On 18 August 2011, the PRC State Administration for Industry and Commerce (SAIC) released a draft (for public consultation)1 of the Administrative Measures on Registration of Debt for Equity Swaps (the Draft Measures). The Draft Measures aim to regulate and administer registrations of equity interests/shares held by foreign and domestic creditors in limited liability companies (LLCs) and companies limited by shares (CLSs) incorporated in the PRC in exchange for cancellation of debts owed by such LLCs and CLSs to the creditors.
Financial restructuring of state-owned enterprises (SOEs) by way of debt for equity swaps started as early as the late 1990s and a number of financial assets management companies were established to take over non-performing loans granted by PRC banks to SOEs and then convert their creditors' rights into equity holdings in the SOEs. Therefore, the Draft Measures are long overdue as there has been a pressing need for rules governing nation-wide registration of debt for equity swaps. While debt for equity swap registration rules have already been issued by various local governments, the scope of registration under those local rules is limited as they only permit registration of such swaps between domestic creditors and debtors, thus excluding foreign creditors and foreign-invested enterprises (FIEs). In this regard, the Draft Measures achieve breakthrough in two important respects by allowing:
- foreign creditors to register debt for equity swaps ; and
- creditors (both foreign and domestic) to register their holdings of equity interests/shares in FIEs converted from indebtedness owed by such FIEs,
both subject to the relevant legal requirements and approvals.
Application and Key Requirements
Types of Debts
Under the Draft Measures, a foreign or domestic creditor may register with the SAIC or its local counterpart a debt for equity swap:
- arising from an indebtedness under a contract between the creditor and an LLC or CLS, including a foreign-invested enterprise (FIE), unless such swap is prohibited under PRC laws, regulations and articles of association of the LLC or CLS;
- upheld by a court judgment; or
- included in a re-organisation plan as approved, or under a settlement agreement as upheld, by the People's Court while an LLC or CLS in bankruptcy is under re-organisation and settlement with its creditors.
Some debt for equity swaps are subject to government approval which will probably include the following circumstances:
- the debtor is an SOE;
- the debtor is an FIE or operates in an industry where foreign investment is restricted or prohibited; or
- a foreign creditor converts its loans registered as foreign debts with the State Administration of Foreign Exchange into equity holdings in a debtor.
Creditor's rights to be converted into equity interests/shares must be appraised by a qualified asset appraiser and the value of the capital contribution in the form of such creditor's rights may not exceed the appraised value.
Non-cash Capital Contribution
Conversion of creditor's rights into equity is considered a form of non-cash capital contribution and therefore the aggregate sum of the value of capital contribution in such form and the value of other forms of non-cash capital contribution may not exceed 70% of the total amount of the registered capital, as specified in Article 27 of the PRC Company Law.
The capital contribution by way of a debt for equity swap must be verified by an institution qualified for capital verification and supported by documentary evidence specified in the Draft Measures.
An application for registration of a debt for equity swap must be accompanied by required documents, including relevant debt for equity swap agreements, court judgments, re-organisation plans, debt settlement agreements and/or shareholders/general meeting resolutions approving the swap transactions.
The Draft Measures, if issued substantially in the current version, will formalise and unify, at the national level, the registration of debt for equity swaps as another form of transferable and appraisable non-cash capital contribution as permitted in Article 27 of the PRC Company Law. These Measures will pave a new way for foreign and domestic creditors to acquire equities in PRC domestic companies on the one hand, and will enable domestic borrowers to use their equity interests/shares to serve their debts on the other. While the issuance of these Measures is belated, it is a right step and therefore better than never.