In June 2007, the Administration for Industry and Commerce of Zhejiang Province announced Measures on Administration of the Registration of Equity Contribution to Other Companies, which provided for the first time for a shareholder to use his equity interest in one company as a capital contribution to another company.  Subsequently, the Administration for Industry and Commerce of Shanghai Municipality promulgated a similar Measures on Registration of Equity to Other Companies under existing laws and regulations such as the Company Law and Regulations on Company Registration.  This article discusses issues related to such equity contribution.

1. Related Parties

According to Measures on Registration of Equity to Other Companies(for trial), the word “investor” refers to a domestic person who has Chinese nationality and resident enterprise. This means people with foreign nationality, stateless persons and residents in Hong Kong, Macao and Taiwan are excluded. A resident enterprise is a company, unincorporated enterprise, partnership, individual proprietorship, Sino-foreign joint venture, Chinese-foreign cooperative enterprise or a wholly foreign-owned enterprise registered in China.

Equity contributions involve two types of companies, equity and investee.  The equity company, whose shares are held by the investor before investment, is either a domestic or foreign-invested limited liability company registered with the administrative department for industry and commerce for all regions within the Yangtze River Delta, but not stock limited companies.  The investee company, newly established or a company whose registered capital is increased by the investor, is a domestic limited liability company or domestic stock limited company which is restructured and registered with the administrative department for industry and commerce for all regions within the Yangtze River Delta.

2. Equity

The equity, as capital contribution to other companies, should be completely held by the investor.  The investor can get equity through investments, transfer of shares, auction, etc., but whether the investor is a legal owner depends on the public records of the shareholders.  Specifically, for limited liability companies, the basis is the registration in administrative departments for industry and commerce, while stock limited company depends on the registration of stockholders.  In addition, there should be no restrictions on equity, meaning there should be no existence of pledge right on the equity for contribution, and the equity should not be sealed or frozen by the court.

Also, the equity for contribution should be proper to transfer.  Equity contributions are not permitted if there are related agreements among shareholders or a decision by regulatory agencies.  For instance, both Article 142 of Company Law and Article 98 of Security Law restricts the transfer of shares.

3. Contribution

When making equity contribution, the equity and other non-monetary contributions may not exceed 70% of the registered capital of the investee company. In accordance with the provision of Company Law, capital contributions in cash should not be less than 30% of the total registered capital.  Moreover, if the investor intends to make an equity contribution, he/she shall obtain the consent from the majority of the other shareholders of the equity company, and the consent from all shareholders of the investee company.

There are two ways to change the shareholder of the equity company instead of the investee company:  transfer of shares and administrative transfer of shares.  The most popular way is by transfer of shares, requiring consent from the majority of the other shareholders, adopting a resolution by the shareholders’ committee, amending the articles of incorporation, signing the agreement of shares transfer and making the shareholders alteration of registration in regulatory agencies;  if state-owned shares are involved, the transfer should be approved by the original agency.

4. Registration

The registration for equity contribution includes: registration for establishment, alteration of the investee company and the alteration of shareholders of the equity company.  If the registration is for establishment of the investee company, the equity should not be the first payment.  The registration for alteration of shareholders of the equity company should be before the registration for alteration of the paid-in capital.

During the registration for establishment and alteration of registered capital for the investee company, the Equity Contribution Informed Commitment should be signed by all investors and filed at the same time. It should contain the commitments on clear equity rights, legal contributions, value assessment alteration registrations and other matters.

5. Value Assessment

According to Article 27 of Company Law, the value of the non-monetary properties as capital contributions should be assessed and verified, it should not be over-valued or under-valued.  Currently, value assessment of the equity is based on the company’s net assets value, number of shares, principle of determining the voting right of stockholders, principle of determining the distribution of shares, operating status, etc.

On September 28, 2007, Shanghai Dongfang Huiwen International Culture and Service Trade Company became the first company established by equity contribution in Shanghai.  They received their business license from the administrative department for industry and commerce of  Pudong New Area.  Although the application of equity contribution is still confined to the Yangtze River Delta region, it is predicted that the new form of investment will be gradually recognized and accepted.