By David Liu and Natasha Xie
Foreign buyers in M&A deals should regard put options as additional protection of their investments in overseas markets. They can withdraw their investments by exercising the options that demand repurchase or buyout of the shares they acquired under specific circumstances that were agreed on in the M&A transaction agreements. Put option issues in China, however, might be more complicated than in mature markets because company law in China is still developing.
Obligors in Put Options
The obligor in a put option can be either the seller of existing shares to the foreign buyer or the target company that has issued new shares to the foreign buyer. Sometimes the foreign buyer may require the target company and the seller to be jointly liable for repurchase of the shares to get better financial protection when exercising its option. The obligor may undertake to repurchase the shares or to procure a third party to purchase them. In a Sino-foreign joint venture situation, the buyout of the shares may lead to one company being invested in by a single shareholder. This is not allowed for a limited liability company that is solely invested in by domestic investors under current company law because there must be a minimum of two shareholders.
All terms and conditions of the option shall be specified in advance, including the conditions for exercising the option, the price and the term. Among other things, price is essential to both parties. A price formula will therefore be developed. Normally, the interest cost incurred as well as the dividends enjoyed by the foreign buyer for holding the shares shall be taken into account in the price formula.
Approval by a Shareholders' Meeting
When the target company undertakes to buy the option shares, corporate authorization shall be obtained. Usually, an option agreement is subject to the approval of the shareholders' meeting. However, will a separate approval for repurchase of the shares and the resulting capital reduction be further required when the option is called on the target company? This is not clear under PRC law. As a practical matter, the company registration authority requires a resolution passed at the shareholders' meeting on capital reduction; therefore, a separate resolution will be required when the option is exercised. Meanwhile, for a listed company, the foreign buyer will have to abstain from voting as a connected person at the relevant shareholders' meeting, which also adds uncertainty to the foreign investor's option rights.
Any shareholding change in the target company in regulated industries will be subject to government approval. Such approval must be obtained when the option is exercised, regardless of whether the transaction agreements, which have granted put options to foreign investors, have been duly approved by the relevant government authority. Should the government authority reject it, an extension of the term of the option could be one solution.
PRC law provides strict statutory requirements for capital reduction by a company, including notifying its creditors and making a public announcement. The creditors would be entitled to demand that the company repay its debts or to provide security for such debt when they disagree with the capital reduction. In addition, the registered capital of such a company following the capital reduction shall not fall below the minimum level set by law. In the option agreement, the target company shall be required to go through these statutory formalities.