Authors: Su Meng, Xi Suodi, Zhao Zhenan, and Zhang Wanying.
In a cross-border financing project with the equity of a domestic company or ** as the main collateral, one of the core risk control measures of the project is the control of the pledged equity or **, including the establishment of the guarantee, the creditor's ability to control the collateral, and how to dispose of the risk after it occurs. This article combines our relevant practical experience in equity or cross-border pledge, and sorts out the possible legal and practical issues in equity and cross-border pledge for readers' reference.
For the sake of unified understanding, the "equity" mentioned separately in this article refers to the equity of the shareholders of a limited liability company in the company, which is usually not divided into equivalent shares;"* refers to the certificate of right of the shareholders of the shares of the company, including both listed companies and unlisted shares, and the full mention of "equity of domestic companies" includes both the equity of shareholders of limited liability companies in the company and the shares of ***.
Under the legal system of Chinese mainland, the "doctrine of registration and establishment" is a basic principle for the establishment of equity pledges of domestic companies. Different from the "registration adversarial doctrine" in some foreign jurisdictions (i.e., the registration of security only serves the role of a third party, rather than a necessary prerequisite for the creation of a security interest), the equity pledge of a domestic company is established when the pledge is registeredThe signing of the contract without the registration of the pledge does not create any security interest under the Chinese mainland legal system. From the perspective of the operation of equity pledge of domestic companies, compared with the unified registration of immovable property[1], the equity pledge of domestic companies has different pledge registration requirements due to the nature of the company.
The registration authorities for the equity pledge of domestic companies may include: the market supervision and administration department (").Municipal Supervision Department), China ** Depository and Clearing Co., Ltd. (").CSDand local equity trading centers.
Measures for the Registration of Equity Pledges (Revised in 2020) issued by the State Administration for Market Regulation (").Measures for the Registration of Equity PledgesIt is stipulated that, in addition to the shares that have been registered with the ** registration and clearing institution, the municipal supervision department responsible for the registration of the pledged equity or the company where the ** is located is the equity pledge registration authority, and the enterprise registration agency of the municipal supervision departments at all levels is the equity pledge registration agency.
As an important financial infrastructure of China's ** market, CSD is the *** depository department of the ** market, and is also responsible for handling the pledge registration of its depository**.
The Administrative Measures for Registration and Settlement (Revised in 2022) issued by the China Securities Regulatory Commission (CSRC) stipulates that companies registered and cleared in CSD include those that are traded on the Exchange and other national trading venues approved by CSD, as well as those that are not traded on the trading venues, but entrust the registration and clearing institutions to handle the registration and settlement business. Including: (1) Shanghai, Shenzhen, Beijing** Stock Exchange and the National Small and Medium-sized Enterprise Share Transfer System Company are all listed or listed;2) Shanghai-Hong Kong Stock Connect, Shenzhen-Hong Kong Stock Connect and other cross-border **;3) Unlisted public companies[2]**4) Non-overseas listings of overseas listed companies (mainly in Hong Kong**. 3]
To sum up, the ** for custody and pledge registration in China Securities Deng includes the following categories:
Listed companies on the main board, small and medium-sized board, and GEM**;
Hong Kong-listed companies are not listed overseas**;
**"Listed Company**;And.
An unlisted public company with more than 200 cumulative shareholders**.
Regional Equity Marketplace ("Local Equity Trading CenterCommonly known as the "four-board market", it is a place to provide facilities and services for the non-public issuance, transfer and related activities of small, medium and micro enterprises in the provincial-level administrative area. As of the end of April 2023, 35 regional equity markets across the country have served a total of 190,000 enterprises, and a total of 2RMB26 trillion, of which RMB778.4 billion was invested in equity pledges. [4] The issuance or transfer of ** in the regional equity market shall be deposited and registered in the institution that handles the registration and settlement business.
However, as mentioned above, although the local equity trading centers are operationally the depository and registration places for small, medium and micro enterprises in these regions, the pledge registration authorities in the "Equity Pledge Registration Measures" only refer to the China Securities Dengxing and the municipal supervision department, and do not include "local equity trading centers". There are different determinations in judicial practice as to whether the registration of equity pledge handled in a local equity trading center can effectively establish a pledge. For example, in the case (2019) Lu 05 Min Chu No. 506, the court held that the disputed equity pledge was registered with the Shandong Provincial Local Equity Exchange Center, which had the power of publicity, and accordingly recognized the establishment of the pledge in accordance with the lawIn the case (2019) E 0606 Min Chu No. 4856, the court held that although the disputed equity was registered as a pledge at the Wuhan Local Equity Exchange Center, it was not registered with the industrial and commercial department, and the relevant pledgee did not enjoy the pledge. In practice, because the market supervision department often only registers the promoters of the shares and does not register all shareholders, resulting in the dislocation of the equity pledge of such companies: for the company's equity registered in the local equity trading center, the market supervision department may not be able to handle the ** held by non-promoter shareholders because it does not file the latest shareholder register. For example, the Shanghai Equity Custody and Trading Center requires the applicant to first go to the regional equity market to obtain the latest shareholder register, go to the municipal regulatory department to go through the pledge registration procedures, and then record it in the shareholder register with the certificate issued by the municipal regulatory departmentThe Shenzhen Qianhai Equity Exchange Center stipulates that the pledge shall be registered and a certificate shall be issued at the center, and then the pledge registration procedures shall be handled by the municipal regulatory department with the certificate document.
On 20 October 2023, the China Securities Regulatory Commission (CSRC) issued the Guidelines for the Supervision of the Regional Equity Market No. 1 - Registration and Settlement (Consultation Paper), which unifies business classification, business definition, and business handling requirements for businesses including but not limited to pledge registration. The guidelines aim to formulate unified business rules for the registration and settlement of regional equity markets, improve the quality of registration and settlement of regional equity markets, enhance credibility, and provide necessary support for various services. It is expected that in the future, after the official draft is issued, the pledge registration function of the local equity trading center can be confirmed at the level of departmental regulations, and a clear pledge registration process can be provided.
In the article "Strategies for Cross-border Mortgage of Domestic Real Estate", we mentioned that the law does not prohibit or restrict foreign creditors from becoming mortgagees of domestic real estate, but in practice there are some obstacles that may prevent foreign creditors from registering mortgages. With regard to the registration of cross-border pledge of equity of domestic companies, the Civil Code, the Company Law or the Measures for the Registration of Equity Pledge also do not restrict foreign entities from becoming pledgees of equity in domestic companies. In addition, based on our experience, the cross-border pledge of equity of domestic companies has fewer practical obstacles than real estate. To a certain extent, this is due to the fact that the equity of domestic companies was opened up to the outside world earlier, and there are a large number of foreign-invested enterprises in the market itself. For example, the fifth part of the Specifications for the Submission of Materials for the Registration of Market Entities issued by the State Administration for Market Regulation on February 28, 2022 clearly states that if the pledgor or pledgee is a foreign investor, it is necessary to submit notarized and authenticated entity qualification documents or identity certificatesThe "China ** Depository and Clearing Co., Ltd. Shenzhen Branch** Pledge Business Guide" and the "China ** Registration and Clearing Co., Ltd. Shanghai Branch Business Hall Business Guide" issued by China Securities Deng Shanghai Branch both specify the notarized and authenticated identity materials that need to be submitted by foreign investors.
Recently, there have been some new developments in the notarization arrangements for overseas entities mentioned above. From 7 November 2023, the Convention on the Abolition of the Requirement for the Legalization of Foreign Public Documents ("ConventionIt officially came into force for our country. According to the Convention, the official documents of the contracting parties are sent to Chinese mainland for use, and after the local notarization procedures are completed, only the additional certificate (apostille) of the country needs to be processed, and there is no need to apply for consular legalization by the country and the Chinese embassy or consulate in the local area. However, the original "local notarization + consular legalization" procedure is still used between China and non-signatories to the Convention (such as Thailand and Malaysia), and the current practice of two-way document circulation between Chinese mainland and Hong Kong and Macao Special Administrative Regions, as well as between Chinese mainland and Taiwan, will not be affected. After the entry into force of the Convention, the time required for the processing of a public instrument required by the contracting authority of the State Party could be reduced from about 20 working days to several working days, and the financial cost to the applicant could also be reduced.
According to our consultation in early November 2023, different local municipal regulatory authorities are gradually adopting additional certificates under the Convention as registration materials, but the progress of adoption varies from region to region. Considering that the Convention has been in force for China for a short time, it is still necessary to communicate with the relevant registration authorities in advance on the acceptability of the additional certificate.
According to the Provisions on the Administration of Foreign Exchange for Cross-border Guarantees ("Circular No. 29If the equity pledge of a domestic company is a security interest and meets the structural characteristics of "overseas loans under domestic guarantees", i.e., the "domestic-foreign-foreign" structure in which "the guarantor is registered in China and the debtor and creditor are both registered overseas", it constitutes a foreign loan under domestic guarantee and needs to be registered in accordance with Circular No. 29.
Below we have listed two possible common situations, in both cases, the debtor and the creditor are registered overseas, the difference is that in the first case, the pledgee is registered in China, and in the second case, the pledgee is registered abroad. In the second case, i.e., if the pledgor of the WFOE is overseas, it does not fall under the circumstance that it is required to apply for a foreign loan under domestic guarantee under Circular 29.
Scenario 1: Constitutes a foreign loan under domestic guarantee).
Scenario 2: It does not constitute a foreign loan under domestic guarantee).
Can the registered capital that has not yet expired and has not been paid in be registered as a pledge?
According to the Company Law, China currently implements the registered capital subscription system, and the paid-in capital of the company is not regarded as an industrial and commercial registration item, nor will it be displayed on the business license. Neither the Company Law nor the Civil Code make mandatory provisions on the validity of unpaid registered capital pledges. In addition, whether the unpaid part of the equity has value and whether it can be used for pledge should be a commercial consideration of the pledgee. In practice, it is sufficient to fill in the amount of the pledgee's subscribed capital contribution in the column of "Amount of Pledged Equity" in the Application Form for Equity Pledge Registration, and the incomplete payment usually does not affect the pledge registration.
Is there an agreement in the articles of association that hinders the pledge or disposal of equity?
Before obtaining the equity pledge guarantee, the pledgee should pay attention to whether there is an agreement in the articles of association that restricts the pledge of equity or restricts the transfer of equity. For example, if the articles of association stipulate that "the company shall not provide guarantees for shareholders or actual controllers", if a company resolution to provide guarantees for shareholders or actual controllers is made in violation of the agreement, according to the Company Law, shareholders may request the people's court to revoke the resolution within 60 days from the date of the resolution. If the resolution is revoked and the creditor fails to fulfill its duty of care to review the articles of association of the company, and does not constitute a bona fide third party, the pledge contract signed by the pledgor will not be effective against the pledgor, which will affect the creditor's security interest.
When the pledgee accepts the guarantee provided by the domestic company, according to Article 16 of the Company Law, the pledgee is obliged to conduct a formal review of the company's resolution to determine whether the resolution violates the company's articles of association, otherwise the pledgee does not constitute a bona fide counterparty. Generally, the pledgee needs to review the articles of association of the company in a timely manner, and if it is found that there is an agreement in the articles of association that hinders the pledge of shares or the disposal of equity, the company should make it a prerequisite to amend such provisions in the articles of association to prevent the risk of the company's resolution being revoked due to violation of the articles of association.
How does the post-pledge capital increase affect the pledge registration?
According to market practice, the equity pledge agreement usually stipulates that when the pledgor contributes capital or obtains any additional registered capital, it shall promptly notify the pledgee, sign the supplementary pledge agreement and register the supplementary pledge within the required time limit. Since the "amount of pledged equity" in the current national unified "Application Form for Equity Pledge Registration" is shown as "10,000 yuan" or "10,000 shares", rather than showing the pledged equity ratio, even if the pledgor pledges 100% of the equity ratio, which leads to an increase in the registered capital after the capital increase, it is still necessary to go through the change registration of equity pledge.
According to the Measures for the Registration of Equity Pledge, an application for registration of the change in the amount of pledged equity shall be applied, and an amendment to the pledge contract or a supplementary contract shall be submitted to the registration authority. However, in practice, the requirements of local registration authorities are different, and some places cannot directly operate the registration of equity change, but require that the existing equity pledge registration be lifted first, and then re-handle the equity pledge registration after completing the capital increase procedure, such as Guangzhou;However, there are also local registration authorities that can handle the capital increase without lifting the original pledge registration, and then handle the registration of the change of equity pledge after the capital increase is completed, such as Shanghai Qingpu, Shandong Zaozhuang, etc.
Effect of Pledge of Restricted Shares.
Article 141 of the Company Law stipulates restrictions on the transfer of shares of the company by the promoters, directors, supervisors and senior management of the company[5]. According to the provisions of the Civil Code, the premise that the pledge can be made is that the ** can be transferred, so does it mean that the restricted shares of the listed company cannot be pledged?
In this regard, the Reply of the Enforcement Office of the Supreme People's Court on the Request for Instructions on the Validity of the Share Pledge Contract and the Bonus Debt Redemption Agreement of the Promoter of a Listed Company ([2002] Zhi Ta Zi No. 22, April 15, 2004) has a clear opinion on the validity of the restricted share pledge contract: "Article 147 of the Company Law shall be understood as a limitation on the time for the actual transfer of equity, rather than a limitation on the time for reaching an equity transfer agreement. In this case, the period for the non-transfer of the pledged shares ended on March 3, 2002, and the period for exercising the pledge right could not begin until September 25, 2005. In the Business Guide for the Business Hall of the Shanghai Branch of China ** Depository and Clearing Co., Ltd. and the Pledge Business Guide of the Shenzhen Branch of China ** Depository and Clearing Co., Ltd., China Securities Deng only restricts "those that have been frozen by the competent authorities, have been repurchased and pledged, and have submitted ** company or the company as collateral" shall not be registered as pledges, without mentioning restricted shares, and only require ** to be unrestricted tradable shares when the pledge is disposed of and transferred and the pledge registration status is adjusted.
After searching the announcements of listed companies, we also noticed that listed companies, including Sichuan Hejia shares, Henan Oriental Silver Star Investment Shares, etc., announced that they had handled the pledge registration of restricted shares.
Whether foreign investors can register pledges held in China through QFIIs or SSE Stock Connect.
If the overseas investor holds the domestic ** through QFII, it is not possible to register the ** pledge in the current practice of CSD. We have learned from the staff of CSD that as far as QFII is concerned, the main problem is that CSD's rules require that the pledgor is a natural person or legal person, but QFIIs are recorded as product holdings in CSD, so they cannot handle pledge registration.
As far as the Shanghai (Shenzhen) Stock Connect is concerned, as shown in the figure above, due to the multi-level custody structure, only the nominee holder will be registered at the CSD level (i.e., Hong Kong Clearing cannot show the real holder, so it is not possible to register the pledge in CSD, but the pledge can be pledged in Hong Kong in accordance with local regulations and practices).
In contrast to the Shanghai (Shenzhen) Stock Connect, the Hong Kong Stock Connect will show the real ** holder at the CSI level, so you can register the pledge in the CSD. Article 21 of the Implementation Rules for the Registration, Depository and Settlement of the Mainland and Hong Kong ** Market Interconnection Mechanism (revised in January 2023) clarifies that the pledge business involved in Hong Kong Stock Connect investors shall be handled with reference to the relevant rules of CSD, and the specific Hong Kong stocks are also specified in the Guidelines for Hong Kong Stock Connect Depository and Settlement Business of Shenzhen Branch of China ** Depository and Clearing Co., Ltd. and the Guidelines for Hong Kong Stock Connect Depository and Clearing Business of China ** Depository and Clearing Co., Ltd. Shanghai Branch Pledge registration and unpledge registration process.
According to the Measures for the Registration of Equity Pledge, to apply for the registration of equity pledge, it is necessary to submit the qualification certificate of the pledgor and the pledgee (if the pledgor or pledgee belongs to a legal person, the seal of the legal person shall be stamped). For overseas pledgors and pledgees, the subject qualification documents issued by the local company regulatory authorities generally cannot be directly used in China, and they can only be used after performing notarization and verification (applicable to Hong Kong, Macao and Taiwan) or notarization and authentication (other overseas regions other than Hong Kong, Macao and Taiwan). However, as mentioned above, after the Convention officially comes into effect for China, the materials to be submitted by overseas entities to apply for pledge registration may be adjusted.
The subject qualification document generally refers to the company registration certificate or business registration certificate, etc., depending on the legal requirements of the place where the company is incorporated. As for whether it is necessary to submit documents such as the articles of association, the Chinese translation of the articles of association, the register of shareholders, etc., the requirements of each registration authority may be different, and it is usually necessary to consult and confirm with the registration authority in advance on a case-by-case basis.
For the determination of the pledgor's official seal and the signature sample of the authorized signatory, since the pledgor is the shareholder of the company, usually during the initial registration of the company's establishment, the shareholders will retain the official seal and the signature sample of the authorized signatory in the system of the municipal supervision department, and some registration authorities allow the notarization procedures of the official seal and the authorized signatory sample to be exempted if the official seal and the authorized signatory have not changedHowever, for the pledgee, it is generally the first time to handle the business with the municipal supervision department when the pledge is registered, so the pledgee may still need to go through the notarization procedures of the official seal and the signature sample of the authorized signatory.
When there are multiple pledgors jointly pledging the equity of a domestic company, the registration authority may require that the number of copies of the application materials be the same as the number of pledgors in order to facilitate the filing by the registration authority. Therefore, if there are two or more pledgors, it is usually necessary to confirm the number of copies of the application materials with the registration authority before going through the pledge registration.
Taking Hong Kong as an example, according to the Hong Kong Companies Ordinance, when a Hong Kong company acts as a pledgor to sign a share pledge agreement of a domestic company, it shall register the charge with the Hong Kong Companies Registry within one month after the agreement is signed, and the Hong Kong Registry shall issue a certificate of registration of the charge. In a loan project, when the equity pledge of a domestic company is used as a follow-up condition of the loan, this requirement of Hong Kong law may be ignored, resulting in a missed time limit for registration of the charge in Hong Kong within one month, which will affect the security interest of the creditor. Therefore, when the parties to the project encounter a Hong Kong company as the pledgor, they usually need to start the registration of the charge in Hong Kong immediately after signing the pledge agreement. If the pledgor is in another jurisdiction, it may also need to go through the relevant procedures according to the requirements of local law.
According to the "Measures for the Registration of Equity Pledge", to apply for the registration of the establishment of equity pledge, a copy of the register of shareholders of a limited liability company with the name (name) of the pledgor and its capital contribution or a copy of the joint stock company held by the pledgor (all of which need to be stamped with the company's seal), and the specific information that needs to be recorded in the register of shareholders, according to the provisions of the Company Law, a limited liability company and a share are slightly different, usually including the name or title and address of the shareholder, the amount of capital contribution of the shareholder, the number of shares held by the shareholder, Certificate of Capital Contribution No. The number of the shareholder's **, the date of issue (for ** only).
The original Guarantee Law and its judicial interpretation provided that "if the shares of a limited liability company are pledged, the relevant provisions of the Company Law on the transfer of shares shall apply." The pledge contract shall take effect from the date on which the shares pledged are recorded in the register of shareholders", "if the shares of a non-listed company are pledged, the pledge contract shall take effect from the date on which the shares pledged are recorded in the register of shareholders", but the above clauses have been deleted in the current effective Civil Code and the Company Law. Therefore, the failure of a domestic company to record the pledge in the register of shareholders after the registration of the equity pledge usually does not affect the validity of the pledgee's acquisition of the pledge. Nevertheless, considering that the preparation of the register of shareholders is still the obligation of the company under the Company Law, it is more prudent to clearly record the pledge of the relevant equity ** in the register of shareholders, so as to further protect the rights and interests of the pledgee.
Equity ** pledge is an important security tool in the structure of cross-border financing transactions, and almost every cross-border financing project will be involved. Therefore, the various legal and practical issues mentioned in this article may be encountered in various stages of cross-border financing transaction structuring, transaction text negotiation and transaction execution. We hope that this article will provide some reference and benefit to parties involved in cross-border financing transactions.
Any reference herein to "Hong Kong" and "Hong Kong Special Administrative Region" shall be construed as "Hong Kong Special Administrative Region of the People's Republic of China".
Footnotes: 1] See:
2] According to the Measures for the Supervision and Administration of Unlisted Public Companies, an unlisted public company refers to: (1) the issuance or transfer to a specific target, resulting in a cumulative number of more than 200 shareholders;(2) **Public Transfer.
4] Wu Qichao, Deputy Director of the Second Market Department of the China ** Supervision and Administration Commission, delivered a speech at the International Forum on SME Investment and Financing at the 18th China Expo on June 28, 2023.
5] Article 141 of the Company Law: The shares of the Company held by the promoter shall not be transferred within one year from the date of establishment of the company. The shares issued before the company's public offering of shares shall not be transferred within one year from the date of listing and trading on the company's ** exchange. The directors, supervisors and senior management of the company shall report to the company the shares of the company and their changes, and the annual transfer of shares shall not exceed 25% of the total number of shares of the company held by them during their tenureThe shares of the company held by the company shall not be transferred within one year from the date of listing and trading of the company. Within half a year after the resignation of the above-mentioned personnel, they shall not transfer the shares of the Company held by them. The articles of association of the company may make other restrictive provisions on the transfer of the shares of the company held by the directors, supervisors and senior management of the company.
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