• Equity Investments in Foreign Investment Enterprises in China
  • January 28, 2013 | Author: John V. Grobowski
  • Law Firm: Faegre Baker Daniels - Shanghai Office
  • The PRC Company Law, as revised in 2005, allows company shareholders to make capital contributions with certain non-cash assets that include equity in other companies. The State Administration for Industry and Commerce (SAIC), China's business registration authority, promulgated the Measures for the Administration of the Registration of Capital Contribution in the Form of Equity (SAIC Measures) to establish a procedure for the registration of equity capital contributions in 2009. The SAIC Measures apply to purely domestic companies as well as foreign investment enterprises (FIEs). In the case of FIEs, foreign investment approvals from Ministry of Commerce (MOFCOM) or its local counterparts (COFCOMs) are also required for equity capital contributions, but there has not been a formal procedure for such approvals until the issuance of the Interim Provisions of the Ministry of Commerce for Equity Investments in Foreign Investment Enterprises (Interim Provisions), promulgated on September 21, 2012 and effective on October 22, 2012.

    Application Scope
    The Interim Provisions apply to situations where a domestic or foreign investor (an Equity Contributor) uses the equity it holds in an enterprise in China (Equity Enterprise) as a capital contribution to an Investee Enterprise which is either an existing or new FIE. The Interim Measures do not limit the nature of the Equity Enterprise, which may therefore be purely domestic companies or FIEs, but they only deal with Investee Enterprises that are FIEs.

    Requirements for Equity as Capital Contributions
    The Interim Provisions specify that the equity to be used as a capital contribution must be transferable and with a free and clear title. These requirements are in line with the current PRC Company Law. However, as is the case with the SAIC Measures, equity capital contributions are not permitted where:

    • The registered capital of the Equity Enterprise has not been paid in full
    • The equity is encumbered by a pledge
    • The equity has been frozen in accordance with the law
    • Pursuant to the articles of association of the Equity Enterprise, its equity cannot be transferred

    The Interim Provisions also provide that equity capital contributions will not be permitted in situations where the Equity Enterprise is:

    • An FIE that has not participated in or failed the joint annual inspection for the previous year
    • A real property enterprise, foreign-investment-type FIE or foreign-invested venture capital enterprise

    Equity Appraisal
    Like other non-cash capital contributions, equity capital contributions must be appraised by a qualified Chinese appraisal firm, and the Equity Contributor and other shareholders of the Investee Enterprise must then determine the "value of equity" and the "amount of the equity capital contribution" based on the equity appraisal.

    The "value of equity" refers to the transaction value of the equity capital contribution. The "amount of the equity capital contribution" refers to the portion of the "value of equity" that will become part of the Investee Enterprise's registered capital (with any remaining value to be treated as capital reserve). The Interim Measures specify that the "amount of the equity capital contribution" may not be greater than the appraised equity value, and the "amount of equity capital contribution" together with other non-cash property used as capital contribution may not exceed 70% of the Investee Enterprise's registered capital.

    Equity Capital Contribution Procedures
    In the equity capital contribution process established by the Interim Provisions, the Equity Contributor or the Investee Enterprise must submit an application to the COFCOM where the Investee Enterprise is located together with the following documents:

    • Application letter
    • Proof certifying that the Equity Contributor lawfully holds the equity to be used as┬ácapital contribution
    • Business license of the Equity Enterprise
    • Certificate of approval (if the Equity Enterprise is an FIE)
    • Equity appraisal report
    • Other documents as required by COFCOM

    COFCOM will verify the application documents and decide whether or not to approve the equity capital contribution. If the approval is granted, COFCOM will issue a preliminary certificate of approval to the Investee Enterprise with a "capital contribution made in the form of equity not paid" notation in the remarks space of the certificate.

    After the Equity Enterprise completes its related change procedures due to the share swap with the Investee Enterprise and the capital verification for the Investee Enterprise by a Chinese CPA firm is issued, the Investee Enterprise will need to apply to COFCOM to replace the preliminary certificate of approval with a final certificate of approval with a "capital contribution made in the form of equity paid" notation in the remarks space of the certificate.

    Since the Interim Provisions came into force only recently, it is not yet clear how COFCOM will construe and enforce the Interim Provisions in practice. It is advisable that potential Equity Contributors and the Investee Enterprises consult with each other and with COFCOM in advance before making definite plans for equity capital contributions.