Capital credit is crucial to an enterprise. Capital credit is even more important to a listed company for which disclosure is required. Furthermore, it directly affects the confidence of investors in profits of the listed company and the ability of the company to fulfill obligations in time.
1. The Three Principles of Capital
To ensure and maintain a company’s capital credit, determination of capital, maintenance of capital, and constant capital are principles originated from Company Law of People’s Republic of China (PRC). The principle of capital determination means that the registered capital of a company should be clearly stipulated in its articles of association and the stipulation should meet the conditions provided in the law. The principle of capital maintenance means that the assets of a company are always in good condition, thus protecting the interests of its creditors. The principle of constant capital means that the change of the capital of a company cannot be made arbitrarily without legal procedures.
2. Relevant Laws and Regulations in China
Such principles above are embodied in regulations such as Company Law of PRC and Measures for the Administration of Initial Public Offering and Listing of Stocks. Company Law provides that a shareholder may make capital contributions in cash, in kind, or intellectual property right, land use right, or other non-monetary assets that may be assessed on the basis of currency and may be transferred according to the law, excluding the assets that shall not be treated as capital contributions under any law or administrative regulation. Company Law also provides that the value of the non-monetary assets as capital contributions shall be assessed and verified and the amount of the capital contributions in cash paid by all the shareholders shall be no less than 30% of the registered capital of the limited liability company. Measures for the Administration of Initial Public Offering and Listing of Stocks provides that for a company to be listed, an issuer's registered capital shall have already been paid in full, the formalities for the transfer of the property rights of the assets contributed by sponsors or shareholders as capital have been completed, and there is no major dispute over the ownership of the primary assets of the issuer.
3. Manual Intervention that Have Occurred Under Current Laws
Capital contributions made by a shareholder in non-monetary assets is a complicated process which includes appraisal, transfer for the property rights and verification of the capital contributions. The value of non-monetary assets is uncertain and there are different forms of the transfer of property rights. The appraisal results will depend on the methods and valuation date the appraisal institution selects. Such peculiarity may result in the loss of capital contribution and inequality of shareholders obligated to make capital contributions.
Although requirement of the capital contributions involved in the public offering of a company to be listed are specified in laws in China, because of reasons mentioned above, there is some uncertainty in practical, which includes fake contributions and the procedural flaws in the process of capital contribution.
The methods being selected and the professional qualities of asset appraisal institutions are crucial to the value of the non-monetary assets. However, the laws in China do not stipulate the selection of appraisal institutions, the conformation of evaluation results, the liability of appraisal institution and other procedures. In addition, shareholders with bad faith may often make capital contributions using worthless assets or assets with inadequate value.
Regulations of the PRC on the Registration Administration of Companies stipulates that certification document indicating the completion of the formalities for transferring the shareholders' property rights is required to be submitted at the establishment of the Company, if the shareholders' initial capital contribution is made in the form of non-monetary assets. However, in practice, when the company is at the stage of establishment, the company does not have the qualification and the company will not be identified as the qualified assignee to go through formalities for transferring the ownership of properties and land use right.
Provisions of the Supreme People's Court on Several Issues concerning the Application of the Company Law of the PRC (III) provides that where an investor makes capital contribution with housing, the land-use right or the intellectual property right for which registration of ownership is required, and has delivered them to the company for use without completing the procedures for change of ownership, and the company, other shareholders or a creditor of the company makes a claim requesting the people's court to determine that the investor has not fulfilled the capital contribution obligation, the people's court shall order the investor to complete the formalities for change of ownership within a reasonable period specified . However, such remedies cannot protect the company and its debtors from the moment a capital contribution is made.
The value of non-monetary assets should be assessed and verified at the time when the capital contributions are made. However, due to the lack of means to determine the value of intellectual property rights such as trademarks, patent right and copyrights, the company’s actual capital contribution is affected.
4. Case Study
The author, when providing legal services for a potential listing exercise, has encountered with problems involved in the capital contributions made with non-monetary assets.
Shareholder of Company A made capital contributions with non-monetary contributions including two proprietary technologies and two copyrights. The patent application of the two propriety technologies has been submitted and the amount contribution depended on the appraisal of the value of the said proprietary technologies. However, when the company was established, one of the proprietary technology has been revoked.
- Problem in the Source of Intangible Properties
Before the company was established, the shareholder worked for another company in which the scope of business was the same as or similar to that of the company and which was also a R&D company. Patent Law of PRC provides that an invention that is accomplished in the course of performing the duties of an employee, or mainly by using the material and technical conditions of an employer shall be deemed a service invention. For a service invention, the employer has the right to apply for a patent. After such an application is approved, the employer shall be the patentee. If the shareholder cannot provide testimony indicating that an invention was not accomplished in the course of performing the duties of an employee or mainly by using the material and technical conditions of an employer and the invention is transferred from the third party, the intangible properties cannot be identified as belonging to the shareholder.
- Problem involved in Transfer of the Ownership
The shareholder is the patent applicant, which means the propriety technologies are not transferred to the company.
- Problems relating to the Subsisting Value
Patent Law provides that upon receipt of an invention patent application, if the Patent Administration Department under the State Council confirms that the application meets the requirements of this Law (after preliminary examination), the application shall be publicized within 18 months from the date of application. The Patent Administration Department may publicize the application on an earlier date upon the request of the applicant. The withdrawn patent will lose its confidentiality if the propriety technologies enter into the public area and the patent application is rejected. Due to the fact the shareholder is the patent applicant and the patent is not authorized, it is possible that the company may not get the patent. If the fair value of the propriety technologies passing the substantive examination is less than the appraisal value or cannot be assessed and verified, the capital contribution made by the shareholder may be viewed as untrue.
In order to solve the problem involved in the capital contributions, shareholders of the company may make capital contributions in cash or with other operating assets to replace the intangible asset, and ensure that the existing shareholders have undergone legal formalities and conduct legal and contractual between shareholders. If this method is adopted, the essence is that the company reduces the registered capital at first and then increases the registered capital. The increased amount is the same as the reduced amount.
Company Law provides that when a company reduces its registered capital, it shall prepare a balance sheet and a list of property and the company shall notify its creditors within ten days after the resolution on the reduction of the registered capital is made, and shall publish an announcement in newspapers within 30 days. Company Law also provides that where a limited liability company increases its registered capital, the capital contribution subscribed for by its shareholders for the newly increased capital shall be governed by the provisions of this Law on the capital contribution for the establishment of a limited liability company.