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LEGAL: Developments on Debt-for-Equity Swaps in China
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altOn 23 November 2011, the State Administration for Industry and Commerce of the People’s Republic of China (SAIC) issued the Administrative Measures on Registration of Debt-for-Equity Swaps (Registration Rules). The Registration Rules took effect on 1 January 2012, and aim to regulate the registrations of debt-for-equity swaps (the Swap) of limited liability companies or companies limited by shares, in order to relieve the financial burden of companies, especially small and medium enterprises. As a Departmental Regulation which has a state-level legal effect regarding the Swap, the Registration Rules is considered of great importance for the unification of different local practices existing before its release.

1. The Situation before the Registration Rules
Before publishing of the Registration Rules, there had already been various local rules and regulations issued by local governmental authorities of provincial and municipal levels (such as in Beijing, Chongqing, Shanghai, etc.) regulating the Swap. However, many of these local rules and regulations clearly exclude the Swap of the debts owed by Foreign Invested Enterprises (FIEs). Furthermore, they also only allow the Swap of the debts owed to domestic creditors.

Even in the places where the Swap of debts owed by FIEs is allowed, it is usually provided that FIEs may only convert their shareholder’s loans into registered capital.

In addition to the above mentioned limitations on the debtor and creditor, there are also other limitations on the Swap, such as the maximum percentage of registered capital increased through the Swap, which is variable from place to place.
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2. Key Points of the Registration Rules
After publishing of the Registration Rules, there are finally rules for the Swap at the state level. Following are the key points which are worth noticing.

2.1 Definition of a Swap
Under the Registration Rules, a Swap is defined as: a creditor converts its creditor’s right against the debtor into the equity of the debtor and thus increases the registered capital of the debtor. Therefore, currently the Swap can only be applied in the form of a capital increase to an existing company.

2.2 Limitation on Debtor and Creditor
Under the Registration Rules, it is not required that the debtor for a Swap has to be a domestically invested company. Also there is no limit on the nationality of the creditor now. Therefore in principle, according to the Registration Rules, Swap for the equity of FIEs is not prohibited and the debt to be swapped by an FIE is not be limited to its shareholder’s loans.

2.3 Debts Applicable for Swap
According to the Registration Rules, the debts that may be swapped shall be one of the following types:

- Contractual debt

It refers to the debt arising during the course of the operation of the debtor while the creditor has fully performed its corresponding obligation against such debt, such as the unpaid goods purchase price for goods which have been actually delivered to the debtor;

- Debt confirmed by judicial decision
It refers to debt confirmed in a ruling or judgment of the people’s court. For example, once a dispute in relation to a debt between two parties is submitted to the people’s court and the judgment is made after the hearing, such debt recognized by the judgment can be used for a Swap;

- Debt in a bankruptcy process

It refers to a claim included in the restructuring plan approved by the people’s court or a settlement agreement recognized in a people’s court’s ruling during a bankruptcy and restructuring procedure of the debtor.

2.4 Percentage Limit
It is required that the Swap shall not cause a non-cash capital contributions to the debtor , including real-estate, machinery, equipment, intellectual property, equity shares and the Swap, or be higher than 70% of the debtor’s registered capital. However, this requirement is in line with the provision of the Company Law of PRC (the “Company Law”) and is not a new obligation.

2.5 Procedure for the Swap and its Registration

- Appraisal

According to the Registration Rules, the value of a capital contribution made through a Swap may not be higher than the appraised value of the debt. Therefore, the debt which is to be converted into equity shall be first appraised by a qualified asset appraisal company.

- Execution of Swap Agreements

Usually, once the value of the debt is confirmed by the appraisal, the debtor, its existing shareholder(s) and the creditor may enter into their Swap Agreements, under which it is agreed that the creditor subscribes to the increased capital of the debtor with its creditor’s right. The Registration Rules do not provide more requirements on the content of such Swap Agreements.

- Capital Verification
As any other form of capital contribution, a Swap shall also be subject to capital verification by a qualified capital verification institution, i.e. a certified public accounting company, which shall issue a capital verification report indicating the basic particulars of the debt, the details of the appraisal and the details of the completion of the Swap, etc.

- AIC Registration

When a Swap is affected, the debtor shall apply to the company registry to change its registration of registered capital and paid-in capital according to the law.

During the registration, depending on the type of specific debt swapped, the Statement of Swap signed by the debtor and the creditor and a valid court ruling or restructuring plan shall be provided.

3 Implications of the Registration Rules


3.1 Expansion of Debt Scope for Swap
altAs mentioned above, the Registration Rules has expanded the scope of debts that may be used for a Swap. Therefore it can be a helpful tool for companies trying to solve the financial difficulties they may face, especially within the current macroeconomic environment.

3.2 Further Clearance of the Appraisal and Registration Procedure
Before the issuance of the Registration Rules, the procedures and requirements for the appraisal and registration of a Swap varied among different provinces and municipalities. The Registration Rules have thus unified these rules on the state level and make it clearer and fairer to debtors and creditors throughout the country.

3.3 Limitation of the Registration Rules
For the Swap of debts owed by FIEs, the capital increase performed through a Swap will involve more governmental authorities such as MOFCOM, SAFE, etc. As the Registration Rules is published by the SAIC, it is necessary for the other involved authorities to also issue their regulations and rules on how to implement the Swap for debts of FIEs from the perspective of each authority. For example, from the perspective of the foreign exchange administration, when the foreign debt owed by an FIE is converted into registered capital, will the foreign debt quota (the total foreign debt quota equals the difference between Total Investment and the Registered Capital of an FIE) consumed by such foreign loan be released and be used by the FIE again? The answer to such a question was never the same in different provinces in the past and needs to be clarified on the state level urgently. In our opinion, once the foreign debts of an FIE are converted into registered capital, such debts will cease to exist and the occupied foreign loan quota should be released, no matter if the foreign loans are short, middle, or long-term.

Therefore, before detailed regulations and rules for implementation of a Swap of an FIE are provided by other involved authorities also on a state level, it is advisable for the parties to the Swap of an FIE to keep close contact with different local authorities for further confirmation and clarification during implementation.



By Manuel Torres (Partner) & Julian Yu (Junior), Garrigues, Shanghai.

Garrigues has over 13 years of experience in advising companies in their investments in China. The team of experienced Western and Chinese professionals at Garrigues Shanghai provides legal advice to foreign companies on a wide range of issues such as incorporation of companies and negotiation of joint ventures, commercial contracting, M&A, tax, real estate, employment, intellectual property, arbitration and infrastructures, as well as to Chinese companies with investments abroad.

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