M&A of domestic engineering design enterprises by foreign counterparts

Article 4 of the Provisional Regulation of the Ministry of Construction on the Administration of Foreign Enterprises Engaging in Construction Engineering Design Related Activities in China stipulates that when a foreign enterprise undertakes construction engineering and design in China, it has to co-operate with at least one Chinese construction engineering design enterprise to proceed with the design undertaking, and it should not provide the services for compiling the preliminary design of construction projects, designing the construction drawings and other services to the clients within China by itself.

Faced with the huge construction design market within China, the shortcut for foreign enterprises to march into the Chinese market is to merge with an enterprise with a construction engineering design qualification, in order to proceed with the design undertakings.

This column will discuss some mergers and acquisitions (M&A) cases that this firm has handled, where foreign companies acquired construction engineering design enterprises located in Beijing, and we can share some experiences.

Requirements for foreign investors

Not all foreign enterprises can acquire construction engineering design enterprises within China. Pursuant to article 13 of the Administrative Regulations on Foreign Investment in Construction Engineering Design Enterprises, which came into effect on 1 December 2002, the foreign investor of the foreign-invested construction engineering design enterprises in China should be an enterprise engaging in construction engineering design in its home country.

This means that foreign enterprises which do not engage in construction engineering design in their home country cannot acquire Chinese construction engineering design enterprises to participate in relevant undertakings.

Determining qualifications

Regarding the determination of whether a foreign investor is an enterprise engaging in construction engineering design in its home country, article 11 of the above-mentioned administrative regulations provides that foreign enterprises should provide the following documents when submitting an application for the establishment of a foreign-invested construction engineering design enterprise:

1. The registration certificate of the enterprise engaging in construction engineering design in its home country;
2. The proof of performance and credit of construction engineering design issued by the authorities or industry societies, associations or notaries in its home country.

The registration certificate is similar to a business licence in China. The first requirement can be satisfied once the business scope in such document includes the construction engineering design undertakings. In practice, the proof of performance in the second requirement may be a little tricky. We encountered a problem in a case where our client was from Japan, which has no such authorities, relevant industrial societies, associations or notaries to issue the required proof.

So we communicated with the Beijing Municipal Commission of Urban Planning, and the alternative approach we agreed on was to provide proof issued by the proprietors that had been provided with the construction engineering design service.

Qualification after M&A

When a foreign enterprise merges with or acquires a domestic enterprise with a construction engineering design qualification, it faces a risk that the qualification of construction engineering design of the target company may not continue to be retained after the M&A.

In article 3 of the Implementing Measures of the Ministry of Construction on the Qualification Administration in the Administrative Regulations on Foreign-invested Enterprises in Construction Industry, the domestic construction enterprises acquired by foreign enterprises therefore become foreign-invested construction enterprises, and their qualifications must be re-examined according to the standard they had actually reached.

Under this provision, the qualification owned by the target company after the M&A cannot be retained with certainty, and it should apply for re-examination by the construction administrative authorities.

Regarding foreign investment in construction engineering design undertakings, China remains cautious and reserved. In practice, there are not too many foreign-invested construction engineering design enterprises. Foreign enterprises face the discretion of Chinese authorities in the re-examination, and the risk remains that the target company may not obtain, or cannot obtain in a timely fashion, the new qualification after the merger.

Re-examination

As discussed above, after the merger by the foreign enterprise, the domestic enterprise has to apply for the re-examination with the construction administrative authorities. In general, it will take at least some months from submission of the re-examination to getting the new qualification. During this period, whether the target company can engage in construction engineering design with the original qualification is not yet clearly defined under existing law.

We have consulted with Beijing Municipal Commission of Urban Planning on this, and received the reply that during the re-examination, the signed construction engineering design contract could continue to proceed with the original qualification, but the target company cannot sign a new construction engineering design contract and proceed with new undertakings.

Avoiding M&A risks

Unlike the M&As of general companies, attention must be paid to whether the target company can retain the design qualification after the M&A of the domestic construction engineering design enterprise with the foreign company. If the target company cannot obtain a new qualification after the M&A, this would be a failed M&A. To avoid such a risk to the greatest extent, foreign enterprises should clearly provide that the original shareholders of the target company should bear the responsibility when the company cannot obtain the new qualification in the acquisition documents, and guarantee the way that the foreign company can exit the target company conveniently.

Han Yanyuan is a partner and Luo Jia is an associate at East & Concord Partners