In a move welcomed by both domestic and foreign investors, the State Administration of Industry and Commerce ("SAIC") promulgated the "Administrative Measures for Registration of Capital Contribution by Equity Stock" on 14 January 2009 ("Measures") and the Measures became effective on 1 March 2009.

The Measures liberalizing the use of equity in capital contributions are expected to encourage new investments in the People's Republic of China ("PRC") with the use of less cash.  Corporate restructuring should also be facilitated especially in the light of the current international credit crisis.  

Background

Currently, Article 27 of the PRC Company Law only allows capital contribution in cash or in kind such as physical property, intellectual property, land use rights which can be valued and freely transferable.  The Article is also subject to restrictions under the other laws or other administrative regulations. The Measures are supplemental to Article 27 and provide the legal basis for capital contribution by the equity interests of another company.

Requirements

According to Article 2 of the Measures, only shares or equity of limited liability companies ("LLC") or joint stock companies ("JSC") incorporated in PRC can be used for capital contribution in another company in PRC ("the Investee Company"). Foreign invested enterprises appear not to be excluded from the application of the Measures.

Article 3 of the Measures requires that the title of shares to be used for capital contribution shall be free from encumbrance, complete and transferable under the law.  Shares of the following categories are prohibited from being used as capital contribution : -

(a)     Shares of an equity company which registered capital has not been fully paid;

(b)     Shares which are charged;

(c)     Shares which are sequestrated according to the law;

(d)     The transfer of such shares are prohibited under the Articles of Association of the company concerned;

(e)     Failure to obtain approval for the transfer of such shares required under any laws, administrative regulations or orders of the State Council; and

(f)       Any other situations prohibiting the transfer of shares under any laws, administrative regulations or orders of the State Council.

In line with Article 27 of the PRC Company Law, the total shareholding used for capital contribution shall not exceed 70% of the registered capital of the Investee Company.  The shareholding should also be appraised by a qualified valuation agency.

Procedures of using shares in capital contribution

Under Article 6 of the Measures, the transfer of shares for capital contribution shall be completed within 1 year of the establishment of the Investee Company.  As for using shares to pay for the increased registered capital of the Investee Company, the transfer of shares should be completed before applying for the increase in the registered capital.

If shares are to be used as capital contribution in the Investee Company, the LLC concerned shall file an application with the SAIC to change the owner(s) of such shares to the Investee Company.  Similarly, if the shares of a JSC registered with any securities registration and clearing institution are used as capital contribution, the JSC shall arrange for the share assignment and transfer to be made through the relevant security registration and clearing institution.  For other equity stocks used for capital contribution, the share transfer shall comply with the law in order to vest such equity interest with the Investee Company.

According to Article 9 of the Measures, if equity stocks are to be used as capital contribution in the setting up of an Investee Company, details of the time schedule, amount and transfer of the shares for capital contribution in the Investee Company shall be provided to the SAIC when the Investee Company is set up.  As usual, capital verification is required after completion of the transfer of such shares to the Investee Company.

Relevant approvals are still required

It is reiterated in Article 7 of the Measures that approval for the share transfer that may be required under any other laws, administrative regulations or orders of the State Council is still necessary for the purpose of capital contribution under the Measures.  Therefore, if the shares of foreign invested enterprises are used as capital contribution, approval(s) of the Ministry of Commerce or their provincial equivalent departments to transfer the shares to the Investee Company will still be necessary. For foreign enterprises or domestic enterprises in the restricted industries, still further approval(s) will be required.

If you have any question about the above Measures or other issues on foreign direct investments, joint ventures, mergers and acquisitions in Mainland China, experienced lawyers in our China Business Department will be happy to assist you.