Responsive to issues faced with difficulty in obtaining financing by businesses (particularly small- to medium-size enterprises) due to the global financial crisis, State Administration of Industry and Commence officially released Administrative Measures for Corporate Debt-for-Equity Swap Registration (the “Measures”) recently, which formalizes regulation of debt-for-equity swap on the national level. The Measures will be put into implementation on January 1, 2012.

A debt-for-equity swap within the meaning of the Measures refers to the conversion of a creditor’s rights in the indebtedness owed to it by a limited liability company or joint-stock company established in China into equity by way of increasing the registered capital of such entity. The Measures apply to the following types of debts:

1. Indebtedness arising from a contract between a creditor and a company in the course of business, provided that the creditor has performed all its contractual obligations giving rise  to the indebtedness and the swap will not violate any prohibitive provision of any laws, administrative regulations, measures of the State Council or the articles of association of the company;
    
2. Debts pursuant to an effective judgment of a People’s Court; and
    
3. Debts included in a reorganization plan as approved,  or a settlement agreement accepted and confirmed, by a People’s Court in connection with a bankruptcy reorganization or settlement of the debtor.

A company seeking to implement debt-to-equity swap shall apply to the company registration authority for change of registered capital and paid-up capital. In accordance with the Measures, the amount converted into equity from debt-for-equity swap when adding to other non-cash capital contribution shall not in the aggregate exceed 70% of the company’s registered capital, and shall not exceed the appraised value of the converted debts.

The Measures also requires that debts to be swapped for equity shall be appraised by legally established asset appraisal institutions, and equity swapped from debts shall be verified by legally established capital verification institutions for which capital verification certificates shall be issued.

The implementation of the Measures will alleviate the debt burdens of businesses after the financial meltdown and broaden financing channels available to them. At the same time, the Measures will effectively manage and mitigate potential risks facing businesses in the course of the debt-for-equity swap by requiring warranties by relevant parties, appraisal and capital verification,  and public disclosure of information, as well as imposing administrative penalties in accordance with relevant laws.