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China’s “New” M & A Review System. Just Chill.

By Dan Harris on Posted in Legal News

Last week, China came out with some guidance as to how it is going to determine whether foriegn company acquisitions (M&A) endanger China’s national security and there have already been all sorts of articles speculating that this is going to mean a real crackdown on foreign acquisitions. I was going to wait a few weeks to write on this, but since Stan Abrams over at China Hearsay just did such a nice job covering it, I am going to write on it now.

I like Stan’s view of it because it comports with mine. In his post, entitled, “Reciprocity and Slippery Slopes: China’s New M&A Review System,” Stan tells everyone to relax. I could not agree more.

Stan bases his advice on the following:

1. China’s laws often start out with little detail and then it “sometimes it takes years before additional guidance (e.g. from the Supreme Court) or simply a track record of judicial action lets us know how a new law is going to be enforced. In other words, let’s not get too excited about the broad language in the scope of this review body just yet.”   

2. “Beijing has always been big on reciprocity. If a foreign government does something to China, or Chinese companies, there is a good chance that Beijing will strike back in some way. We’ve seen this with trade and investment matters, visa procedures, etc. To some extent, this national security review is a reaction to similar bodies abroad that have hindered efforts of Chinese companies to engage in offshore acquisitions.” China is likely to treat companies from other countries similarly to how those countries treat companies from China. 

3. China already has plenty of ways it can block deals so there is no reason to think it has added this national security review simply to do so.  

Agreed.

By the way, if you are not reading China Hearsay, you should be. There used to be a number of excellent China law blogs out there, but with the exception of China Hearsay, few if any of those post wtih any real regularity. It really is pretty much just us two now and so if you read us, I urge you to read China Hearsay as well. Stan’s blog is generally more analytical and less nuts and bolts than this one, which is all the more reason to read us both.   

  • Aaron

    Stan @ China Hearsay article wrote,
    “The US security review body, called CFIUS (PDF file), isn’t used that often, but it has been used to nix several Chinese deals, including CNOOC/Unocal and Huawei/3COM. In my humble opinion, those proposed transactions were sabotaged by a blatantly political use of the CFIUS process.”
    To give a little more context, the latest Chinese review body rules came as a DIRECT response to US CFIUS’s blatant and obsurd interference in the Huawei/3Leaf deal.
    3Leaf is a US company that went bankrupted a while ago. It did R&D in cloud computing technologies. It had no government contracts and no products on market.
    Huawei came in the auction of 3leaf assets and bought up 7 patents, some building / equipment, and hired 15 ex-3leaf employees (probably for the winding up process).
    CFIUS has “recommended” that Huawei voluntarily divest the purchased assets, and this morning, Huawei announced that it will not voluntarily abide CFIUS’s recommendation.
    CFIUS, again, cites Huawei’s ties to the Chinese government, and says the deal jeopardizes national security that Huawei acquires such technologies.
    -
    That’s an illogical argument from CFIUS.
    Huawei’s purchase of 7 patents is not a technology transfer. Those patents are already published by the USPTO. None of those 7 patents are classified as any kind of secret. (And Huawei has proven in its history that, like any giant tech company, it is very capable of reverse engineering technologies.)
    Making Huawei turn over those 7 patents (and equipment) won’t stop the technology transfer.
    CFIUS’s recommendation makes zero sense in this case, even less sense than its previous recommendations.
    -
    Frankly, it is expected that the Chinese government would respond by creating a body similar to CFIUS.
    And it is entirely rational for Huawei to refuse to follow CFIUS’s recommendation. Huawei is definitely going to fight this.

  • Anon

    This will do nothing but maybe put a different hat on the same realities, with a net effect of approximately zero. China already prohibits foreign investment in swathes of its economy and significantly restricts the terms on which it can occur in others, in catalogues “guiding” foreign investment. I believe Stan touched on this in his post, albeit in kinder words. There is no case by case review for the most part. In these industries, it is a categorical “no,” or an “only on our terms,” right from the start. These industries happen to be some of the most profitable, and the ones in which foreign multinationals have been most competitive globally over the last decades. “National security,” in this sense includes a broadly defined notion of the “security” of the “people’s economy.” And it’s this system through which Huawei itself, with more than a little bit of assistance from just about every major western telecom firm on the planet, grew from nothing into the (second?) largest telecom firm on the planet in about a decade. It is this system, founded on the strategic significance of the state’s interest in the intellectual property of a number of key industrial sectors, that serves as the basis and rationale for the now-infamous indigenous innovation campaign. Everything that CFIUS does plus a lot more has been going on in China ever since reform and opening up started, to far more commercially significant effect. So, yes, let’s just chill about this new review procedure. In real terms, it is quite literally nothing new, except different window dressing.
    The problem that I have with it is the political significance. Aaron is right that it is a direct reaction to the CFIUS review process, i.e., little more than a political spitball at the eye of the United States. CFIUS’ primary detractors–including and perhaps especially those speaking from or on behalf of China–are just as politically motivated as the CFIUS process itself, and I would say much more so. CFIUS is not nearly as bad as so many people make it out to be. Take one frequently-bashed example of the CFIUS process–the CNOOC/Unocal deal. At the time, Unocal owned the only rare earths mine in the US. Rare earths mining in China? Essentially prohibited to foreign investment–private or otherwise–without any talk of any kind of review.

  • Hillbilly

    Anon has excellently addressed the manner in which the PRC already inhibits foreign investment in a variety of industries, and the impact of the CFIUS, including the often overlooked rare earths aspect of the CNOOC case. The only effect I can see from China detailing equivalent regulations is that it will to a degree clarify sectors which are out of bounds for foreign businesses and prevent some from wasting their time and money.
    I really cannot let Stan and Aaron’s criticism of CFIUS pass unanswered. For starters, 3COM and Unocal were rightly rejected. The 3COM acquisition most definitely comprised a viable threat vector to US national security under the terms proposed by Bain/Huawei, and had to be rejected, although I did argue myself that we should offer Huawei a set of conditions under which it would have been acceptable (though with no expectation that Huawei would agree to the conditions).
    As regards the 3Leaf acquisition, Huawei pursued it in a manner that would have been successful in 2007, by not informing CFIUS, but their attempt to do so post-3COM was an absurd provocation likely to result in rejection regardless of the nature of the business acquired. Any possible effect on national security as a result of the transfer of 3Leaf’s assets is not contingent on whether the assets and patents have been commercialized yet, but whether they are subject to EAR and ITAR, which seems highly likely in the former instance.
    “Huawei has proven in its history that, like any giant tech company, it is very capable of reverse engineering technologies.)…Making Huawei turn over those 7 patents (and equipment) won’t stop the technology transfer.”
    Aaron, if a mugger steals your wallet and the cash therein, do you not cancel your credit cards? I rather doubt that you will let him max out your credit cards just because he got his hands on some petty folding money. Even in the event that the patents are judged to be non-controlled under EAR, this acquisition required review by CFIUS in order to create a policy precedent that would subject future technical IP to automatic review, with a penalty of near certain divestment for the buying company that attempts to avoid review.
    Huawei’s intention to challenge the CFIUS recommendation and avoid divestment is a self-defeating strategy, and incredibly foolhardy. First, a Chinese company asking the President to side with them over the DOD and Treasury is a blatant attempt at provocation. they know very well it will be rejected and media/diplomatic recrimination will follow. Odd to say the least given Huawei’s publicly stated intention of investing heavily in North American business expansion in the next two years. Second, if they do refuse to divest the assets/patents they will only precipitate further legislation detailing punitive measures to be applied in the event of future refusal to comply with the direction of the President. All that for some petty cloud computing patents? If you are going to steal something, steal something worth the consequences.