Notes when converting loans into charter capital in the company

Enterprises borrowing capital from the parent company or a partner but cannot pay the debt, can convert the loan into contributed capital and increase its charter capital

Legal grounds:

• Law on Enterprises in 2020;
• Circular No. 03/2016/TT-NHNN.

One of the ways to raise capital chosen by many businesses is to borrow from the parent company, existing investors, or other partners. The signing of loan contracts to mobilize capital is an efficient channel in terms of procedures and costs. When the debt is due, there are options including:

1. The borrower pays principal and interest as agreed in the loan contract;
2. Borrower and lender may continue to agree to extend the loan term;
3. The borrower and the lender agree to convert part or all of the debt into contributed capital in the company and at the same time increase the charter capital. In this case, the lender will increase the percentage of ownership in the company or become one of the owners of the company.

With options 1 and 2, it does not fundamentally change the role of the lender in the borrower’s business.

With option 3, when becoming the owner of the company, the lender has the right to participate in the operation and management of the company and enjoy the benefits from capital investment. We will present some issues to keep in mind when businesses implement this option.

1. Matters needing attention

Currently, there are no detailed instructions to convert the loan into capital contribution to the company, apart from an regulation at Point b, Clause 2, Article 34 of Circular No. 03/2016/TT-NHNN:

Article 34. Cases of capital withdrawal and debt repayment that are not made through a foreign loan or debt repayment account

2. Cases of debt repayment not through foreign loan and debt repayment accounts:

b) Paying debt with shares or contributed capital of the Borrower in accordance with the provisions of law;

According to the above regulations, the nature of the loan conversion into contributed capital is debt repayment, but instead of paying the debt in cash, the parties agree to convert that debt into the additional charter capital of the company. In addition, instead of the investor making the payment after registering to purchase the additional capital contribution, in this case, the purchase amount of contributed capital has been made previously through the loan disbursement and the loan interest. Therefore, in order to carry out this activity, the parties should pay attention to the following issues:

1. Due to the increase in charter capital, the approval of the General Meeting of Shareholders, the Board of Members, and the owner of the company is required before the conversion.
2. The signed loan contract must be real and legal
3. If it is a foreign loan then:

• • Must register a loan with the State Bank if it is a medium and long term loan
  • Must notify the State Bank if it is a short-term loan
  • The loan must be transferred to the company’s direct investment capital account or loan account
  • After conversion, the percentage of capital contribution in the company of foreign investors must comply with the ownership limit (if any) as prescribed by law
  • Foreign-invested companies must comply with the conditions on investment and business in Vietnam as prescribed by law

2. Procedures for converting loans into contributed capital

To convert a loan to a contributed capital, the lender and the borrowing company refer to the following sequence:

1. Make a written agreement on converting the loan into contributed capital. This document should clearly show the amount of principal, interest, the conversion rate of the loan to contributed capital, the ownership ratio after conversion, the time of conversion, etc.
2. Hold a meeting of the General Meeting of Shareholders, the Board of Members to approve the increasing in charter capital
3. Administrative procedures to be carried out:

• • Apply for approval of the purchase of shares/contributions of foreign investors at the Department of Planning and Investment
  • Notice of change of business registration contents due to increase in charter capital and change of capital contributors
  • Notice of change of contents of Investment Registration Certificate: change of investment capital of project, foreign investor information
  • Notify the State Bank of debt repayment by shares/contributions