The State Administration of Industry and Commerce ("SAIC") promulgated the Administrative Measures on Registration of Capital Contribution with Equity Interests ("Measures") on 14 January 2009, which will take effect on 1 March 2009. 
The Measures allow investors to invest in limited liability companies ("LLC") incorporated in the People’s Republic of China ("PRC") and PRC companies limited by shares ("LBS") by contributing equity interests of another LLC or LBS owned by the investors.
The Measures are expected to facilitate restructuring of PRC companies and stimulate investments either by setting up new companies or by carrying out mergers and acquisitions within China.

A. Background
According to the Company Law of the PRC, investors may make capital contribution in cash, in kind, or intellectual property right, land use right, or other non-monetary properties that can be assessed by currency and transferred legally. However, it does not expressly mention that equity interests are treated as one type of "non-monetary properties".  Besides, in practice, before promulgation of the Measures, making capital contribution by equity interests was not readily accepted by certain PRC government authorities due to lack of detail guidelines.
A pilot scheme for using equity interest as capital contribution was started in 2006 in  Shanghai, Jiangsu, Zhejiang, Chongqing, Chengdu, Shandong and Guangdong provinces.  However, the relevant trial rules had limited application as they expressly restricted the use of equity interests in foreign-invested enterprises ("FIEs") as capital contribution of another LLC or LBS.  Besides, equity interest of a LLC or LBS could not be used as capital contribution of a FIE.
After promulgation of the Measures, capital contribution by equity interests is expressly allowed nationwide and FIEs are not expressly excluded from the Measures.

B. Application
The Measures apply to investments in LLC or LBS ("Invested Company") by investors with equity interests in another LLC or LBS ("Equity Company") held by such investors.
Since the Measures do not expressly exclude FIE from being an Invested Company or an Equity Company, the Measures apply to both pure PRC domestic companies and FIEs which are also LLC or LBS.
C. Legal Requirements of Equity Interests to be Contributed
According to the Measures, equity interests to be used as capital contribution shall satisfy the following criteria :
  • They have clear and complete title and can be legally transferred;
  • The total amount of in-kind capital contribution including equity interests contribution and other non-monetary properties cannot exceed 70% of the total amount of registered capital of the Invested Company; and
  • Equity interests must be appraised by a qualified valuation agency.
Besides, equity interests to be used as capital contribution shall not be subject to any of the following circumstances :
  • The registered capital of the Equity Company has not been paid in full;
  • The equity interests are subject to a pledge;
  • The equity interests have been legally frozen;
  • Transfer of the equity interests is prohibited by the articles of association of the Equity Company; 
  • The requisite governmental approvals for transferring the equity interests as provided by applicable PRC laws, administrative regulations or decisions of the PRC State Council have not been obtained; or
  • Transfer of equity interests does not comply with applicable PRC laws, administrative regulations or decisions of the PRC State Council.
D. Contribution Procedures
The procedures for using equity interests as part of the capital contribution for the establishment of an Invested Company are as follows :
  • Make application to set up the Invested Company and register the name of investor using equity interests as contribution, the amount and mode of such contribution and the timing for making such contribution;
  • Complete contribution of equity interests within one year after establishment of the Invested Company;
  • Verify the contribution by a qualified capital verification institution and issue capital verification report;
  • Apply to change registration of paid-up registered capital of the Invested Company to show that the registered capital has been paid by contribution of equity interests;
  • Apply to change registration of the amount of paid-up registered capital and timing of such contribution etc. of the relevant investor if the Invested Company is a LLC.
If equity interest is used as contribution for increase of the registered capital of an Invested Company, the contribution shall be completed before the Invested Company applies to change its registration for increasing its paid-up registered capital.

E. Practical Implications
Stimulate New Investments by Rejuvenating the Investments made by Investors in Existing PRC Companies
The Measures have clarified that equity interests of LLC or LBS can now be used as a form of capital contribution to another LLC or LBS.  Before promulgation of the Measures, if investors would like to make use of the assets they have invested into LLC or LBS for further investment, they may try to obtain financing from financial institution by pledging their equity interests in those LLC or LBS, or realise the existing investments by selling the equity interests.  Starting from 1 March 2009, investors may now make further investments within China by contributing their equity interests in existing investments and thus avoid the costs and hassle of obtaining financing from cautious financial institutions or going through the time-consuming process of selling those equity interests during the current economic turmoil. 
This alternative way of making investment should be attractive to investors as they can still, on one hand, enjoy the benefits of holding their existing investments and, on the other hand, expand their investments by using those existing assets.  Besides, as capital contribution in-kind can be up to 70% of the registered capital of the Invested Company, it greatly reduces the requirement of cash for making investments.
Facilitate Corporate Restructuring of PRC Companies by Reducing Cash Requirement and Expediting the Process
Similarly, for those businesses which would like to consolidate or conduct corporate restructuring, such as by adding a level of holding company above the various operating companies, the Measures allow it to be done in a simpler and more expedient way.  Investors do not need to come up with all the cash for paying up the registered capital of the holding company first and then use the capital of the holding company to acquire the existing LLC or LBS of the investors. Instead, the investors only need to pay 30% of the registered capital of the holding company in cash and then transfer the equity interests of the existing LLC or LBS owned by the investors directly to the holding company as contribution to the rest of its registered capital.
Issues of Concern for Investors
Apart from the stimulating effect brought by the Measures on investments and corporate restructuring of PRC companies, the Measures also give rise to some issues that investors would need to pay attention to :
  • Shorter time period for contribution
According to the relevant PRC law, investors of a LLC may complete their capital contribution by instalments within two years, except for the first instalment which shall not be less than 15% or 20% of the registered capital of the LLC (depending on whether it is a FIE or a pure domestic company).  However, under the Measures, if capital contribution is made by transferring equity interests to the Invested Company, such contribution has to be completed within one year after the establishment of the Invested Company.
For increase of registered capital of a FIE, generally speaking, not less than 20% of the newly increased registered capital should be contributed when a FIE applies to register the increase of its registered capital with the local commission of SAIC, and the rest of the increased portion should be contributed within two years. However, under the Measures, the Invested Company cannot apply to increase its registered capital before the newly increased registered capital has been fully contributed.
  • Undertaking letter for contribution of equity interests
According to the Measures, those investors who would like to make capital contribution by equity interests have to provide the relevant government authority with an undertaking letter confirming that the equity interests to be contributed comply with all those requirements set out in Section C above.
  • Changing the nature of Invested Company and/or Equity Company
As both Invested Company and Equity Company can now be a FIE, a foreign investor may convert the Invested Company into a FIE if it becomes an investor with 25% or more equity interests of the Invested Company. By the same token, a FIE may also be converted into a pure domestic PRC company if all the equity interests of a FIE held by foreign investor(s) are transferred to an Invested Company.  In such circumstances, investors may need to consider the following issues :
- Whether the sino-foreign shareholding proportion and the requirements for establishment of the Invested Company can still be complied with after it becomes a FIE;
- Since transfer of equity interests of FIE requires approval from competent government authority, investors may need to take into account the time period required for obtaining such approval;
- If an Equity Company ceases to be a FIE, it may lose the benefit of enjoying its preferential treatments (if any) as a FIE.
F. Conclusion
Despite the above limitations and extra requirements imposed on investors, the Measures will no doubt be welcomed by both domestic and foreign investors.  In a word, the Measures do not only help to ease the cash requirement for new investments and corporate restructuring exercise but also provide an alternative to obtaining financing in merger and acquisition transactions within China.
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