Financial asset investment companies may acquire creditors’ rights of banks on businesses for the purpose of market-based conversion of those debts to equity, or set up debt-to-equity investment schemes for the investment in market-based debt-to-equity swap assets.
In the case of the former, financial asset investment companies will need an exit route for their newly obtained equity. In the latter, they must identify market-based debt-to-equity swap assets suitable for their schemes. The authors believe that targeting the right to benefit from equity of debt-to-equity companies in investment schemes can effectively satisfy both the above-mentioned demands.
Legal basis and precedence for the transfer of rights to benefit from equity.
In practice, the right to benefit from equity is often classified as a right to income from property corresponding to certain equity that the shareholder lawfully holds, and is entitled to dispose of. As the Company Law expressly grants shareholders the right to obtain capital proceeds, the right to benefit from equity in essence falls under shareholders’ lawful entitlement to income from property other than voting rights.
Under existing laws and regulations in China, shareholders are not prohibited from disposing of rights to income from property, which means they may be transferred, as long as the rights attached to such equity are not restricted.
There is already universal court recognition and support for the transfer of rights to benefit from equity, as well as related financings, such as in Cheng Shaobo v Ludianfund (2020), Anxin Trust v Tianyue (2017), Shixin Ronghe v Chang’an Trust et al (2016), and Wang Zhirong v Nantong Jinqi Ruixin Venture Capital Fund (2016). In its ruling for Zhang Jude v Nanyang Xinyuan Gold et al (2015), the Henan Higher People’s Court supported in its ruling the transferability of the right to benefit from equity, and that the price may be subject to negotiation.
Transfer of the right to benefit from equity in debt-to-equity companies by financial asset investment companies is not prohibited under existing Chinese laws and regulations. In article 3.7 of its Guiding Opinions on Market-Oriented Debt-to-Equity Swaps of Banks, issued in 2016, the State Council provided that “multiple market-oriented approaches should be considered for equity exit. Where there is an expectation for equity exit, the investor may reach an agreement with the company with respect to the manner of exit.
“Where the debt-to-equity company is listed, its equity exit may be conducted via lawful transfer, provided that the restricted period and other securities regulations are observed. Where such a company is unlisted, it is encouraged to achieve equity exit through merger and acquisition, listing on the National Equities Exchange and Quotations, trading in the Regional Equity Trading Markets, or listing on a stock exchange.”
According to article 45 of the Measures for the Management of Financial Asset Investment Companies (for Trial Implementation), issued by the China Banking and Insurance Regulatory Commission (CBIRC) in 2018: “Financial asset investment companies are encouraged to substantially transfer equity of debt-to-equity companies to qualified investors through market-oriented measures.”
It should be pointed out that, while the above-mentioned guiding opinions further encourage the implementors of debt-to-equity swaps to achieve equity exits through various market-oriented measures and channels, as financial asset investment companies still hold the equity of the investee after transferring the right to benefit from equity, in terms of legal relationship, such transfer does not constitute an equity exit as specified under the guiding opinions and the above-mentioned measures. On the other hand, there is no prohibition for financial asset investment companies to dispose of the rights to income from property attached to their own held equity.
Investment companies may invest in the rights to benefit from equity under debt-to-equity investment schemes. Under article 1.1 of the Notice on Matters Concerning Asset Management Businesses of Financial Asset Investment Companies, issued by the CBIRC in 2020, “the primary target of debt-to-equity investment schemes should be market-based debt-to-equity assets, including creditors’ rights, convertible bonds, special bonds, ordinary shares, preferential shares, debt-to-preferential shares and other assets with the specific purpose of market-based debt-to-equity swap”.
To sum up, market-based debt-to-equity assets should: (1) be for the purpose of market-based conversion from debt to equity; and (2) take the form of, among others, creditors’ rights, convertible bonds, special bonds, ordinary shares, preferential shares, or debt-to-preferential shares. The authors believe that as long as investments into, and contributions to, debt-to-equity companies are made with the purpose of converting such debt to equity, the resultant equity and rights to benefit are perceived as assets for the purpose of market-based debt-to-equity swaps. Although the above-mentioned notice did not specifically list the right to benefit from equity as a form of market-based debt-to-equity asset, as a right to income from property, an indispensable component to shareholders’ rights, the right to benefit from equity should not be excluded to the scope of target assets under debt-to-equity investment schemes.
Matthew Ching is a partner and Zhang Dong is an associate at Jingtian & Gongcheng
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