Jurisdiction - China
Reports and Analysis
China – Foreign Investors Allowed To Inject Equity Interest As Capital Contribution.

6 December, 2012

 

In 2009, the State Administration of Industry and Commerce (“AIC“) issued the Measures for the Administration of the Registration of Capital Contribution in the Form of Equity Interest (股权出资登记管理办法), permitting Chinese companies to use equity interest in other Chinese companies as equity contributions.  However, it was difficult to implement these regulations in practice because there were no corresponding regulations from the MOFCOM, ie the Ministry of Commerce and many local MOFCOM authorities were reluctant to approve such type of capital contributions.
 
Now, with the recent promulgation of the Interim Provisions on Equity Interest Contributions involving Foreign Invested Enterprises (商务部关于涉及外商投资企业股权出资的暂行规定, the “Provisions”) by MOFCOM, starting from October 22, 2012, foreign and PRC investors can now use their equity interests in a Chinese company (whether domestic or foreign invested (“FIE“) as capital contribution to (i) establish a new FIE; (ii) convert a domestic company into an FIE; or (iii) increase the registered capital of an existing FIE.
 
I. Scope
 
The Provisions allow domestic and foreign investors (an “Investor”) to useequity interest held by them in a Chinese Company (“Equity Company“) as capital contribution (i) to establish a new FIE, (ii) to invest in a nonFIE and hanges it to an FIE, or (iii) to change the capital structure of an existing FIE (such company, the “Target Company”). 
 
Note that the  equity can only be used as a contribution to the Target 
Company’s registered capital and to receive additional interest in the 
Target Company and  cannot be used in a share swap transaction where the Investor exchanges its equity interest in the Equity Company with the equity holders of the Target Company.
 
II. Conditions of Equity Interest to Be Used as Capital Contribution 
 
The Provisions specify the types of equity interest which may be used as capital contribution. Interest in an Equity Company cannot be used for contribution as equity in the Target Company under the following circumstances:
 
  1. the Equity Company’s registered capital has not been fully paid up, or the Equity Company (if an FIE) did not participate in or failed to pass the previous year’s annual inspection; or
  2. the equity interest to be contributed has been pledged, frozen, or is not transferable according to the articles of association of the Equity Company; or
  3. the Equity Company is a real estate company, a foreign invested holding company (外商投资性公司) or a foreign invested venture capital or private equity enterprise (外商投资创业(股权)投资企业).
 
III. Foreign Investment Policy
 
The  foreign investment  industry policies  in China continue to apply to such equity contribution, thus only Target Companies which allow foreign investment could be invested using interest of an Equity Company. Otherwise, the Target Companies must spin off those businesses which prohibit foreign investment.
 
IV. Valuation and Pricing of the Contributed Equity Interest
 
The equity interest to be used as capital contribution must be appraised by a PRC appraisal firm. If the Target Company will have multiple shareholders after the contribution, the Investor and the Target Company’s existing shareholders may negotiate and decide the value of the contribution (股权作价金额) but the value of the increased registered capital (股权出资金额) may not exceed the appraisal value of the equity interest to be contributed (股权评估值). Accordingly, if the parties agree the value of the contribution (股权作价金额) would be higher than the appraisal value, then the excess amount may only be reflected in the reserve account, and not in the registered capital. 
 
In addition, the registered capital of the Target Company must comprise at least 30% cash, which means that the aggregate value of the equity interest to be contributed together with the  other non-cash assets that have been or may be contributed  may not exceed 70% of the total enlarged registered capital of the Target Company. This requirement is consistent with the requirement under the  PRC  Company Law in ensuring  the Target Company will have enough working capital for its operations.  Also note that the contributed equity will be excluded from calculation of the Target Company’s debt-equity ratio for purposes of determining the permitted amount of offshore debt.
 
V. Approval Procedures
 
Any transaction involving the contribution of equity interest must  be approved by the  provincial-level MOFCOM (“Transaction Approval Authority“) in the province where the Target Company is located,  unless central MOFCOM’s approval is required under other relevant  regulations.  If the Equity Company is also an FIE and was originally approved by  a  different  local counterpart of MOFCOM,  the Transaction Approval Authority should consult  with the provincial-level MOFCOM in the province where the Equity Company is located before it deliberates on the matter.
 
The application may be filed by the Investor or the Target Company.  In addition to the regular application documents that are required for changing the capital structure of an FIE, the applicant also needs to submit:
 
  1. the equity contribution agreement;
  2. documents proving the Investor’s title to the equity interest in the Equity Company;
  3. the business license of the Equity Company, its approval certificate and annual inspection record (if it is an FIE);
  4. the appraisal report issued by the appraisal firm; and
  5. a PRC legal opinion confirming (i) satisfaction of the conditions set forth in the Provisions (as described under Part II above), and (ii) compliance with the Chinese foreign investment industry policy with the proposed equity contribution.
 
After the proposed transaction is approved by the Transaction Approval Authority, the Equity Company must also apply to its original approval authority for approval of the change of shareholder.
 
Although there  are still some legal  and practical issues that need to be clarified by  MOFCOM and  other governmental agencies (such as  the level of  details  that  should be covered by the legal opinion), foreign investors now are able to consider using the equity interests it holds in China in their proposed restructurings, 
mergers and acquisitions.
 



For further information, please contact:

 
Jeanette Chan, Partner, Paul Weiss

Leave a Reply

You must be logged in to post a comment.