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Both article 48 of the new Company Law and article 27 of the 2018 revised old Company Law set out provisions regarding the forms of shareholder contributions. A comparison reveals that, in the case of non-monetary contributions, the old law did not include debt contribution as a form of capital contribution, whereas the new law introduces debt contribution and explicitly requires that such contributions be subject to assessment and valuation.

This article intends to examine, in light of relevant legal provisions and principles, whether shareholder debt contributions made prior to the new law¡¯s effective date require assessment and valuation.

Q: What is the purpose of assessing and valuing non-monetary contributions?

A: The ultimate purpose of assessing and valuing non-monetary contributions is to uphold the capital maintenance rule.

The capital maintenance rule requires that a company maintain sufficient capital to conduct its business activities and to secure the realisation of creditor claims. ¡°Sufficient¡± means that shareholders must fulfil their genuine capital contribution obligations, and the company must ensure that the actual value of its assets matches the amount stipulated in its articles of association.

Q: Which specific laws and regulations address the form of capital contribution known as a debt-to-equity swap?

A: A debt-to-equity swap is a process by which a creditor exchanges its claim against a company for equity, replacing a shareholder¡¯s capital contribution and extinguishing the debt. Article 24 of the 1993 Company Law adopted a closed-list approach to non-monetary capital contributions, explicitly prohibiting debt contributions. Following the 2005 revision, the law shifted to an open-ended and catch-all approach for non-monetary capital contributions, neither expressly including debt as a form of non-monetary contribution nor explicitly prohibiting it. The 2013 and 2018 amendments maintained this position, remaining silent on the issue of debt contributions.

Article 14 of the 2003 Supreme People¡¯s Court Provisions on Several Issues Concerning the Trial of Civil Dispute Cases Related to Enterprise Restructuring affirms the validity of debt-to-equity swap agreements. Furthermore, article 7 of the 2014 Provisions on the Administration of Registration of the Registered Capital of Companies, issued by the State Administration for Industry and Commerce, expressly provides that ¡°a creditor may convert its lawfully held claim against a company established within China into equity in the company¡±. The above provisions demonstrate that the debt-to-equity swap is now underpinned by a legal basis.

Q: What legal effects arise from the act of a debt-to-equity swap?

A: A debt-to-equity swap possesses the dual nature of payment in kind and equity contributions, and is therefore subject to both the Contract Law (now abolished) and the Company Law.

From the perspective of the Contract Law, the following conditions must be met: (1) Proper parties. The parties to a debt-to-equity swap agreement must be the creditor and the target company, both possessing full civil capacity. The creditor must hold a claim against the target company, not against a third party; (2) Authentic and definite claim.

The claim involved in the debt-to-equity agreement must be genuine and exist in fact, and must arise from economic dealings between the creditor and the target company. Generally, this is limited to liquid monetary debts, and does not include claims of a personal nature, claims exclusive to the creditor, or claims prohibited by law from being transferred; and (3) Absence of collusion or fictitious claims. The agreement must not involve malicious collusion, fabrication of claims, or any circumstances that violate mandatory provisions of laws or administrative regulations.

From a company law perspective, an incremental debt-to-equity swap that raises registered capital and amends the articles of association must be approved by a shareholders¡¯ resolution passed by at least two-thirds of the voting rights, and filed with the company registration authority to take effect externally.

Q: Does the absence of an asset valuation process constitute an obstacle to recognising a shareholder¡¯s capital contribution in a debt-to-equity swap?

A: Article 9 of the Judicial Interpretation (III) of the Company Law provides that ¡°where a shareholder contributes non-monetary property without proper valuation, and a company creditor disputes the fulfilment of that contribution, the court should appoint a qualified valuer to assess the property¡±. The notion of a ¡°non-monetary property contribution¡± ought to be read narrowly, confined to the types of assets listed in article 27 of the 2005 Company Law, namely tangible assets, intellectual property, and land-use rights, all of which must be transferable and capable of monetary valuation. It does not extend to creditors¡¯ rights.

In a debt-to-equity swap, however, the amount of the monetary claim is already determined, so there is no need for a court-appointed valuation. In addition, the Provisions on the Administration of Registration of the Registered Capital of Companies draw a clear line by treating the ¡°valuation of non-monetary property contributions¡± in article 5 and ¡°debt into equity swap¡± in article 7 as separate matters, underscoring their different legal character.

The same regulation abolishes the capital-verification requirement for debt-to-equity swaps and does not impose a fresh valuation requirement. In the author¡¯s view, prior to the new Company Law taking effect, the absence of a valuation process in a debt-to-equity swap does not affect the recognition of shareholder capital contributions.

Q: Does a genuine debt-to-equity swap violate the capital maintenance rule or harm the interests of other creditors?

A: No. The reasons are twofold. First, on capital maintenance: Any debt-to-equity swap cancels the corresponding claim. It adds no cash to the balance sheet, but reduces liabilities and increases the owner¡¯s equity. A properly executed swap does not amount to a fictitious capital contribution and therefore neither breaches the capital maintenance rule nor falls within the circumstances of non-performance or incomplete performance of contribution obligations referred to in article 13 of the Judicial Interpretation (III) of the Company Law.

Second, on the interests of other creditors: Under the pari passu principle, all creditors rank equally in insolvency proceedings. Discharging a specific debt through a debt-to-equity swap does not compromise the position of others. Once a creditor becomes a shareholder, its claims fall behind those of remaining creditors under the rule of subordination of shareholder claims, strengthening creditors¡¯ relative standing. With some creditors converted into shareholders, the prospects of recovery for those who remain also improve.

Wang Haihua is a partner at Ronly & Tenwen Partners