With the further deepening of deleveraging and the implementation of new regulations on asset management, market funds are tight and the debt crisis of listed companies has made headlines. For listed companies with profitability and large capital reserve but tight cashflow, it is necessary to explore solutions to the debt crisis outside of bankruptcy procedures.
In this case, referring to the practice of issuing shares from converted capital reserve to holders of tradable shares in the reform of non-tradable shares, the conversion of the capital reserves of listed companies has returned to the attention of the industry.
In the author’s opinion, based on the difference of transaction structure and issuance target, there are the following options for conversion of capital reserve: (1) listed companies issue shares to existing shareholders, and shareholders transfer the shares to creditors of the company that accept the shares with, creditor’s rights as consideration; (2) the introduced external investors subscribe for shares issued by listed companies, and the listed companies use the share subscription payment to repay debts; and (3) listed companies directly issue shares converted from capital reserve to creditors, and creditors subscribe for shares with creditor’s rights as consideration, thus repaying debts.
Issuance to certain shareholders
Whether the company can issue shares to certain shareholders is not clearly provided for in the Company Law and relevant laws and regulations. However, it can be explained through the revision history of the Company Law. When the Company Law was revised in 2005, the provision that, “when a company limited by shares converts its reserve into capital through the resolution of the shareholders’ meeting, new shares shall be distributed according to the original share ratio of shareholders, or the par value of each share shall be increased” was deleted.
The author understands that before the revision, the issuance of shares from capital reserve was limited to the original shareholders. In 2005, the revision cancelled the restriction of issuance scope, that for conversion of reserve into capital, new shares shall be distributed, or the par value of each share shall be increased among the original shareholders, establishing the legitimacy of issuing shares to others subjects besides the original shareholders.
In fact, the private placement of shares from capital reserve is not uncommon in China. In the process of reform of non-tradable shares, a large number of state-owned listed companies have helped non-tradable shareholders to obtain the circulation right and realize the integration of equity and circulation by means of compensation through issuing shares to tradable shareholders. For example, in 2009, Zhangjiajie Tourism Group carried out the reform of non-tradable shares, which was realized by conversion of capital reserve into shares.
Issuance to non-shareholders
There are two ways to issue shares from converted capital reserve of listed companies to other subjects. The first is that external subjects purchase tradable shares of listed companies in the open market to become shareholders. The second is that listed companies directly issue shares to external subjects, pursuant to the agreement with external subjects, to make them become shareholders.
However, the second method leads to the question of whether listed companies can directly issue shares to other subjects besides original shareholders. In author’s opinion, the shares from converted capital reserve of listed companies can be issued to subjects other than shareholders. The reasons are as follows:
(1) The Company Law and other laws and regulations do not restrict the subjects that can receive shares from converted capital reserve. The practice that shareholders of the company give up their shares converted from capital reserve, and agree that external subjects can obtain corresponding shares, is corporate governance behaviour. Through this, the company is able to adjust its equity structure and implement debt settlement. Also, it is the embodiment of shareholders’ autonomy and the basic principle of the Company Law;
(2) Even if the issuance of shares from converted capital reserve is limited to existing shareholders, external subjects can still become shareholders of listed companies by purchasing shares of listed companies. The purpose of such restrictions is very hard to achieve. It has neither legislation necessity nor normative value to forbid issuance to external subjects; and
(3) As a part of the owner’s rights and interests, whether shares from converted capital reserve are issued to existing shareholders or external subjects, the corresponding benefits are converted into company capital eventually. Therefore, the related benefits will not flow out of the company, and the registered capital and paid-in capital of the company will not be reduced. The retained amount of the capital and its benefits after the issuance is determined and stable, which conforms to the doctrines of capital – capital determination, capital maintenance, and capital unchangeableness.
Pursuant to article 168 of the Company Law, the capital reserve shall not be used to make up for the company’s losses, which leads to the problem that to repay debts with the method of capital reserve into capital may possibly violate this provision.
In the author’s opinion, capital reserve comes from stock premium rather than operating income, and the purpose of drawing capital reserve is to consolidate the company’s property base and improve the company’s credit. The purpose of the Company Law prohibiting capital reserve from making up for losses is to make clear the difference between capital and operating income, to prevent profit distribution of stock premium by shareholders, and to avoid making up for operating loss through financing.
In the process of converting capital reserve into capital, although the ultimate purpose of the transaction is to repay the company’s debts, this is not directly paid to creditors with capital reserve. The capital reserve is firstly converted into the registered capital of the company through the subscription of the original shareholders, external investors or creditors. If the price of capital reserve conversion is appropriate, the company’s assets will not be decreased substantially, and the essence of converting capital reserve into company capital will not be changed.
The repayment that creditors obtain is from the payment of the additional subscribers who purchase the company’s equity, or the share, which is not against the rule of prohibiting using capital reserve to make up for losses. In 2014, Sinovel successfully converted capital reserve into capital to repay debts, and , Guangxia (Yinchuan) Industry, which was in crisis, also successfully implemented debt reduction by targeted conversion of capital reserve into capital.
Sun Lin is a partner at Grandway Law Offices