Wal-Mart, Yihaodian, and the Mystery of the VIE

August 20, 2012

It didn’t take long for the usual suspects (i.e., foreign investment lawyers) to start chattering about the significance of the reference by the Ministry of Commerce to VIEs in its conditional approval of Wal-Mart’s purchase of a controlling stake in e-commerce giant Yiahodian. I wrote about the deal and the approval last Friday.

I’ve since had a chance to look at the actual approval language (in Chinese) as well as some of the conversations that have ensued, including this brief article from British firm Herbert Smith.

In my post last week, I did not make a big deal of the VIE aspects of this case because frankly I didn’t see it as the central issue, and besides, it didn’t appear as if the MOFCOM ruling changed anything with respect to the legality of the VIE structure.

I think I’m going to stick with that thinking. However, in light of the Herbert Smith article and other speculation out there, I figured a further comment might be a good idea.

Let me start off by saying that I haven’t yet read anything that suggests anyone really knows for sure what that MOFCOM ruling really means for VIEs. No, seriously. I’ve read it myself, along with several interpretations, and I have to say, more than one of them sounds feasible.

I think I understand the shareholding structure at this point:

1. Wal-Mart was a minority shareholder of a company called Niuhai, which has a Hong Kong offshore structure as well as one or more onshore subsidiaries. Niuhai is the entity in which Wal-Mart increased its shareholding.

2. Yishiduo is a Chinese company HQ’d in Shanghai that is the holder of the necessary VATS license required to operate the Yihaodian e-commerce platform. This is the VIE.

3. Presumably, Niuhai’s onshore company and Yishiduo have several contractual arrangements we all know and love, the basis of the VIE structure.

OK, in other words, Niuhai was basically doing some old-style round-tripping, which means money from China was taken offshore and used to capitalize a foreign entity, which was in turn used to set up one or more foreign-invested enterprises. The original investor was Chinese, but the companies in China were considered foreign under Chinese FDI law. Classic stuff.

Wal-Mart wanted to buy out one of the investors’ offshore holding, which triggered the anti-monopoly review. Wal-Mart, therefore, was not buying the e-commerce operating platform directly, therefore, only the foreign portion and its rights under the VIE.

So all is clear? Not exactly. The problem, as usual, is that the language from MOFCOM is mushy and unclear. Welcome to China law.

FYI, the language in question is the following:

(一) 纽海上海此次收购,仅限于利用自身网络平台直接从事商品销售的部分。

(二) 在未获得增值电信业务许可的情况下,纽海上海在此次收购后不得利用自身网络平台为其他交易方提供网络服务。

(三) 本次交易完成后,沃尔玛公司不得通过VIE架构从事目前由上海益实多电子商务有限公司(益实多)运营的增值电信业务。

Before you Chinese speakers out there say “Hey, that language doesn’t look all that complicated,” take another look and explain to me exactly what it means. I’m genuinely not sure.

For example, in that third paragraph, when it says that Wal-Mart may not use the Yishiduo network, via the VIE, I cannot really say for sure what that entails. I hope that Wal-Mart understands what it can/cannot do.

Obviously Wal-Mart cannot jump on the Yishiduo platform and start expanding it as a Wal-Mart business, offering services to third parties. That would be a pretty blatant use of a restricted license. Similarly, it also seems clear that Niuhai (i.e., Wal-Mart) can use its own network, although I have questions there as well.

The Herbert Smith article includes the following reaction:

The imposition of these conditions appears to be primarily driven by MOFCOM’s concern over the potential use of the VIE structure by Walmart to operate essentially a VATB business without obtaining the requisite foreign investment approval.

I disagree with the emphasis here. Yes, it’s true that MOFCOM is concerned about Wal-Mart’s potential use of the Yihaodian platform. This is a normal competition law issue, one that we would expect in such a conditional ruling.

The presence of the VIE is however, at least in my mind, purely incidental. This deal happens to involve a VIE structure, and so if Wal-Mart was going to abuse a post-deal dominant position by using the Yihaodian platform, then yes, that would include its VIE structure, a key asset.

In other words, MOFCOM isn’t so much worried about Wal-Mart’s use of a VIE per se, but rather with a possible market concentration that could, in part, be built upon a VIE.

Does that make sense?

So has MOFCOM said anything concerning VIEs that is significant? Herbert Smith suggests yes, but is cagey about it:

The MOFCOM approval therefore is the first time that the VIE structure has been expressly mentioned by a PRC authority. It should be noted that the approval itself does not expressly say the use of such structure is illegal. Accordingly, it remains to be seen whether MOFCOM will take any further action in this regard.

There are three ways I could argue this. Being a lawyer, this comes second nature to me:

1. MOFCOM’s warning about the use of the Yishiduo VIE suggests that it is adopting a policy of closer scrutiny of such structures. Investors beware! (King & Wood’s Susan Ning supports this interpretation.)

2. MOFCOM’s specific acknowledgement that the target company for which it is giving an approval operates a VIE structure is as close to a formal recognition of the legality of VIEs that we are going to get. Investors celebrate!

3. MOFCOM’s chief concern with this approval was competition in the retail space. Yihaodian could just as easily owned the country’s largest trucking or warehousing business instead of a VIE-operated e-commerce platform. MOFCOM seems neutral on VIEs and will probably only deal with them on a case-by-case basis. Investors go back to sleep!

Me, I’m kinda thinking Argument #3 makes the most sense, but I’ll admit that I’m speculating along with everyone else out there.