With the State Administration for Market Regulation stepping up anti-monopoly regulation in private equity (PE) transactions in recent years, the matter of merger filing gains mounting traction within the field. This article illustrates conditions that trigger merger filing for PE transactions, pointing out common misconceptions and offering compliance advice.
TRIGGER OF FILING
Merger filing is obligatory if a PE transaction triggers a concentration of undertakings, while also meeting the turnover threshold.
Concentration of undertakings. Concentration can take place throughout all phases of a PE, namely setting up, investment, management and exit. This includes the following scenarios:
Fundraising and setting up: when more than two partners assume “common control” over the PE, whether via dual general partnerships (GPs), multi GPs, GP-limited partnership (LP) joint control, or a joint venture under common control of multiple parties acting as a GP;
- Investment: by investing in another undertaking, the PE acquires sole or joint control over it;
- Post-investment management: control over the PE itself shifts, or the control of any controller changes, or control over the investee changes; and
- Exit: by pulling out of the investment, the PE causes control over the investee to change, or an exit of the PE’s own investor causes its control structure to shift.
Meeting turnover standard. If, besides fulfilling the definition of the above-mentioned “concentration of undertakings”, undertakings also meet the turnover standard under the Provisions of the State Council on Thresholds for Notification of Concentration of Undertakings, merger filing becomes obligatory.
When calculating the PE’s turnover, figures of the following undertakings should be consolidated: the PE itself, other undertakings directly or indirectly controlled by the PE, de facto controller of the PE (i.e. all controllers if the PE is under common control of more than two parties), other undertakings solely or jointly controlled by the PE’s de facto controllers, and other undertakings under the common control of any two or more of the above-mentioned undertakings.
There are some typical misunderstandings in merger filing of PE transactions, including the following:
There is no need to consider merger filing when setting up a PE; or the PE is for investment, so only transactions relating to the investment transaction require assessment for filing. When setting up a new PE, if more than two undertakings assume common control and the turnover threshold is met, merger filing should be completed for the new PE before its formation. Setting up the PE and its subsequent investment are two separate transactions.
If the PE obtains sole or joint control of the investee via investment, and all undertakings involved meet the turnover threshold, the investment transaction is subject to its own merger filing.
If the PE’s formation and subsequent investment transaction are mutually conditional and highly correlated, they may be consolidated into a single transaction and filed once before the establishment.
PE investments are usually minority investments, for which no merger filing is required. Whether a transaction constitutes a concentration of undertakings depends first and foremost on whether the PE will afterwards gain control over the investee, which in turn is not judged solely based on shareholding.
If the PE has the right to decide on the investee’s major business matters (such as the appointment or dismissal of senior management, budgeting and operation plans), it is usually considered to have “taken control”. If all undertakings involved in the transaction meet the turnover threshold, merger filing becomes obligatory.
No merger filing is needed for single GP PEs. In the case of single GP PEs, if the LP gains the right to decide on the PE’s investments and operations via a partnership agreement, or by appointing members to the investment decision-making committee or the advisory committee, the GP and LP would be deemed to have common control over the PE. Then, if the GP and LP meet the turnover threshold, the formation of such a PE will also require merger filing.
Most PEs are set up for financial investments, so as long as they don’t affect competition in the relevant market of the investee, merger filing is not required. Merger filing is a prior review process, not always premised by the assumption that the transaction will adversely affect market competition. Therefore, no matter if the PE’s establishment or investment will affect competition in a relevant market, undertakings must proceed with merger filing, as long as both above-mentioned conditions are met.
As merger filing involves the disclosure of a “concentration of undertakings in relevant markets of the undertaking and its affiliated entities within the past three years” and a “history of formation and major modification of a company”, there is a risk that past transactions, for which due merger filings were not made, might come under investigation by the anti-monopoly authority.
Accordingly, it is advisable that PE firms conduct a systemic review of historical transactions as early as possible, and make supplementary merger filings where necessary.
For new transactions, firms should thoroughly assess the necessity for merger filing; and for transactions that do not necessitate a transfer of control, firms may consider amending the transaction documents to avoid triggering a merger filing.
A dynamic management system would also be ideal for real-time updates and management of the PE’s own turnover, as well as that of its portfolios, to ensure the firm always enters a new transaction with accurate, up-to-date turnover figures.
Ryan Fang is a partner and Simon Shi is a counsel at Jingtian & Gongcheng
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