April 01, 2009

Measures for the Administration of Registration of Capital Contributions in the Form of Equity

Issuing Body: State Administration for Industry and Commerce
Issuing Date: January 14, 2009
Effective Date:         March 1, 2009

How does a government stimulate investment when there's a worldwide shortage of cash and credit for would-be investors?

Over the past year or so, China, like many governments around the world, has tried to address that question by enacting a variety of laws and policies. In December 2008, for example, the China Banking Regulatory Commission issued the Guidelines for Risk Management of the Merger Loans of Commercial Banks, allowing banks in China to make loans, for the first time, in order to fund corporate mergers and acquisitions—an explicit effort to stimulate M&A activity in China.

Now China's State Administration for Industry and Commerce (SAIC) has enacted the Measures for the Administration of the Registration of Capital Contribution in the Form of Equity (Equity Contribution Measures), allowing investors to contribute equity in one company, rather than cash, property (including intellectual property) or property rights, to obtain an ownership interest in another company. While not solely intended for use in mergers and acquisitions, the Equity Contribution Measures are clearly designed to stimulate such activity—and, more broadly, the Chinese economy. The new rules came into effect on March 1, 2009.

Background and Purpose

Since early 2006, with implementation of the amended PRC Company Law, shareholders in a company have been allowed to make capital contributions with cash or "tangible objects, IP rights, land-use rights and other kinds of property that can be appraised in terms of currency and are entitled to be legally transferred." The Equity Contribution Measures add to that list a new type of non-monetary contribution: ownership interest in a company.

As of March 1, investors may use equity held in a limited liability or joint stock company (the Equity Company) to invest in another limited liability or joint stock company (the Invested Company). In all cases, both the Equity Company and the Invested Company must be established in China.

Though not groundbreaking, these measures make it reasonably clear and straightforward to make capital contributions using equity interests nationwide, and they provide the necessary details to help smooth transactions. The SAIC explicitly hopes that equity contributions, as a new form of capital contribution to Chinese companies, will help expand capital, ease financial difficulties for enterprises, stimulate growth and create jobs.

Provisions

In order to be used as a capital contribution, equity must be clear, unencumbered and capable of being transferred in accordance with the law.

Equity cannot be used, under the Equity Contribution Measures, as a capital contribution if:

  • the registered capital of the Equity Company has not been fully paid;
  • there is a pledge or other encumbrance on the equity;
  • the equity has been frozen in accordance with law;
  • the articles of association of the Equity Company prohibit the transfer of equity;
  • prior approval of the transfer is required by law, an administrative regulation or a decision of the State Council, and such approval has not been obtained; or
  • another circumstance prohibiting such transfer as specified in laws, administrative regulations or decisions of the State Council.

The equity to be transferred shall be appraised by a lawfully established appraisal firm in China.

The total amount of equity plus all other forms of non-monetary contributions to the Invested Company must not exceed 70 percent of the Invested Company's registered capital.

When the equity contribution is made upon establishment of a company, the investor is required to pay in such capital contribution within one year after the establishment of the Invested Company.

When an equity contribution is used to increase the registered capital of an existing company, the shareholder is required to pay such contribution before the Invested Company applies for registration of a change of its registered capital.

Conclusion

Despite general agreement that the Equity Contribution Measures are generally advantageous and allow Chinese companies greater flexibility, some concerns have arisen among foreign investors in China. Depending, for example, on the amount of equity contributed to the Invested Company, this type of capital contribution might significantly change the structure and nature of the company (or companies), which might in turn cause problems for a newly created company, for example by changing it from a foreign-invested company to a domestic company, or by transcending its original business scope.

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