• At Last, Measures for the Registration of Equity Pledges
  • September 19, 2008
  • Law Firm: Troutman Sanders LLP - Atlanta Office
  • Background

    Structures for financing and controlling Chinese operating companies without holding direct ownership interests have a long history, especially in highly regulated businesses such as value added telecoms and real estate. Such structures inevitably involve financing secured by a pledge of the registered capital of a company but have been difficult if not impossible to perfect because China has lacked a reliable system of security registration.

    This promised to change when the PRC Property Rights Law came into effect on October 1, 2007. The law stipulates that where an equity interest is pledged, the pledgee’s rights shall only become effective upon registration with the administration of industry and commerce (“AIC”).  This requirement changed the previous practice under PRC Security Law that provided an equity pledge took effect when it was recorded in the company’s list of shareholders.  Finally, the SAIC issued the Equity Pledge Registration Measures (“Registration Measures”) on September 1, 2008 (effective on October 1) thus ending a year long gap between law and practice.

    The Registration Measures will be good news for private equity, venture capital as well as bank financing of Chinese businesses.

    Authority in Charge

    The registration of pledge of equity shall be filed with the AIC at the place of incorporation of the company the equity of which will be pledged.

    Equity to be Pledged by FIE

    In addition, the application for a pledge of equity in a foreign invested enterprise must first be approved by the original approval authority before it is filed for registration.

    Equity Subject to a Court Order

    Equity frozen by a court order may not be pledged. 

    Application Documents

    The required application documents include the following:

    • Application form signed or chopped by the applicant (the SAIC has issued template application forms for adoption by local AICs);
    • A copy of the company’s list of shareholders showing the pledgee’s name and capital contributed;
    • Pledge agreement;
    • A copy of incorporation certificate of identification of the pledgee and pledgor; and
    • Other documents requested by AIC.

    Where the pledgee is a foreign entity, the AIC may require its supporting documents to be notarized and legalized according to customary procedures. This may considerably extend the time required for registration.

    Although the AIC is require to register the pledge “immediately” after complete and satisfactory documents have been filed, in practice, until the filing process begins next month, it is anyone’s guess how long it will take and this will, as ever, vary from time to time and place to place.

    Impact on Existing Financing Transactions

    Equity pledges agreed after October 1, 2007 (the effective date of the Property Rights Law) must be registered with the AIC according to the Registration Measures.  Otherwise, the equity pledge will be regarded as invalid, and the security created through equity pledges will be ineffective.

    Although the Property Rights Law and the Registration Measures are silent on the question of pledges made before October 1, 2007, it is assumed that these pledges will remain valid without further filing. Any other interpretation would result in chaos as the AIC would overnight be facing innumerable retrospective filings.