Security review for M&A by foreign investors under spotlight

By Leo Wang and Ben Chai, DaHui Lawyers
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There are no specific laws in China that govern a national security review of mergers and acquisitions of Chinese domestic enterprises by foreign investors. The relevant principles for such reviews are set out in the Anti-Monopoly Law, implemented since 1 August 2008, and the Provisions of the Ministry of Commerce on Merger and Acquisition of Domestic Enterprises by Foreign Investors (foreign M&A rules), enacted by the Ministry of Commerce (MOFCOM) on 22 June 2009.

Leo Wang Senior associate DaHui Lawyers
Leo Wang
Senior associate
DaHui Lawyers

However, while the above-mentioned regulations provide principal rules requiring relevant parties to report foreign M&A transactions that may have a potential impact on national security, no specific and enforceable mechanism sets out details of the security review, such as the scope, procedures or duration.

Following the above principles, the Notice of the State Council on Establishment of Security Review System Pertaining to Mergers and Acquisitions of Domestic Enterprises by Foreign Investors was released by the State Council on 3 February 2011. On 25 August 2011, MOFCOM released the Provisions of Ministry of Commerce on Implementation of Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors. Since that time, although there is no separate law, through administrative regulations China has established a workable national security review regime for foreign M&A.

Review authorities. The security review for foreign M&A is mainly handled by the Inter-Ministerial Conference, co-chaired by MOFCOM and the National Development and Reform Commission (NDRC). According to the specific industry or the key regulatory authority of the target enterprise, opinions from key regulatory authorities other than MOFCOM may have special weight during the process of a national security review.

Scope of review. According to the State Council notice and MOFCOM provisions, the protected areas of national security mainly concentrate on enterprises in military and national defence sectors, along with “fundamental industries”, which covers “enterprises and supporting enterprises in the military industry, enterprises located near key and sensitive military facilities, other entities related to national defence and security, enterprises affecting national security that provide key agricultural products, key energy and resources, vital infrastructure, important transportation services, core technologies, significant equipment manufacturing, etc.”

Right of control. A national security review will only be triggered when the foreign investor acquires the right of control, otherwise only general rules on foreign investment apply. A foreign investor will be regarded as having obtained the right of control under the following situations: (1) the foreign investor, individually or in aggregate, holds 50% or more of the shares of the target enterprise; (2) the foreign investor, although holding less than 50% of the shares of the target enterprise, has a significant impact on the resolutions of the shareholders or board of directors; or (3) other circumstances which result in the actual transfer of the rights to control operational, finance, personnel and technology decisions of a domestic enterprise to the foreign investor.

Review procedures. The national security review mainly consists of five steps.

  1. Consultation. The applicants may request a consultation on procedural issues with MOFCOM. Consultation is not mandatory for the review procedures.
  2. Initiation. The process will be initiated under two circumstances: (i) upon application by the foreign investor; or (ii) upon suggestion by relevant departments of the State Council, national industry associations, enterprises in the same industry, or upstream and downstream enterprises, provided that the Inter-Ministerial Conference finds it necessary to initiate the security review, in which case MOFCOM will initiate the review on its own authority.
  3. Acceptance. For any self-initiated applications, MOFCOM will accept those applications that meet all the application requirements.
  4. Review. The Inter-ministerial Conference will first conduct a general review, and if the application fails to pass the general review, a further special review will be undertaken. During the special review, if there are significant differences of opinions during the Inter-ministerial Conference, the application will be submitted to the State Council for decision.
  5. Decision. The Inter-ministerial Conference or the State Council will decide to permit or terminate the foreign M&A.


The MOFCOM provisions explicitly state that: “Foreign investors shall not substantially circumvent security review on mergers and acquisitions in any way, including but not limited to holding shares on behalf of others, trust, re-investment at multiple levels, lease, loan, control through agreement, overseas transactions, etc.”

Ben Chai, Associate, DaHui Lawyers
Ben Chai
DaHui Lawyers

Among the measures above, “control through agreement” (which would include the popular VIE structure) is common in China for foreign investors to control domestic enterprises that operate in industries that are restricted or prohibited to foreign investors, especially those in technology and internet-related industries. Theoretically, “control through agreement” is a method to avoid regulation on foreign investors. However, there have not been any large-scale investigations or punishment by relevant Chinese authorities on this practice.

Given that the MOFCOM provisions explicitly mention “control through agreement”, we recommend that foreign investors that conduct mergers and acquisitions in sensitive industries be cautious about such arrangements in order to avoid triggering a security review, which increases the likelihood that government authorities will determine that there has been a violation of relevant laws. Once a security review is triggered, the risk of the “control through agreement” arrangements being questioned or prohibited by regulatory authorities would be higher.

In short, the national security review regime aims to protect Chinese national security from potential risks caused by foreign M&A. Although a security review will be triggered only under limited circumstances, foreign investors should evaluate the potential effects on national security while analyzing their potential M&A targets. Relevant legal arrangements should be prepared in advance for projects that may trigger a security review, so that closing will not be affected by such a review.

Leo Wang is a senior associate and Ben Chai is an associate at DaHui Lawyers

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