The conversion of foreign loans into capital contributions has increasingly become a popular financial strategy for foreign-invested enterprises operating in Vietnam. This approach not only enhances a company’s financial resources but also optimizes its capital structure, facilitating business expansion. However, to ensure a smooth and compliant process, businesses must possess a comprehensive understanding of the relevant legal regulations and key considerations.

This article offers an overview of the conversion process, as well as the necessary conditions and precautions.

1. What is the legal basis for converting foreign loans into capital contributions?

In addition to repaying the loan through the designated loan account, banking regulations also allow the borrower to make repayments through alternative methods, such as:

• Repayment in the form of goods or services provided to the lender;
• Repayment through a mutual agreement between the lender and the borrower to convert the outstanding debt into equity or capital contributions owned by the borrower;
• Repayment through the conversion of outstanding debt into equity or capital contributions owned by the borrower;
• Repayment of medium- and long-term foreign loans through the offsetting of receivables directly with the lender;
• Repayment through the borrower’s account opened overseas (in cases where the borrower is permitted to open an overseas account for the foreign loan).

In this article, we would like to share some practical experiences in the parties choosing the form of debt repayment to convert the loan into capital contribution. Accordingly, converting the loan into capital contribution will be understood as investment capital, the charter capital of that enterprise will increase because the lender is also a shareholder/member, increasing the capital contribution ratio of that shareholder/member in the company. Alternatively, another case may occur where the company acquires additional shareholders or members. This happens when the lender, who is not an existing shareholder or member, becomes a new shareholder or member through the conversion of the loan into a capital contribution. Depending on the company’s current business type, additional steps may be necessary to change the business type at the business registration agency.

Under current investment and corporate laws, there is currently no legal provision prohibiting or restricting a company from increasing its capital through the conversion of debt from a loan agreement into equity. However, in certain specific cases, companies should also consider permitted business sectors and the foreign ownership limit for enterprises in Vietnam.

2. Why do enterprises choose foreign loans as a form of capital mobilization?

In addition to requiring capital to execute business plans, establishing a loan agreement for foreign loans is considered a “firefighting” solution for Vietnamese enterprises, especially when businesses urgently need capital for operation. However, the procedures for increasing capital from foreign sources are complex and time-consuming. In some cases, enterprises that aim to increase capital by accepting more members and shareholders who are foreign individuals or organizations, however, enterprises will be forced to rearrange their current business sectors, some business sectors will have to be eliminated, some business sectors will have to seek opinions from specialized management ministries. This processing procedure takes 15 working days for simple cases and can last for several months for complex ones. Therefore, securing a loan agreement is considered a firefighting solution during urgent periods for businesses.

In certain cases, foreign borrowing can serve as a capital mobilization channel during the exploratory phase of foreign investors in the Vietnamese market. Instead of directly investing in Vietnamese enterprises through capital contributions, some investors opt for loans. This may be due to their caution about Vietnam’s policies,  arising from a lack of full understanding, yet they wish to have capital already present in the Vietnamese market. Therefore, they choose to establish foreign loans initially instead of other forms such as increasing capital or becoming members or shareholders.

3. What are the conditions for converting foreign loans into capital contributions?

To successfully convert foreign debt into equity, both parties must thoroughly evaluate the loan compliance and investment conditions. Regarding the loan compliance requirements, it is understood that short-term loans must be reported, medium- and long-term loans must be registered, and full reporting obligations must be met for both types of loans. The process of transferring the loan into the borrower’s account must strictly adhere to legal provisions governing loan recipient accounts. Regarding investment conditions, the enterprise must ensure that, after the conversion of the loan into capital contribution, the foreign ownership ratio remains within the permitted limits.

4. What are the necessary steps for an enterprise to convert foreign debt into capital contributions?

The conversion of foreign loans into capital contributions can be defined as the process of increasing capital by accepting new members or shareholders who are foreign investors, or by increasing the ownership ratio of existing foreign investors who are already members or shareholders of the enterprise. Thus, to carry out this conversion, the investor must first:

• To complete the procedures for obtaining approval to contribute capital, purchase shares, or purchase capital contributions from foreign investors at the Department of Planning and Investment/Industrial Park Management Board. The competent authority will review the loan agreement between the parties and the conditions that the investor meets to consider approving or rejecting the application. If the application is valid, the competent authority will issue a written approval for capital contribution, and share purchase, and clearly state the contribution ratio of the lender after approval. Please note that in some cases, enterprises will need to adjust their Investment Registration Certificate to increase total investment capital and contributed capital.
• Carry out procedures to change enterprise registration information, accordingly, information about members/shareholders, ownership ratio, and charter capital will be adjusted. In case of accepting new members, the business will also carry out the conversion of the type of operation if it was previously only a single-member LLC.
• Carry out procedures at the State Bank, accordingly, the enterprise will need to carry out reporting procedures with the State Bank for short-term loans and registering changes for medium and long-term loans.

The specific documents required will vary depending on the individual circumstances and the legal status of the business in Vietnam. However, in all cases, both the lender and the borrower should note that the obligation to report the loan is mandatory. Failure to comply with reporting obligations may result in penalties and delays in the process.

Time of writing: 26/08/2024

The article contains general information which is of reference value, in case you want to receive legal opinions on issues you need clarification on, please get in touch with our Lawyer  at  info@cdlaf.vn

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