Performance commitments in listed firms’ M&A

In recent years, numerous listed companies have boosted their share values on the secondary market through company mergers, acquisitions and restructurings. With share values sharply spurred by promises of large profits, the market has been frequent witness to high multiple performance commitments. However, due to regulation flaws, insufficient punishment and a lack of honesty and transparency in the market, a significant number of performance commitments ultimately turn out not to be worth the paper they are written on.

Catch me if you can

In May 2008, the China Securities Regulatory Commission (CSRC) issued the Administrative Measures for Material Asset Restructurings of Listed Companies, specifying that when a listed company acquires assets, it is required to provide a profit forecast report for the proposed assets and execute a performance compensation agreement with the transaction counterparty. However, in reality, once a high multiple performance commitment is announced, the share value on the secondary market will skyrocket, allowing the committed party to obtain profits high enough to cover the costs it incurs due to a breach of contract. This results in exaggerated performance commitments. In December 2013, the CSRC issued Guidelines on the Regulation of Listed Companies No. 4 to regulate commitments and performance thereof by listed companies and their actual controllers, shareholders, connected parties and acquirers. The guidelines set out the procedure that a listed company and its acquirer are required to carry out in the event of a change in their commitments.

The amended restructuring measures in October 2014 specify that where a listed company purchases assets from a specific counterparty other than its controlling shareholder, actual controller or a connected party controlled thereby, and such purchase does not result in a change of control, the listed company and the transaction counterparty may negotiate at their own discretion as to whether to adopt performance compensation and earnings per share remedial measures and related specific arrangements.

However, due to the motivation to cash out, the revised restructuring measures have been unable to fully put a stop to listed companies and acquirers modifying their commitments at will. It is common for listed companies to use the guidelines to modify their performance compensation commitments. For example: Holitech and EM Technology changed their profit compensation principle from year-to-year calculation of compensation to three-year aggregate calculation of compensation. When Shenzhen Huaxin proposed to revise its committed performance, the plan was then deliberated on by the board of directors, supervisory board and shareholders’ general meeting, and an independent opinion issued by the independent directors and a legal opinion issued by a law firm, stating that:

(1) The restructuring had not resulted in a change in the actual controller, and the restructuring party was not the new controlling shareholder or actual controller of Huaxin or a connected party controlled thereby; accordingly, the deadline for the performance compensation may be adjusted only relying on the provision of the Contract Law specifying that parties may amend a contract if they reach a consensus through consultations;

(2) Pursuant to the restructuring measures, if in the course of a material asset restructuring by a listed company a material matter occurs that laws or regulations require be disclosed, an announcement is to be promptly made. If such a matter causes a substantive change in the contemplated transaction to occur, the same must be submitted anew to the shareholders’ general meeting for deliberation, and if a circumstance under article 13 of the measures applies to the transaction, it must be submitted to the CSRC anew for approval. Given that the circumstances under article 13 did not apply to the moneys for the contemplated material asset restructuring, there is no need for resubmission to the CSRC for approval;

(3) After consideration and adoption by the shareholders’ general meeting, the Supplementary Agreement to the Profit Forecast Compensation Agreement entered into effect.

In order to solve this kind of phenomenon, the regulator further tightened regulation. In January 2016, the CSRC issued the Questions and Answers on Performance Compensation in Acquisitions and Restructurings, emphasizing that until the controlling shareholder, or actual controller of a listed company, or a connected party controlled thereby, had completed implementation of its performance commitments it was required to use the shares and cash obtained by it to effect compensation.

In June 2016, the CSRC issued the Questions and Answers on Performance Compensation Commitments of Listed Companies, pointing out that the restructuring party’s performance compensation commitments in a material asset restructuring of a listed company are a key integral part of the restructuring plan, and the restructuring party may not apply the Guidelines No.4 to modify such commitments.

These CSRC documents have limited to some degree, but not truncated, the creeping spread of empty performance commitments. In October 2016, Medical System Biotechnology announced that it was proposing to revise the performance commitment term and commitment amount of the restructuring party, and as the preceding acquisition did not constitute a material asset restructuring, it was not bound by the CSRC June document above, and the revision of the commitments was considered and adopted by the company’s board of directors, supervisory board and shareholders’ general meeting, and the independent directors issued an independent opinion.

Given the relevant regulations and cases, the authors would make these recommendations: (1) Shoring up the performance commitment performance system. Depending on the degree of completeness of implementation of the performance commitments, the relevant party could be granted the right to unlock a certain percentage of the shares, and with respect to those performance commitments that have not been fully performed, it would not be permitted to unlock or pledge the shares it holds.

(2) Strengthening information disclosure and oversight. The CSRC and other regulators could require listed companies and relevant parties that have given commitments to issue a dedicated account of the feasibility of implementing the performance commitments and compensation plan.

(3) Active participation of small and medium shareholders to ensure procedural fairness in the pricing and transaction process. Small and medium shareholders should correctly assess high multiple performance commitments, rationally judge the investment value and not overly believe in its effectiveness in protecting their interests.

Du Lili is a partner and Wang Xiaoxing is a paralegal at Grandway Law Offices