope
of their permits.
4. Ownership of Assets – often complex, no clear trail of
ownership.
5. Tax payments – often negotiated, underpayment is the rule.
6. Bribery/illicit payments – are the rule not the exception.

16. ©2012 Foley & Lardner LLP
Due Diligence Process
1. Background checks of the company, key owners and
management – usually conducted by a third party
investigation firm.
2. Management Questionnaires.
3. Facility Visits.
4. Meetings/conversations with third parties – tax
authorities and other governmental officials, customers,
suppliers, current or former “partners.”
5. In-depth financial review.
6. IP Review – IP audit.
7. Analysis of product development.

17. ©2012 Foley & Lardner LLP
The Acquisition Agreement
Key Limitations
1. Structure of the Transaction.
2. Structure of the Purchase Price.
Cash.
Equity – Must be freely traded on an overseas exchange and
meet other requirements; requires MOFCOM approval.
Earn-out –Difficult to use, rules require payment of purchase
price within three months, can be extended to one year; requires
MOFCOM approval.
Seller Financing/ Notes – difficult to use.
3. Indemnification and Holdbacks – Similar challenges to
earnouts.

18. ©2012 Foley & Lardner LLP
The Acquisition
Agreement Key
Limitations (cont.)
4. Appraisal – Value of target’s equity or assets set by an
appraisal firm located in China.
5. Non-competition – Can be attached to employment
agreement; limited to two year term; after expiration of
employment agreement, buyer must pay compensation.
6. Governing Law – According to PRC law, cross-border
acquisitions with a target in China may only be governed
by Chinese law.

19. ©2012 Foley & Lardner LLP
The Acquisition
Agreement Key
Limitations (cont.)
6. Dispute Resolution – China is part of the New York
Convention which allows the enforcement of foreign
arbitration awards in China. Hong Kong International
Arbitration Center, Singapore International Arbitration
Center are preferred forums.

20. ©2012 Foley & Lardner LLP
Obstacles to Deals
The M&A landscape in China is full of obstacles
including:
1. The laws and regulations are inconsistent and unclear.
2. Chinese companies lack transparency and due diligence is
challenging.
3. The governmental examination and approval process is
complicated and time-consuming.
4. Strict foreign currency control.

21. ©2012 Foley & Lardner LLP
Key Challenges and
Potential “Deal
Breakers”
In evaluating potential Chinese targets, there are many
challenges.
1. Lack of integrity of the target’s management.
2. The inability to establish clear title to assets.
3. High expectations of value.
4. Unreliability of financial statements, lax regulatory compliance.
5. Ownership of the company itself.
6. Complex integration.

22. ©2012 Foley & Lardner LLP
Chinese Government
Approvals
MOFCOM.
– National Security Review.
– Anti-Monopoly Review.
– Price and Terms Review - Deals over $300 million are reviewed
by Central Government office of MOFCOM. Under $300 million
are reviewed by provincial or local branches of MOFCOM.
National Development and Reform Commission (NDRC)
–applies to companies involved in manufacturing,
equipment import or export, land use, real property,
establishing or acquiring non-financial enterprises.

23. ©2012 Foley & Lardner LLP
Chinese Government
Approvals (cont.)
National Development and Reform Commission (NDRC)
–applies to companies involved in manufacturing,
equipment import or export, land use, real property,
establishing or acquiring non-financial enterprises.
State Administration of Industry and Commerce (SAIC) –
Issues the operating license.
Others – public security bureau, tax authorities, statistics
bureau etc.

24. ©2012 Foley & Lardner LLP
Differences Between
U.S. and Chinese
Acquisitions
1. In China, the due diligence is much more thorough,
expensive and time consuming.
2. The contractual protective devices available in the US
are not as readily available in China -
escrows/holdbacks, notes, earnouts to offset against,
indemnification.
3. Dispute resolution is not effective.
4. Cultural differences such as lack of transparency,
unorthodox business practices, little interest in “win-
win”.

25. ©2012 Foley & Lardner LLP
Biography
Mr. James Chapman is a Partner in Foley & Lardner’s
Silicon Valley office. His practice focuses on Mergers
and Acquisitions, Venture Capital and Securities law.
Mr. Chapman has been involved in over 250 Mergers,
Acquisitions and financing transactions. He also has
extensive experience in international business transactions.
Mr. Chapman assists U.S. companies acquire China-based
companies, structure investments
in China and represents Chinese companies in public
and private securities offerings in the U.S. Mr. Chapman is
a frequent speaker at China-focused events and has been
named as one of the top M&A attorneys in the U.S. by
Legal 500. Email: jchapman@foley.com
Partner
jchapman@foley.com
975 Page Mill Road
Palo Alto, CA 94304
(650) 251-1120