A definition of horizontal competition is not provided for in the existing laws and regulations of the PRC, although restrictions on horizontal competition are scattered here and there in regulatory documents of the China Securities Regulatory Commission (CSRC) and stock exchanges. For example, article 27 of the Code of Corporate Governance for Listed Companies in China requires that: “A listed company’s business must be completely independent from that of its controlling shareholder. The controlling shareholder and its subsidiaries must not engage in any business identical or similar with that of the listed company. The controlling shareholders must take effective measures to avoid horizontal competition with the listed company.”
In connection with restructuring of any material asset of a listed company, the CSRC requires intermediaries to disclose or check whether the listed company upon restructuring is exposed to any actual or potential horizontal competition. In principle, actual horizontal competition that cannot be addressed poses a material threat to success in passing CSRC review procedure. If there is any
potential horizontal competition, however, the review will focus on whether it has material impact on independence of the listed company, and whether there is any solution to the horizontal competition, which may comprise specific measures, timetables, or progress and assurance for addressing horizontal competition. The review will also consider whether the timetable is appropriate, whether the specific measures proposed are justifiable, and whether these measures are sufficiently detailed and feasible.
Therefore, we have to consider, in theory and in practice, if article 43 of the Administrative Measures for Restructuring of Material Assets of Listed Companies, which requires “conduciveness to avoiding horizontal competition and enhancing independence”, can be complied with.
According to applicable regulations and review requirements for restructuring material assets, the review on horizontal competition of a listed company must particularly cover the controlling shareholder and actual controller of the listed company, their controlled entities, and the original controller of the asset being restructured.
In determining whether a business is “identical or similar with that of the listed company”, thus constituting horizontal competition, we should prefer substance over form, looking beyond business scope and industry at whether: (1) the two businesses share the same business contents, suppliers and clients, identical or similar processes or core technology, or overlapped sales channels; and (2) products or services of one business are replaceable by the other. In order to win support from review authorities, we may have to combine analysis with demonstration, taking into consideration not only the above-mentioned factors, but also industry features and expertise if necessary.
With respect to a business (entity) in horizontal competition with the listed company, which cannot be injected into the listed company in the contemplated restructuring, solutions focusing particularly on the competitive business or entity as described below can be adopted. We can also draw on the experience of some cases.
Closing business or disqualification (if licensed operation is involved). If an entity covered by the review procedure engages in any business identical or similar with that of the listed company upon the restructuring, horizontal competition can be avoided by closing the competitive business, insofar as the competitive business has not actually been started by the entity, or represents a minimal percentage of the entity’s revenue due to its small scale. Measures to be taken include terminating contracts concluded by the competitive business with third parties, requesting competent authorities to cancel qualifications, and modifying business scope and articles of association accordingly.
Transfer or sale to third parties. If the competitive business is of substantial scale, we may consider disposing of the entity in horizontal competition with the listed company. If any entity in horizontal competition position under control or direction of the restructuring party is not fit for being injected into the listed company, or if the listed company is unwilling to take it as part of the acquired assets, the restructuring party may consider transferring the entity to any unrelated third parties.
Entrusted management by the listed company. If injecting the competitive entity into the listed company as part of the restructuring is not feasible for the time being due to any significant obstacle to compliance (for example, the entity is involved in any outstanding significant dispute over real estate ownership, or in any other issues related to project approval or business qualification that must be addressed for compliance purposes), entrusted management combined with a commitment of takeover within a specified period may be a solution, provided that the obstacle will be removed in the foreseeable future and acquisition of the entity is feasible. It should be noted that entrusted management is a transitional, auxiliary alternative to avoid horizontal competition that is adopted in the case where a finalized solution is in place but cannot be implemented prior to the review procedure for the restructuring.
Likewise, if the business in horizontal competition with that of the listed company cannot be disposed of completely prior to review procedure for the restructuring, entrusted management combined with a commitment to close or cancel the business or transfer equity in the business to any unrelated third parties within a certain period upon restructuring can be a final solution. By “a certain period”, it means an explicit, specific and practicable timeframe. Vague terms such as “as soon as practicable” and “when the time is ripe” must not be used to avoid failure in passing the review procedure.
Market division. Although there were precedents where market division was accepted in CSRC review procedures as a solution to horizontal competition, the probability of it being acceptable to the CSRC is declining given that it may potentially restrict future growth of the listed company in the macro backdrop of an increasingly accelerated and normalized flow of physical objects, information, capital and talent in domestic and global markets.
Commitment. A solution to horizontal competition that contains only commitments is hardly acceptable to the CSRC, given the number of restructuring parties who break their commitments, and the purpose of protecting legitimate rights and interests of minority shareholders. Therefore, as a solution, a commitment is usually accompanied by one or more of the above-mentioned approaches.
Cao Yiran is a partner at Grandway Law Offices
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