Issues to note when a parent absorbs a wholly owned subsidiary by merger

There are a number of methods that a merger and restructuring may take, such as equity transfer, asset transfer, investing in other enterprises through capital increases and mergers and divisions between enterprises. This column will address certain legal issues to keep in mind when a parent company absorbs a wholly owned subsidiary via merger. “Company” in this column refers to a limited liability company.

Parent’s registered capital

It may seem on the surface that a merger between two companies is the start of a relationship between the merger and the mergee. However, it is actually a restructuring of shareholders’ equity. The mergee company shareholders swap their equity for equity in the merger company, all of which is manifested as an increase in the number of merger company shareholders and a change in the company’s registered capital.

The law is silent on how the registered capital of a company post-merger is to be calculated. Further, it is only touched briefly upon only in the legislation at the departmental level.

The Opinions on Duly Registering Company Mergers and Divisions to Support Enterprise Consolidation and Restructuring, issued by the State Administration for Industry and Commerce (the SAIC) in 2011, provide that parties to a merger are supported in autonomously determining the post-merger registered capital amount of the merging party and the shareholders’ capital contributions. Where an investment relationship exists between the parties to the merger, the amount of registered capital and paid-in capital equivalent to the investment should be subtracted when calculating the pre-merger total registered capital and total paid-in capital of the companies.

Under normal circumstances, the merger company’s shareholders increase post-merger, and its registered capital is adjusted. The SAIC’s opinions set out that the post-merger registered capital and shareholders of the parent company and their respective shareholding percentages remain unchanged, however. There are no injections of new assets into the parent when it absorbs a wholly owned subsidiary by merger, nor an increase in the number of its shareholders. Rather, it is treated as recovery of an investment into a third party.

Merger agreement

A merger by absorption requires amending the company registration with the local administration for industry and commerce (AIC). AIC will in turn demand a copy of the merger agreement, and, lacking such, the AIC may return the amended registration unapproved and demand amendment.

Pursuant to the opinions and related SAIC guidelines, a merger agreement should include the names of the parties, the type of merger, the name of the post-merger company, the amount of registered capital of the post-merger company, the plan for succession to
the claims and debts of the parties, details on the dissolution of the company’s branches and disposal of the equity in other companies, and the date and place of execution and other matters deemed necessary by the parties to the agreement.

Business registration

Parent business registration. Article 38 of the Regulations on the Administration of Registration of Companies sets out that a company that survives a merger is required to register any changes to its registered information.

There are differences between a parent absorbing its wholly owned subsidiary by merger and normal company mergers. Namely, there are no changes in the registered particulars of the parent, such as its registered capital, scope of business, legal representative, name and domicile address. The law is currently silent on whether the parent is required to amend the registration of a company surviving a merger.

In practice, the AICs of disparate regions hold different opinions and methods. For example, the Dongguan AIC told subordinate AICs in 2013 that registration procedures are not required, while SAIC recommended that the relevant legal documents on the merger be submitted to the AIC in response to a similar query.

Cancelling business registration. Neither articles 173 nor 183 of the Company Law require that a liquidation committee be formed when a company is dissolved by merger. A wholly owned subsidiary thus does not need to be liquidated before cancelling the registration. If the merger agreement specifies that liquidation must be carried out before dissolution of the subsidiary, however, the liquidation report must be submitted to the AIC when cancelling the subsidiary’s registration.

Branch and subsidiary registration. The merger agreement must include a disposal plan for branches or subsidiaries of the wholly owned subsidiary in the event that it has them. If the agreement sets out that their registrations are to be cancelled, they should be cancelled prior to the merger.

Prior to the merger, the registration must be amended to note subsidiary divestment via equity transfer or capital reduction if provided in the disposal plan. Where the disposal plan provides that the branches or subsidiaries vest in the parent, the name change, arrangement of the hierarchical relationship and registration of the subsidiaries’ change in shareholders need to be performed following the merger.

It should be noted that the AIC requires at this stage that proof be provided of the mergee company’s registration cancellation and of the establishment of, or changes to, the merger company, each providing the details of the merger when the merged company’s branches or subsidiaries vest in the merger company.

As mentioned above, a parent-subsidiary merger does not involve a change in the parent company’s registration. Therefore the possibility cannot be discounted that the AIC may refuse to amend the wholly owned subsidiary’s branches’ or subsidiaries’ registrations if proof of the parent company’s amended registration cannot be secured. With hope, SAIC or the provincial AICs will issue uniform guiding opinions on this.

Zhang Meiying is a partner of East & Concord Partners