Dealing with competing business when quoting on the New Third Board

1. The concept of competing business

Where a company carries on the same or a similar business as its controlling shareholder, its actual controller, or a natural person or legal person having a material influence over it, together with the other enterprises they control, the two sides constitute, or may constitute, a direct or indirect competitive relationship.

The reason competing business obstructs quotation on the New Third Board is this: between two companies in competition, and above all between two companies one of which controls the other, the controlling shareholder or actual controller may move business and commercial opportunities about at will, so that the interests of the controlled company and of its investors may be harmed. To protect the quoted company and the investors at large, most of whom are minority shareholders, many capital markets prohibit competing business strictly.

2. The scope of the check for competing business

When a company is quoted on the New Third Board the scope of the check is comparatively narrow, but in principle the principle that substance prevails over form should be followed. In general intermediaries check the following:

1. the company's controlling shareholder and actual controller and the other enterprises they control;

2. the close relatives of the controlling shareholder and of the actual controller, and the other enterprises they control;

3. the other enterprises controlled by the company's directors, supervisors and senior officers and by their close relatives;

4. a legal person or natural person shareholder holding 5 per cent or more, and the other enterprises it or he controls;

5. other subjects identified under the principle that substance prevails over form.

3. The tests for competing business

In deciding whether a company to be quoted and a related enterprise are in competition, the chief question is whether their businesses are competitive or substitutable. Generally the company to be quoted is examined as follows:

1. The statutory business scope and the business actually carried on

Where the statutory business scopes of the two are competitive or substitutable, but the business actually carried on and the products actually made are not, there is no competing business.

2. The region in which, or the customers to whom, the products or services are sold

This check is chiefly to establish whether the businesses are competitive, that is, whether the situation is one of "the same trade without competition".

3. The production process

The point of this check is whether the production processes differ materially. Where the company to be quoted and its competitor both fall within one broad industry but their products are subdivided, the difference in production process may be an important aspect in deciding whether there is competing business.

4. The characteristics of the industry and the mode of business of the two companies

In some individual cases the regulators will also decide whether there is competing business in the light of the characteristics of the industry in which the two companies operate and their modes of doing business.

Competing business is a difficult point in practice, and intermediaries should examine strictly in deciding whether two companies compete. Even where the two are in "the same trade without competition", the sameness of trade should as far as possible be removed, or there will be considerable risk.

4. How competing business is dealt with

1. Reorganisation: the company to be quoted acquires the competitor and absorbs it as a subsidiary; or the business is reorganised, the competing business of the competitor being transferred to the company to be quoted.

2. Divestment by the company to be quoted:

where the competing business is not the principal business of the company to be quoted, that part of the business may be transferred to a third party, or the company may cease to carry it on.

3. A change on the part of the competitor:

(1) the competitor is deregistered;

(2) the competing business of the competitor, or its equity, is transferred to a third party with no connection to it.

4. A letter of undertaking. The controlling shareholder, the actual controller, and the directors, supervisors and senior officers sign an undertaking to avoid competing business.

5. The rules and guidance

1. The Guidelines on the Content and Format of the Public Transfer Prospectus of the National Equities Exchange and Quotations System (for trial implementation)

Article 26: a company applying to be quoted shall disclose whether it carries on the same or a similar business as its controlling shareholder, its actual controller or the other enterprises they control. Where it does, it shall give a reasonable explanation whether there is competing business.

The company applying to be quoted shall disclose the measures its controlling shareholder and actual controller have taken, and the undertakings they have given, to avoid competing business.

2. The Guidelines of the National Equities Exchange and Quotations System on the Due Diligence of Sponsoring Brokers (for trial implementation)

Article 20: to investigate whether the company and its controlling shareholder, its actual controller and the other enterprises they control are in competing business.

By questioning the controlling shareholder and the actual controller of the company, examining the business licences and visiting the production or sales departments on site, to investigate the business scope of the company's controlling shareholder and actual controller and of the other enterprises they control, and to determine from the nature of the business, the customers, substitutability and differences in the market whether they carry on the same or a similar business as the company, and so are in competing business.

Where competing business exists, the company is required to explain why it is reasonable, and an investigation is made of the measures the company has taken and the undertakings it has given to avoid it.

3. The Rules on the Preparation and Submission of Information Disclosures by Companies Publicly Issuing Securities (No. 12) — the Legal Opinion and the Lawyer's Work Report on a Public Issue of Securities

Article 38: related-party transactions and competing business

whether the issuer and a related party are in competing business; if so, the nature of that competition.

(7) whether the parties concerned have taken effective measures, or undertaken to take them, to avoid competing business.

(8) whether the issuer has disclosed fully the related-party transactions and the undertakings or measures for resolving competing business, and whether there is any major omission or major concealment; if so, the effect on this issue and listing.