Verification of Registered Capital in Equity Transfer

Since China's adoption of the open-door policy, numerous laws and regulations have been promulgated to regulate foreign investment enterprises. These may differ from those enterprises with domestic investment. China's foreign exchange control system is playing an active role in foreign direct investment also, which makes equity transfer of an enterprise with foreign investment a little more complicated than a transaction involving only domestic companies. The Reply states that specific provisions will apply to the equity transfer of limited liability companies with foreign investment.

A foreign investor is required to contribute its proportion to registered capital in foreign currency, based on the assumption that a foreign investor will not have income in renminbi (except re-investment with income deriving within the territory of China). On the other hand, renminbi cannot be freely converted into any foreign currency. Further, in practice, the foreign investor is usually required to make payment in foreign currency when acquiring equity of a company with foreign investment and the company shall change its form to an enterprise with foreign investment. As a result, the foreign exchange system makes it difficult for foreigners to acquire equity held by the local investors and especially for local investors to acquire equity held by foreign investors pursuant to the Reply. In practice, the State Administration of Foreign Exchange (SAFE) or its branches will require a domestic entity to present the following documents when applying for foreign currency in an equity transfer transaction where the domestic entity is the transferee:

a) an application letter stating background company information and modification of equity structure;

b) a letter of approval issued by the examination and approval authority (the Ministry of Foreign Trade and Economic Cooperation or its branches);

c) the equity transfer agreement;

d) the business licenses and certificates of approval prior to and after equity transfer;

e) the latest verification report on the company's registered capital;

f) the annual auditing report on foreign exchange of the company;

g) the statement of settlement and utilization of the capital account in foreign exchange;

h) revised shareholders' agreement and articles of association;

i) the foreign exchange registration certificate of the company; and

j) other documents SAFE considers necessary.

The latest verification report on registered capital shall reveal how the transferor obtained the equity and whether the transferor has completely contributed its portion to the registered capital. It is particularly important when a domestic entity intends to purchase foreign currency for the purposes of acquiring equity in a foreign investment enterprise held by a foreign investor who is not an original equity investor of that enterprise.

Obviously, according to the Company Law and other pertaining laws and regulations, a transferee shall effect payment directly to the transferor under an equity transfer transaction. However, due to China's foreign exchange control system, it seems that this well-established practice needs time to be adopted in equity transfer transactions involving foreign investment enterprises.

By David Yu,
Llinks Law Office
Shanghai