On November 23, 2011, the State Administration for Industry and Commerce (the "SAIC") promulgated the Administrative Measures for Registration of Debt-for-Equity Swaps ("Debt-for-Equity Swaps Measures"). The Debt-for-Equity Swaps Measures will become effective on January 1, 2012 and allow a creditor to convert its creditor's right against a limited liability company or a company limited by shares incorporated in the PRC into equity interests of the concerned company. As a result, the registered capital of such company will be increased.

1. Under the Debt-for-Equity Swaps Measures, only the following three types of debts can be converted into equity interests:

(1) contractual debts between the creditor and the company arising from the operation of the company, provided that the creditor has performed its contractual obligations corresponding to its creditor's right and its performance did not violate the laws and administrative regulations, the decisions of the State Council, or the Articles of Association of the company;
(2) debts confirmed by an effective judgment made by a People's Court; and
(3) debts mentioned in a reorganization plan approved by a People's Court or in a reconciliation agreement confirmed by the verdict of a People's Court.

The wording of the Debt-for-Equity Swaps Measures does not include the debts confirmed by an arbitration award made by an arbitration tribunal. It remains to be seen whether the SAIC will issue a separate circular at a later stage to cover such debts.

2. The Debt-for-Equity Swaps Measures further provide that the value of creditor's right to be converted into equity interests shall be appraised by a qualified assets evaluation institution. Meanwhile, for each company the total amount of its capital contribution made by non-monetary assets, including creditor's right, shall not exceed 70% of its registered capital.
3. According to the Debt-for-Equity Swaps Measures, the debt-to-equity swap shall be first approved by the competent authority if required by the laws, the administrative regulations and the decision of the State Council. Given the above, we understand that an approval shall be sought from the competent examination and approval authority, i.e. the Ministry of Commerce ("MOC") or its local counterpart, as the case may be, if a foreign company or individual intends to convert its creditor's right into the equity interests of a PRC company and/or such company is a foreign invested enterprise. Secondly, a certified public accounting firm shall issue a capital verification report on the debt-to-equity swap. At last, a registration shall be made with the competent Administration for Industry and Commerce ("AIC").

Before issuance of the Debt-for-Equity Swaps Measures, the Circular [Gong Shang Wai Qi Zi (2010) No. 94] promulgated by the SAIC on May 7, 2010 only allowed foreign investors to convert their foreign exchange loans granted to a foreign invested enterprise in the PRC into equity interests. The Debt-for-Equity Swaps Measures now provide foreign debtors the possibility to also convert other kinds of creditor's right as mentioned above into equity interests of the PRC obligor(s).

For foreign creditors, the conversation of debts owed by a PRC company to them is subject to the approval by the MOC or its local counterpart. The MOC is expected to also promulgate relevant regulations to formally confirm the feasibility of the above-mentioned debt-for-equity arrangement from its perspective.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

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The original publication date for this article was 12/12/2011.