Key due diligence issues for gas M&A

By Lucia Yang, East & Concord Partners
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Gas enterprises can accelerate transformation through M&A, expanding their scale to quickly enter regional markets. This article discusses key points that distinguish legal due diligence issues of gas M&A projects from other industries.

GAS BUSINESS LICENCE

Article 15 of the Regulations on the Administration of Urban Gas stipulates that “the state implements a licensing system for gas operations”. In other words, enterprises engaged in gas business are required to obtain a gas business licence from the gas administration department of the local people’s government at or above county level.

Lucia Yang, East & Concord Partners, Key due diligence issues for gas M&A
Lucia Yang
Partner
East & Concord Partners

When verifying such a licence, special attention should be given to the scope, region and validity period of the franchise stated in the licence. In addition, based on actual business activities, it should be judged whether there is any out-of-scope operation, out-of-term operation, operation before obtaining the gas business licence, or other such violations. Importantly, gas business activities are actually carried out by holding a hazardous chemical business licence, typically in the form of LNG (liquefied natural gas) single-point direct-supply gasification station operations.

In due diligence, enterprises should therefore focus on whether the gas is sold as fuel or industrial raw materials, and whether the activities involve only sales conducted by way of bills, or also include self-processing, storage, transportation and terminal operation. Since the devastating Shiyan gas pipeline explosion in Hubei on 13 June 2021, tragically resulting in 25 deaths and 138 injuries, gas administration departments nationwide have intensified inspection of illegal gas operations, especially single-point direct-supply stations.

Considering that single-point direct-supply stations remain justifiable for historical reasons and can meet certain market demands, attention should also be paid to changes in regulatory policies during due diligence. For example, both the municipal government of Tangshan and provincial government of Zhejiang issued notices on special rectification of single-point direct-supply stations in 2021.

LOCAL FRANCHISE

Judging from article 2 of the Administrative Measures for the Franchise of Municipal Public Utilities and article 2 of the Administrative Measures for the Concession for Infrastructure and Public Utilities, franchising of gas supply is not mandated at state level. Therefore, before conducting legal due diligence on gas enterprises, it is necessary to check relevant laws and regulations of the province, city and county where the target company is located, and business operation is located, to ascertain whether local franchising of gas supply is mandatory, and accordingly whether a franchise is required to carry out gas supply business in a particular area to verify legal compliance of a business operation.

PIPE NETWORK ASSETS

Due diligence on gas pipe network assets primarily concerns two issues – ownership and use of special equipment.

In terms of ownership, it should be noted that although article 19 of the Regulations on the Administration of Urban Gas stipulates that a gas operator is responsible for the operation, maintenance, repair and renovation of gas facilities outside the proprietary construction area of owners within the building zone, article 274 of the Civil Code provides that “other public places, public facilities and property service rooms within the building zone shall be co-owned by building owners”.

By definition, this means that courtyard pipe network facilities, namely those within the red line of the building zoning, are jointly owned by building owners, and unless ownership of these assets is transferred to the gas operator by owners’ meeting or owners’ committee, the gas operator cannot naturally own such assets.

As for pipe network facilities within the building zone for non-resident users, namely industrial and commercial users, it is necessary to first determine if there is agreement on ownership of such facilities in the contract signed with the gas operator. In the absence of such an agreement, as stipulated in the above-mentioned Civil Code article, ownership of such assets belongs to the non-resident users. However, if non-resident users contractually agree that ownership of such assets belongs to the gas operator, such an agreement is deemed as the owner’s disposal of them, and is legal and effective.

In terms of special equipment, according to the Special Equipment Safety Law, the state implements catalogue-based management on special equipment. Pressure vessels and pressure pipes are special equipment listed in the Special Equipment Catalogue formulated by the General Administration of Quality Supervision, Inspection and Quarantine. The gas operator should, before or within 30 days of putting special equipment to use, register such use with the department responsible for safety supervision and administration of special equipment, and obtain a certificate of use registration. Therefore, during due diligence it is crucial to ascertain whether the target company has obtained this certificate of use registration.

QUALIFIED OPERATORS

In terms of personnel, due diligence requires establishing whether the company has qualified special equipment operators and production safety management personnel, as well as operation, maintenance and emergency repair personnel.

According to the Special Equipment Safety Law, operators of special equipment and relevant management personnel (collectively, special equipment operators) may engage in corresponding operation or management having only passed the examination of special equipment safety supervision and administration, in accordance with relevant state provisions, obtaining the national unified-format Certificate of Special Equipment Operator. It is necessary to check whether the company’s special equipment operators have this valid certificate.

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According to the Regulations on the Administration of Urban Gas, persons in charge and production safety management personnel of gas enterprises, as well as operation, maintenance and emergency repair personnel, should receive professional training and pass examinations.

In addition to the qualification of special equipment operators, due diligence must also attest to qualification of production safety management personnel and operation, and maintenance and emergency repair personnel including, but not limited to: the qualification certificate of production safety management personnel; the certificate of production and operation unit managers; the training certificate of full-time safety officers; the certificate of gas appliance installation workers; the certificate of gas appliance installation and maintenance workers; and the qualification of gas transmission workers.

Lucia Yang is a partner at East & Concord Partners

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