China: Engaging with Mofcom

Author: | Published: 1 Oct 2010
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August 2010 marks the second anniversary of the Anti-Monopoly Law of China (AML). Although still young, the AML has already proved to be an important factor in M&A activities when a transaction meets the threshold of Chinese anti-trust filing.

According to statistics from the PRC Ministry of Commerce (Mofcom), the sole competent authority for anti-trust filing in China, Mofcom has already received 140 merger applications for review. Mofcom has completed its review in approximately 90% of these 140 applications. Ninety five percent of those reviewed were approved unconditionally. This is in line with international practice; on average in the EU and in the US 93% of mergers are approved unconditionally.

Thus far, only six mergers have been approved with conditions and only one merger rejected (Coca-Cola's proposed acquisition of Huiyuan). Conditional clearances were made of the following transactions: the acquisition of Anheuser-Busch by Inbev NV/SA, and the acquisition of Lucite International by Mitsubishi Rayon, the acquisition of Delphi Corp by General Motors, the acquisition of Wyeth by Pfizer, the acquisition of Sanyo by Panasonic, and the acquisition of Alcon by Novartis AG.

Although the number of Mofcom's decisions to prohibit or to supplement restrictive conditions to the concentration only account for a small percentage among all the decisions that have been made, they still aroused considerable discussion and interest. We think that the significance of the above seven cases to the legal and business world is that it is clear that the Chinese anti-monopoly authorities have the power to veto or to modify M&A transaction undertakings; and therefore, when planning M&A strategy or implementing M&A transactions, the undertakings which have met the anti-monopoly filing threshold must carefully consider the impact of anti-monopoly filing to the transactions. We will also take two cases, in which King and Wood has represented, to illustrate what kind of strategy should be taken to get the best result where a condition is unavoidable.

Overview

According to Article 29 of the AML, Mofcom can supplement the restrictive conditions in a proposed transaction to reduce the likely anticompetitive effects of the transaction. The article does not specify the restrictive conditions that could be supplemented; Mofcom therefore has considerable discretion in this regard.

Mofcom can impose structural, behavioral and combined structural and behavioral remedies. As indicated, there have not yet been many cases where Mofcom has imposed remedies, but already a variety of remedies have been sought.

According to the Measures for the Undertaking Concentration Examination (the Measures) Mofcom and business operators involved in concentration may raise suggestions on amendment of the restrictive conditions. If the notifying parties and business operators involved in concentration cannot reach an agreement with Mofcom on the conditions, Mofcom cannot impose the conditions unilaterally but can prohibit the proposed transaction.

In the EU and other jurisdictions, the notifying parties may decide to give up the transaction and withdraw their notifications before the issuance of decisions by the authorities where they are unable to reach an agreement with the authorities on the conditions. It is also possible to do this in China.

According to Articles 11 and 12 of the Measures , the business operators that are parties to the concentration must pay attention to the following requirements when proposing conditions:

(1) The text of the restrictive conditions shall be clear and definite enough to evaluate their effectiveness and feasibility;

(2) The conditions proposed by the business operators must be effective to eliminate the actual or potential effect of eliminating or restricting competition caused by the proposed concentration, and must be feasible.

Business operators can, in the review process, modify the conditions they have proposed, and/or propose new conditions.

If the conditions proposed are found not to eliminate the actual or potential effect of eliminating or restricting competition caused by the concentration of business operators, Mofcom can make a decision to prohibit the concentration.

Therefore, it is advisable for the business operators to prepare for the possible negotiation of conditions with Mofcom before making a notification.

Structural conditions are aimed at restoring the competition structure of the relevant market before the transaction; they called one-off remedies.

Frequently adopted structural conditions include the separating off of part of the assets or business of the business operator(s).

In offshore transactions, the notifying parties may want to separate off the PRC subsidiaries or assets on the basis that by doing so the approval may be obtained without delay in China.

According to the authors' previous experiences, the above strategy does not necessarily ensure prompt clearance in China.

When the geographic market of the relevant products is greater than the territory of the PRC, the peeling off of the PRC subsidiaries or assets may not completely eliminate Mofcom's concerns. Mofcom may still hold concerns regarding the increase of import volume, the establishment of new plants by the parties in China in the foreseeable near future, etc. Therefore, the separating off of the PRC subsidiaries or assets may not remove the possibility that Mofcom denies the offer of a structural remedy and Mofcom may even prohibit the transaction.

Structural conditions are preferred by Mofcom as one-off measures such as assets divestitures are easier to supervise and are often likely to be more effective because they bring about the maintenance of two real competitors who will continue to compete in the market.

Behavioural conditions are aimed at restricting the behaviour of the parties so as to maintain or restore effective competition; they are referred to as continuing remedies.

Frequently adopted behavioural conditions include:

(1) Opening of networks, access to a platform or other essential facilities of the business operator;

(2) Licensing of essential technologies (including patents, proprietary techniques or other intellectual property rights); and

(3) Termination of exclusive agreements.

Due to their nature, behavioural conditions require post-implementation supervision. Moreover, the effectiveness of the behavioural conditions may not emerge immediately. That is why Mofcom usually prefers structural conditions.

Integrated conditions are a combination of structural and behavioural conditions.

Mofcom recently issued Interim Regulations on Implementing the Divestiture of Assets or Businesses in Concentration of Business Operators (divestiture regulations). The regulation provides some sort of structure from which business operators can expect to divest their assets pursuant to a merger control decision issued by Mofcom. In our view, the regulation is consistent with the divestiture regulations in the more experienced antitrust jurisdictions such as the EU.

In practice, it is important to work closely with Mofcom when a business has been told to divest pursuant to a merger control decision. Regular consultations with Mofcom will ensure that the divestiture process goes smoothly. In our experience, it takes approximately six months for a business to find a suitable purchaser for the divested business and to reach the relevant agreements for the sale. It is also noteworthy that Mofcom has stipulated that divested businesses should be transferred to the purchaser within three months of the execution of the sales and other agreements; although this time limit may be extended with Mofcom's consent.

Furthermore, according to Article 15 of the Measures, Mofcom shall make examination and supervision of the implementation of concentration with conditions attached.

Mofcom requires business operators participating in the concentration to report to Mofcom regarding the implementation of the conditions in accordance with the prescribed schedule. In this regard, not only the notifying party must report to the Mofcom, but also the other parties to the transaction that are involved in the implementation of the agreed conditions.

The AMB has established the Supervision and Enforcement Office, which has the task of assisting other offices to supervise the implementation of the conditions.

If the business operators to the concentration do not fulfill the restrictive conditions, they may face the following legal consequences:

(1) Mofcom may require them to fulfill the conditions within a specified time frame; and

(2) Should they persist in failing to do so, Mofcom may impose a sanction applying the AML's remedies, such as a fine or the disposal of the shares or assets according to Article 48.

Undertakings not satisfied with a Mofcom decision can seek administrative or judicial relief. Under Article 53 of the AML, parties must first seek administrative review before initiating administrative litigation.

Administrative review is conducted by the Treaty and Law Department of Mofcom. Judicial review will only be granted if the administrative procedure is in violation of the law, or the administrative discretionary power is abused, or the result is obviously unjust. Hence, while use of administrative review or administrative litigation to overturn the prohibition decision or decision with additional restrictive conditions is possible, it is difficult.

Novartis/Alcon case

On August 13 2010 the proposed acquisition of Alcon, Inc (Alcon) by Novartis AG (Novartis) was approved by Mofcom with conditions. This is the first merger that has been approved with conditions this year. King & Wood acted as the sole Chinese legal counsel in respect of the antitrust aspects (including the antitrust filing) of this transaction.

The Novartis and Alcon transaction is a cross-border or global deal. The parties have filed merger review applications in some 19 jurisdictions. Currently, the acquisition has been cleared by antitrust authorities in most of these jurisdictions. Besides China, the transaction was conditionally cleared by the antitrust regulators such as the EU and USA.

Novartis and Alcon (the parties) are global suppliers of pharmaceutical products. Post-acquisition, Novartis would become the majority shareholder in Alcon. This transaction is worth approximately $28 billion. Both the parties are engaged in eye care products, ophthalmic pharmaceuticals and lens care products.

During consultations with Novartis, Alcon and other stakeholders, Mofcom was of the view that there were antitrust concerns in the market for ophthalmic anti-inflammatory and anti-infective combination products and the market for lens care products. Mofcom was concerned about the impact of the transaction in light of Novartis' and Alcon's market shares in these markets both globally and in China.

Mofcom noted that the combined global share of the parties in relation to ophthalmic anti-inflammatory and anti-infective combination products was over 55%. The parties' combined share for the same product market in China was over 60% (Alcon's share is over 60%; whereas Novartis' share is less than 1%).

As a condition of clearance, Novartis agrees to (i) continue to withdraw its product in China by the end of 2010; (ii) refrain from re-entering the Chinese market with products under the same or a different brand for five years from August 13 2010; and (iii) refrain from supplying to the Chinese market its ophthalmic anti-infective and anti-inflammatory compounds currently sold outside China for five years.

The parties' combined global share in relation to lens care products was almost 60%. In addition, the parties' combined shares for the same product market in China was almost 20%. Post-acquisition, the parties would become the second largest supplier of lens care products in China.

Mofcom noted that Shanghai Ciba Vision Trading Co., Ltd. (Shanghai CV), one of Novartis' subsidiaries, has in place an exclusive distribution agreement with Haichang Contact Lens Co., Ltd (Haichang) to distribute lens care products in China. Haichang is currently the largest manufacturer and supplier of lens care products in China (its share in China is over 30%).

Mofcom was concerned that the parties would be able to collude on pricing and other issues with Haichang (via the distribution agreement), post-acquisition. According to Mofcom, such collusion would restrict or exclude competition in the lens care product market in China.

In light of this concern, Mofcom stipulated that Novartis terminate its distribution agreement with Haichang within 12 months of closing.

The notification of the transaction was submitted to the Administrative Management Service Center of Mofcom on April 13 2010. On April 20, Mofcom officially accepted the notification. On May 17 Mofcom issued the notice to start further review, which meant that the review of the transaction entered into the Phase II review period. On August 13 2010 Mofcom issued its approval decision of the proposed acquisition.

The review of the transaction comes through the entire two phases (ie Phase I and Phase II). During Phase I, Mofcom did not raise any questions. All the supplementary requests and competition concerns were raised during Phase II.

All the remedies provided in China for the transaction are behavioral remedies. The public announcement issued by Mofcom only provided limited explanation of the reasoning behind its requirements.

In its public announcement, Mofcom did not articulate whether the relevant geographic markets for the ophthalmic anti-inflammatory and anti-infective combination products and lens care products were global or China-wide. However, it appears that Mofcom might have taken the parties' shares in both the global context and the China context into consideration, in determining whether the acquisition would eliminate or restrict competition in China.

The rationale behind this may be that Mofcom was concerned that the strong combined market power of the operators involved in the concentration in global market may leverage (transmit) such power to China's market which could restrict or eliminate the competition, although the relevant geographic market of the concentration shall be identified as national market and the incremental market share after the concentration is small.

In Novartis/Alcon case, Mofcom stressed the importance of the existing relationship between the operators involved in the concentration and their competitors (ie the relationship between Novartis, its subsidiary and Haichang). The rationale behind the condition requiring Novartis to terminate its distribution arrangement with Haichang regarding lens care products may have been a concern about the possible coordinated effects which may result from the completion of a transaction which may restrict or eliminate the competition even though the combined market share of the parties is not high.

The information about horizontal or vertical agreements of cooperation among operators in a relevant market is necessary information required by Mofcom. The existence of horizontal and vertical cooperation among enterprises in China is a sensitive issue under the PRC AML, and may cause potential legal risks for those enterprises. However, if the notifying party does have such existing agreement or relationships and does not disclose such information to Mofcom, the notifying party may be at risk of violating rules on cartel under the PRC AML.

For those large or sensitive transactions, an internal antitrust notification evaluation is needed. The operators shall layout the timetable and sketch the possible difficulties before filing the notification.

For those global notification cases, Mofcom does refer to the review process/opinions/concerns of other jurisdictions, especially for EU and US. Under these circumstances, the notifying party shall inform Mofcom about the general information and review process in other jurisdictions, which may assist and appendix the review process in China. As a side remark, it was noted that some multinational enterprises had recently tried to exert pressure on Mofcom with their global deal timelines, and that this had not been helpful.

Pfizer/Wyeth case

On September 29 2009, Mofcom announced the clearance, with restrictive conditions, for Pfizer Inc.'s (Pfizer) acquisition of Wyeth Corporation (Wyeth).

Pfizer is a research-based, global pharmaceutical company. It is publicly owned, and its shares are listed on the New York, London, Euronext, and Swiss stock exchanges. Pfizer discovers, develops, manufactures and markets prescription medicines for humans and animals, and consumer healthcare products. Pfizer has a presence in 89 countries and its products are sold in over 150 countries. Pfizer's operations can be divided into two business segments: human pharmaceuticals and animal health.

Wyeth, formerly known as American Home Products, is a research-based pharmaceutical and healthcare company. Wyeth is based in Madison, New Jersey and operates in 145 countries around the world. It has approximately 47,426 employees worldwide. Wyeth's has three primary business divisions. These are Wyeth Pharmaceuticals, Wyeth Consumer Healthcare and Fort Dodge Animal Health. The core businesses below are Wyeth business divisions from an internal management structure perspective. From the perspective of the sectors in which Wyeth is active, its activities mainly cover five areas, namely: pharmaceutical, consumer health, animal health, vaccines and nutritionals.

In 2009, Pfizer and Wyeth entered into an agreement and plan of merger. As a result of the transaction, Wyeth will become a wholly-owned subsidiary of Pfizer and Pfizer will thus acquire sole control over Wyeth.

Mofcom received Pfizer's merger filing application regarding its proposed acquisition of Wyeth on June 9 2009 and supplemental materials on June 11 and June 14 respectively. Mofcom commenced its preliminary review on June 15. By July 15, which was the expected deadline of the preliminary review, Mofcom identified competition issues regarding the transaction in the area of animal health products and therefore decided to conduct a further review, which was due to expire on October 13 2009. Finally, on September 29, Mofcom announced it had cleared the concentration, subject to conditions.

Since this is the first multinational pharmaceutical filing in China, in order to define the product market appropriately, we successfully persuaded Mofcom to adopt the Europe ATC3 as the classification method of human pharmaceutical products. The human pharmaceutical products market definition will be based on this classification. With regard to the animal health products, the PRC Ministry of Agriculture divided the animal health products into three categories for relevant administration: vet-pharmaceuticals, vet-biological, and vet-feed additives and the major operators and large industry associations all adopt this classification method. We also successfully persuaded Mofcom to adopt this kind of classification as the basis of animal health products.

The relevant geographic market of the notified concentration is the domestic market of mainland China. The relevant product markets of the notified concentration are human pharmaceuticals and animal health products. The products of notifying parties overlap in the following Chinese markets: (i) human pharmaceuticals, in particular J1C (broad-spectrum penicillins) and N6A (anti-depressants and mood stabilisers), and (ii) animal health products, in particular swine MH vaccines, swine pseudorabies vaccines and canine multivalent vaccines.

Mofcom considered that the concentration between Pfizer and Wyeth may have the effect of limiting or excluding competition in the market for swine mycoplasma pneumonia vaccine. According to the information obtained by Mofcom:

The market share of the merged entity would reach 49.4% (Pfizer now holds 38% and Wyeth 11.4%) which is a much larger share than Intervet/Schering-Plough Animal Health, who is second in the market with only 18.35%, and other competitors in the market which hold less than 10% of the market. As such, the merged entity would have the ability to use its scale to expand in the market and to control the market price.

Market concentration is high and as a result the proposed concentration would have the effect of eliminating or excluding competition in the Chinese market of swine mycoplasma pneumonia vaccine, as evidenced by analysis using the Herfindahl-Hirschman Index (HHI).

Technological barriers to entry into the relevant market would be even higher and the merged entity might limit other companies from development by taking advantage of its scale in the Chinese market.

Given the effects of restricting competition on the Chinese swine MH vaccine market after the acquisition of Wyeth by Pfizer and for the purpose of reducing such adverse effects, Mofcom decided to approve the concentration with conditions, according to which Pfizer must divest its swine mycoplasma pneumonia vaccine business in mainland China under its brands of Respisure and Respisure One. The subject matter of the divestiture includes any tangible, intangible assets and intellectual property rights of Pfizer which are necessary to ensure the continuity and competitiveness of the divested business. Within six months, Pfizer must, through a trustee, find an independent buyer that is approved by Mofcom and execute an agreement for sale of the relevant business. If Pfizer fails to find a buyer within the prescribed period, Mofcom may appoint a new trustee to dispose the relevant business with no set minimum price.

Mofcom also required that Pfizer appoint a provisional manager during the six months divestiture period. The manager is to monitor the divestiture and is to protect the continuity, marketable quality, competitiveness and independency of the business to be divested.

Further, for a period of three years following the divestiture, Pfizer is required, upon the request of the buyer, to provide reasonable technical support, to assist in purchasing materials needed for the production of the swine mycoplasma pneumonia vaccine, and to provide training and consultancy services to the buyer and its staff.

In our experience, Mofcom will probably organize hearings during the review process to investigate and collect evidence from relevant parties, including the competitors, the players in up and down stream industries, and the industry associations, etc. Other operators who participate in the hearings can propose some suggestions of the restrictive conditions to Mofcom, which may include divestiture, a cap on the selling prices, output, amount of import, or proposed investment in the future after the transaction, etc. Mofcom may adopt restrictive conditions in accordance with suggestions collected from consultation with the interested parties.

To better understand the suggestions proposed by other relevant parties in the hearings, the filing parties may apply to Mofcom for attendance at the hearings. Even where the application for attendance is denied, the filing parties may take the initiative to communicate with Mofcom directly or respond to questions and issues raised in the hearings by other relevant parties.

There is no statute or case law that specifically indicates whether the remedies shall take place before or after the closing of the relevant transaction. We understand that it shall depend on the features of the specific remedy proposed by the authority or the parties.

With respect to products with high aggregated market shares, the most likely remedy would be a divestiture. Divestiture is a complicated procedure, so timing is crucial for the parties who have to reach the agreement with the officials on the conditions of divesture within the review period, and finish the divestiture within a tight timeframe.

Therefore, it is highly recommended that the parties communicate with the officials at the earliest stage about their intention to offer remedies if divesture is inevitable.

In our experience, the final remedy will be the result of bargaining between the parties and Mofcom. Therefore, the parties should make full use of their negotiation skills to minimise the possible remedies.

In order to dissolve Mofcom's concerns, the parties may need to find the purchaser at the earliest stage, and may even propose the purchaser to Mofcom during the negotiation.

If the parties believe there is a risk that the transaction may be denied or only approved with supplementary restrictive conditions by Mofcom, consideration should be given to proactively providing substitute plans to win the support of Mofcom, and avoid the transaction being blocked and the imposition of restrictive conditions. If divesture is inevitable, it is highly recommended that the parties communicate with the officials at the earliest stage about their intention to offer remedies.

Furthermore, if the parties to a concentration believe that the transaction will eliminate or restrict competition in a relevant market and will possibly be objected by interested parties, they are well advised to undertake PR and lobby work with industry associations, consumer association and the competent department. In particular, they may want to promote that the transaction will bring more privileges to consumers, create more job opportunities, improve technologies and that the transaction will not negatively impact; or that the prohibition of the transaction will have negative consequences.

Last but not least in importance, care should be taken in drafting the notification report. A good notification report that organises the materials well, highlights advantages and avoids disadvantages can be very helpful in obtaining approval of the antimonopoly notification.

About the author

Susan Ning is the head of the Antitrust Group at King & Wood. She specialises in antitrust, international trade, and general corporate law in China. Ms. Ning has advised on the anti-trust aspects of M&A transactions since the relevant legislation came into force in 2003. Ms. Ning has represented a wide variety of companies before the Chinese competition authorities and has provided clients with the Anti-Monopoly Law compliance training. Ms. Ning has been actively involved in the legislative process behind China's antitrust law. She is the chairwoman of the Antirust Committee of the Inter-Pacific Bar Association (IPBA) as well as the frequent speaker of American Bar Association (ABA) antitrust forum. Her articles on the anti-monopoly law of China have been published by Euromoney's Competition & Antitrust Review since 2007. She has been recently awarded in the International Who's Who of Competition Lawyers (2010) and 2009 Legal Awards for Practice
Excellence by Corporate INTL.

Ms. Ning is the leading counsel to the Beijing Organizing Committee for the Games of the XXIX Olympiad in 2008 and is highly regarded in China and internationally. She is the Vice Chair of the China Committee of the ABA Section of International Law and is a member of the board of directors of the World Law Group.

Susan Ning joined King & Wood in 1995. Before joining King & Wood, she worked at the Global Law Office and several foreign law firms.
Ms. Ning received her LLB from Peking University Law School and her LLM from McGill University Law School in Canada. Ms. Ning was admitted as a Chinese lawyer in 1988. She is proficient in Chinese and English.

Contact information

Susan Ning
King & Wood

40th Floor, Tower A
Fortune Plaza,
7 Dongsanhuan Zhonglu, Chaoyang,
Beijing, 100020

Tel: +8610-58785010
Fax: +8610-58785599
Email:susan.ning@kingandwood.com Web:www.kingandwood.com

About the author

Jiang Liyong is a member of the Anti-trust Group at King & Wood. He specializes in antitrust, international trade, and general corporate law in China. In the area of antitrust and competition, Mr. Jiang has advised dozens of international and domestic clients in diverse industries including software; beverages; telecommunications; energy and chemical and pharmaceutical industries, on their compliance with Anti-Monopoly Law and Anti-Unfair Competition Law, and in anti-monopoly filing with MOFCOM in the course of M&A. Before joining King & Wood, Mr. Jiang served as a legal official in the Ministry of Commerce (Mofcom) of China. He is also the first legal diplomat in charge of dispute settlement to have been sent by Chinese government to its Mission to World Trade Organization (WTO) in Geneva.

During his public service life, he has been actively involved in many bilateral or multilateral negotiations as a leading legal advisor, and appeared numerous times before the WTO panel and Appellate Body. Mr. Jiang is coauthor of the Chapters, "General Introduction of Chinese Anti-trust Legal Regime" and "Administrative Monopoly" in a CCH book published by Wolters Kluwer regarding the Anti-Monopoly Law of China. He has published several articles in  pioneering academic journals in China.

Mr. Jiang joined King & Wood in 2008. Mr. Jiang received his LLB from China Youth University for Political Sciences, and his LLM from both Peking University and Oxford University. Mr. Jiang was admitted as a Chinese lawyer in 1999. He is proficient in Chinese and English.

Contact information

JIANG Liyong
King & Wood

40th Floor, Tower A
Fortune Plaza,
7 Dongsanhuan Zhonglu, Chaoyang,
Beijing, 100020

Tel: +86 10 5878 5217 
Fax: +8610-58785599
Email:jiangliyong@kingandwood.com
Web:www.kingandwood.com

About the author

Chai Zhifeng joined King & Wood in 2007 and is a senior associate in the Antitrust and Competition Division. Mr. Chai has worked on a range of antitrust and competition matters including merger filings and assisting companies in their Anti-Monopoly Law compliance program and planning. Since joining the division, he has worked on some 10 merger filings on a wide range of industries. Some of the recent merger filings he has worked on include: Pfizer Inc’s acquisition of Wyeth; and Novartis AG’s acquisition of Alcon Inc. Mr. Chai holds a Master of Law from the University of International Business and Economics in Beijing. Mr. Chai is a Chinese qualified lawyer.

Contact information

Chai Zhifeng
King & Wood

40th Floor, Tower A
Fortune Plaza,
7 Dongsanhuan Zhonglu, Chaoyang,
Beijing, 100020

Tel: +8610 5878 5222
Fax: +8610-58785599
Email:chaizhifeng@kingandwood.com
Web:www.kingandwood.com

About the author

Ms. Liu Jia specializes in antitrust legal affairs, corporate matters.
Ms. Liu assists dozens of clients in antitrust filing in China with MOFCOM in the course of M&A, including Fiat, NEC, Renesas, Cisco, Chartered, Nippon oil, Nippon Mining, Bucyrus, Novartis, and many other multinational companies. Ms. Liu has also provided legal services to companies including due diligence, documents drafting and review, issuing legal advice.

Work Experience
Ms. Liu Jia joined King & Wood in 2009.
Ms. Liu obtained LL.M from Tsinghua University. She is proficient in Chinese and English.

Contact information

Liu Jia
King & Wood
40th Floor, Tower A
Fortune Plaza,
7 Dongsanhuan Zhonglu, Chaoyang,
Beijing, 100020

Tel: +8610-58785588
Fax: +8610-58785599
Email:liujia2@kingandwood.com
Web:www.kingandwood.com