FIEs face new regulations for capital contributions in the form of equity

By Elvin Ye and Henry Song, Martin Hu & Partners
0
1928
LinkedIn
Facebook
Twitter
Whatsapp
Telegram
Copy link

The Measures for the Administration of the Registration of Capital Contributions Made in the Form of Equity, issued in 2009, were the first regulations to govern capital contributions made in the form of equity.

Elvin Ye, Associate, Martin Hu & Partners
Elvin Ye
Associate
Martin Hu & Partners

On 22 October, the Provisional Regulations for Capital Contributions Made in the Form of Equity Involving Foreign-Invested Enterprises published by the Ministry of Commerce (MOFCOM) were formally implemented. Pursuant to the regulations, investors inside and outside China can make capital contributions in the form of equity that they hold in limited liability companies or companies limited by shares in China, and the three circumstances under which the regulations apply are: establishment of a foreign-invested enterprise (FIE) in the form of a new company; a capital increase that causes a non-FIE to become an FIE; and a capital increase that causes a change in the equity of an FIE.

General provisions

Like the measures, the regulations require that the total amount of capital contributions made in the form of equity and of other non-monetary property by all shareholders of an investee enterprise not exceed 70% of its registered capital. The regulations further provide that the equity of an FIE that did not participate, or failed, in the joint annual inspection of FIEs for the previous year, or the equity of a real estate enterprise, foreign-invested investment company or foreign-invested venture capital enterprise may not be used to make a capital contribution.

Henry Song, Associate, Martin Hu & Partners
Henry Song
Associate
Martin Hu & Partners

The regulations provide that once a capital contribution in the form of equity has been made, the investee enterprise, the enterprise whose equity is used to make the capital contribution (the “equity contributor”), and the enterprises in which it directly or indirectly holds shares are required to comply with such foreign investment regulations including the Regulations for Guiding the Orientation of Foreign Investment and the Catalogue for Guiding Foreign Investment in Industry. If any of them is not in compliance with a relevant regulation, then it is required to split off the relevant assets or business, or transfer the equity, before applying for the capital contribution in the form of equity. Domestic and foreign investors may not use a capital contribution made in the form of equity to evade foreign investment administration.

The draft of the regulations had expressly specified that a cross-shareholding between the investee enterprise and the equity contributor could not arise as a result of the capital contribution made in the form of equity, but this provision did not find its way into the final regulations.

Additionally, pursuant to the regulations, the authority for approving a capital contribution made in the form of equity rests in the hands of the competent provincial-level commerce authority in the place where the investee enterprise is located, or MOFCOM. However, if the investee enterprise and the equity contributor fall under the jurisdictions of two different approval authorities, the approval authority of the investee enterprise is required to seek the opinion of the approval authority of the equity contributor.

Approval procedures

The regulations require a series of more complicated and specific application materials for a capital contribution made in the form of equity, including: an application letter for a capital contribution to be made in the form of equity and the agreement for such capital contribution; proof of lawful ownership of the equity to be used to make the capital contribution; an equity appraisal report; and a legal opinion relevant to such capital contribution.

The purpose of the legal opinion is to complement articles 4 and 5 of the regulations, namely whether title to the equity that is to be used to make the capital contribution and whether the investee enterprise, the equity contributor and the enterprises in which it directly or indirectly holds shares comply with relevant regulations on foreign investment.

It is clear that having a lawyer issue a legal opinion can lower the risk of defects in the capital contribution to be made in the form of equity. Although such provision does not serve as a guarantee in the approval process, it nonetheless clarifies and acknowledges the status of lawyers in such transactions.

Equity appraisal and pricing

The second paragraph of article 27 of the Company Law specifies that when equity, as non-monetary property, is to be used to make a capital contribution, it is required to be appraised and valued. The regulations further specify that it is to be appraised by a lawfully established domestic appraisal institution. The regulations also specify that the investor contributing the equity and the shareholders of, or other investors in, the investee enterprise may determine, on the basis of the equity appraisal, the value of the equity and the amount of the capital contribution made in the form of equity, and that such amount may not be greater than the appraised value of the equity.

However, it is also necessary to consider article 31 of the Company Law, which specifies that once a limited liability company is established, if the actual value of non-monetary assets (including equity) used as a capital contribution in establishing the company is markedly lower than the value determined in the company’s articles of association, the relevant shareholder is required to make up the difference, and the other shareholders are required to bear joint and several liability. However, both the regulations and the measures make no reference to this issue.

Accuracy concern

Additionally, even if the law expressly requires that a professional appraisal institution is needed to appraise the value of equity, the volatility of equity – e.g. the value of the equity of a limited liability company is usually determined based on its net assets, and that of a publicly listed company on its stock market quote – as a non-monetary asset makes it impossible to ensure that the value of equity as appraised by a professional institution is completely accurate.

Fortunately, the Asset Appraisal Law (Draft) has entered the deliberation process. This law is China’s first law that specifically addresses the appraisal of assets and we hope that its final promulgation can provide a satisfactory answer to the foregoing conundrum.

Elvin Ye and Henry Song are associates at Martin Hu & Partners

martin_hu_logo

胡光律师事务所

上海市芳甸路1155号浦东嘉里城办公楼8楼

8/ Floor, Kerry Parkside Office

1155 Fangdian Road, Pudong

Shanghai, China

邮编 Postal code: 201204

电话 Tel: +86 21 5010 1666

传真 Fax: +86 21 5010 1222

www.mhplawyer.com

胡光 Martin Hu

电子信箱 E-mail: martin.hu@mhplawyer.com

叶陈尧 Elvin Ye

电子信箱 E-mail: elvin.ye@mhplawyer.com

宋文祺 Henry Song

电子信箱 E-mail: henry.song@mhplawyer.com

LinkedIn
Facebook
Twitter
Whatsapp
Telegram
Copy link