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How Do a Foreign-Creditor Covert to the Shareholder of Chinese Company

Facts:

The Chinese enterprise A has defaulted on the payment for goods in the cross-border trade with enterprise B from another country. Due to the large investment in reproduction, A is unable to make the payment to B in short period of time. Nevertheless B is optimistic about A’s future development and wishes to further cooperating with A. After negotiation with A, B decided to convert the debt as increasing capital of A and then B will be a shareholder of A.

Case Study:

In accordance with the PRC Company Law, a shareholder may make capital contributions in cash, or intellectual property right, land usage right or other non-monetary properties that could be assessed and be transferred according to the law. It is complied with law to convert debt into shares among domestic enterprises. Since the foreign exchange management system related to the foreign currency has made a difference between the capital account and international trade account, only the registered foreign debt can be converted into capital contribution. However, on November 22, 2010, the Industrial and Commercial Bureau of Guangdong promulgated the "opinions on further serving the development of foreign-funded enterprises in Guangdong" (Yue Gong Shang Wai Qi Zi [2010] No. 674), which Article 1(2) provided that “......Restrictions on foreign-funded enterprises making capital contributions will be lifted. Investors of foreign-funded enterprises are allowed to convert their creditor's rights arising from the transaction of movable property such as raw materials, equipment and products during the operation of the enterprise, into capital contributions of the company and increase the registered capital of the company.

The authenticity of transaction regarding to creditors’ rights occurred during international trade must be verified when the enterprise registers the shares according to the said provisions, which is different from registration of foreign debt into capital contributions. Therefore both A and B shall prepare all the related documents during international trade, including but not limited to contract, bill of lading, cargo customs declaration, and other transaction evidences of import and export etc. Furthermore, pursuant to the Article 27 of the PRC Company Law, “the value of the non-monetary properties as capital contributions shall be assessed and verified, which shall not be over-valued or under-valued.” The creditors’ rights created during trading shall be verified and evaluated by the appraisal agency before they can be converted into the capital contributions.

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