Supply chains: Restructuring to address global fragmentation

Why is this an important issue now?

• Rising tensions between the U.S. and China and increasing use of policy tools such as import tariffs, foreign investment restrictions, export controls, and tighter national security protections are challenging the economics and feasibility of global supply chains.
• In response, businesses are faced with the decision of whether to restructure their international operations to address geopolitical risk, for example by adopting a model that either sources and produces goods in a greater range of markets or that could continue to deliver globally even if regional elements were cut off. 

What are the main legal and regulatory considerations involved in supply chain restructuring?

Divestitures and carve-outs in China: What are the primary policy challenges?

• Chinese industrial policy is geared towards boosting domestic champions, technological self-sufficiency, and industrial modernization.
• Engagement with regulators around a potential divestiture should therefore demonstrate the benefits of carve-out to China’s economic development (e.g., job creation, support for domestic supply chains etc) to improve likelihood of obtaining support and avoiding/minimizing regulatory impediments.

What could impact deal certainty?

• Geopolitical environment may impact deal certainty, valuation, and timing, given Chinese regulators’ tendency to slow-walk deals during periods of higher tension. Here, the knock-on impact on investor communications needs to be considered.
• Regulatory conditions to closing will draw in the seller. If getting to closing requires any “remedies”, the seller will need to decide its pain threshold and reflect that in the deal documentation.
• Domestic Chinese buyers may be able to resist “significant efforts” obligations to reach closing and may want to incorporate safeguards such as a material adverse event (MAE) trigger and/or break fees in a Chinese law/jurisdiction sale and purchase agreement (SPA) due to the perception of higher execution risk. 

How can sellers move technology and know-how out of China?

• It is common to transfer know-how, proprietary technology, and/or key staff out of China before a sale. However, this has become more challenging in recent times and requires a detailed assessment that considers China’s tightening of data, technology export, and counter-espionage laws.
• The Beijing government is increasingly using technology export control regulations to prevent cross-border transfers of technology, IP, and know-how, especially if classified as “dual-use” or “sensitive”.
• Staff transfers, especially of PRC nationals with technical knowledge, may be scrutinized. Potential challenges here should factor into choice of where to relocate facilities, alongside other commercial and regulatory considerations. 

What about moving key people?

• Deal planning should be refined to map the in-scope leadership and other critical roles, determine who must remain for any PRC domestic continuity versus who can transfer or exit, and to test buyer type (strategic vs sponsor) for willingness and legal ability to assume or rehire staff. Transfer mechanics and timelines should be built into the plan (any PRC consent or termination/rehire, TUPE-style transfers in EU/UK, authority notifications, and consultations).
• Management should decide early which senior managers and experts need to be retained for value preservation and knowledge transfer, and which should move with the business. This should be calibrated against works council/union processes, collective bargaining obligations, TUPE or equivalent regimes, and PRC constraints (any mass layoff thresholds, protected categories, severance economics), with costs and conditions reflected in the deal.
• Targeted, milestone-based retention should be implemented from the outset to stabilize operations through cutover, and align equity/bonus, notice/garden leave, and enforceable confidentiality/IP and restrictive covenants to protect know‑how and customer relationships.
• HR diligence and data sharing should be privacy-compliant (PRC PIPL and destination laws) to avoid delays.

How can intellectual property be protected?

• Rapid reconfiguration or relocation of supply chains can significantly increase the risk of trade secret loss or leakage. Disgruntled local partners and redundant employees, both of whom may have had access to sensitive IP, could be incentivized to use or disclose trade secrets to further their own interests.
• Existing agreements (e.g., joint ventures, collaborations, research agreements) may contain imperfect provisions regarding background/foreground IP and termination mechanisms. Employment contracts may also lack adequate protections, and local employment laws may be unfamiliar or untested.
• Procedural tools and remedies are available to mitigate IP risks, including using disclosure mechanisms to establish infringement, leveraging the US International Trade Commission (ITC) to block products from the U.S. market in cases of trade secret infringement, and applying the EU Trade Secrets Directive to prevent infringing products from entering Europe.
• Attention should be paid to problematic contractual provisions and opportunities to renegotiate terms to strengthen IP protection.

Buyer universe

Selling to a non-Chinese entity

• Sales to non-Chinese buyers are possible, subject to availability. However, depending on the manufacturing activity there may be a higher risk of state intervention in the deal through specific regulatory tools, especially National Development and Reform Commission (NDRC)/national security review.
• Opinions from Chinese industry associations and regulators will be highly influential in the process.

Selling to a domestic Chinese acquiror

• Selling to a Chinese domestic buyer may therefore be more likely.
• Here, domestic manufacturers’ focus is shifting towards supply chain resilience, technological adaptability, and sustainability.
• If potential buyer is a state-owned enterprise (SOE), the deal is likely to be complicated by a wider set of stakeholders and additional bureaucracy, which can impact speed and valuation. Early engagement and informal discussions are a key component of deal execution with these counterparties.
• Transactions with Chinese listed companies have particular dimensions, e.g., if the deal size is significant and the structure offshore, a “material asset restructuring” may be triggered, which has significant regulatory implications.
• Understanding listing rules is also important; many listed buyers will actively structure around (rather than seek) approvals.
• Chinese private equity firms are playing a more prominent role in key sectors, backed by municipal government entities, which may increase options but raises certain issues (e.g., local government involvement may increase the risk of ongoing commitments). 

Deal structuring

What are the key issues in a full vs partial exit?

• Depending on the nature of the supply chain for the business being disposed, the seller’s ability to achieve a full or “clean” exit may be constrained as domestic buyers may look to pursue supplementary commercial arrangements (e.g., securing a stable and cost-effective supply of upstream raw materials) as a package deal.   
• As a result, it may be prudent to consider embedding full value of the package in the transaction from the start—rather than risk it being extracted by regulators as a price to close (though the risk of buyers using the regulatory system to create leverage to re-trade remains). 

What about a direct vs indirect divestiture?

• An indirect divestiture (via an offshore entity) offers greater flexibility in terms of structuring and from a funds flow perspective.
• A direct (via a domestic entity) divestiture will subject the seller to tax withholding and foreign exchange regulations when withdrawing the sale proceeds from China.
• Domestic buyers typically require a direct divestiture to avoid the need for separate and substantive outbound investment approvals which can be difficult to obtain and are in practice highly politicized.
• If this option is pursued, early engagement with the relevant local and national NDRC bodies is critical to gauge the transaction feasibility, with choice of buyer a key hidden consideration.

What exit charges might be involved?

• Exit taxes are likely to comprise capital gains tax, VAT on asset sales, and potential withholding taxes on remittance of proceeds.   
• Here again there may be timing considerations; in sensitive transactions, approvals may be withheld or delayed, prompting sellers to maintain supply contracts post-sale, or make exit conditional on continued supply, especially if the supply chain is deemed strategically important.

How will the payments be structured?

• Arrangements to ensure that funds are available and can be released in a timely manner will be defined by the type of divestiture (i.e., if it takes place onshore, PRC onshore escrow arrangements are likely to be favored).
• Escrow arrangements are commonly used in cross-border deals to address potential payment uncertainties. Several international banks in China provide escrow services with flexible release instructions.
• Engaging a creditworthy guarantor can provide greater assurance regarding payment risk. It is essential to ensure both the guarantor’s financial standing and the enforceability of the guarantee.
• Letters of credit are another possible option, though buyers may be reluctant due to the associated costs, especially for deferred payments over an extended period.
• To facilitate foreign exchange procedures and remittance, alignment between the seller and the buyer’s banks should be arranged in advance.
• International investment banks with historically strong China presence are active in the market, but there are signs that they are reducing their coverage.
• Chinese investment banks are frequently involved, especially when marketing to domestic buyers. 

What governing law will apply to the deal?

• If an onshore structure is adopted, PRC counterparties will typically prefer PRC law as the governing law. In many cases—particularly where the counterparty is an SOE—PRC arbitration is likely to be the preferred dispute resolution mechanism. This may have downsides, but in practice, sellers may have limited room for maneuver.
• There may be more flexibility in transactions involving private buyers, who may for example be willing to consider Hong Kong law and Hong Kong arbitration as a compromise. 

How might Chinese buyers approach an acquisition?

• There is a high degree of variability between players, making the familiarity of the buyer with international transactions and market norms an important selection criterion.
• SOE buyers are generally less flexible than private equity buyers, but there is a lot of divergence within each group. As a result, specific assessment will be needed.
• Due diligence is usually conducted by local advisers following international market practices (e.g., management presentations, site visit, virtual data room).
• However, not all domestic buyers are familiar with the customary common law construct of indemnities, so indemnity requests may be broad and without limits.
• Deferred consideration, escrow arrangements, or deposit are common, but subject to foreign exchange controls.

How long will the sale take to complete?

• A sale will typically take between eight and 12 months. However, it is not unheard of for deals to take longer, with the timeline dependent on the complexity of the transaction and the regulatory approvals required.
• Day-to-day geopolitical tensions may have an impact on timeline, but they ultimately tend not to be decisive.
• Practical delays (e.g., “window guidance” from authorities, slow processing of foreign exchange remittance) may extend the process further.