With the revision of China’s Company Law, Article 48 now expressly recognizes creditor rights as a valid form of capital contribution. This legislative amendment brought an important issue to the forefront for investors and companies: how a shareholder can set off a claim against the company itself to fulfill its capital contribution obligation, outside an insolvency context. In the market, this mechanism is known as a debt-to-equity conversion.
Article 19 of the draft judicial interpretation of the Company Law also recognizes these conversions, reflecting a discernible practical trend in the Chinese business environment. However, an analysis of recent judicial decisions shows that courts continue to apply rigorous scrutiny focused on the substance of these transactions.
The Shift in Chinese Legislation
Prior to the implementation of the new Company Law, debt claims were not recognized as a permissible method of capital contribution. Courts maintained a cautious stance regarding debt-to-equity conversions by shareholders, although the underlying rationales varied.
Most rulings held that a shareholder’s capital contribution obligation is statutory in nature. This means it is distinct from a general unsecured claim. Consequently, standard set-off rules did not apply, preventing shareholders from unilaterally using their claims to satisfy their capital contribution duty.
Other rulings relied on insolvency principles. The reasoning was that setting off claims could prejudice the company’s other creditors, even if the enterprise had not yet entered formal bankruptcy proceedings. Today, with the new legislation offering a firmer legal basis, the practice is permitted, but courts maintain a strict review.
The Four Criteria for Validating Conversions
Chinese judicial practice has developed specific requirements to ensure the validity of debt-to-equity conversions. The primary factors assessed are:
1. Genuine and Legally Valid Debt
Because these conversions often rely on internal corporate resolutions or agreements, they frequently lack external transparency. For this reason, courts demand robust evidence of the authenticity of the debt. In addition to primary contracts, judges examine performance and delivery records, such as invoices and bank statements, to confirm the existence of genuine business consensus.
In Wang et al v Beijing Guanjing Investment Management Co (2023), the court rejected a shareholder’s claimed debt due to gaps in commercial plausibility and performance records. Similarly, in Qiong 97 Min Zhong No. 420 (2025), the Hainan No. 2 Intermediate People’s Court dismissed an appeal, ruling that internal corporate materials, such as accounting vouchers and expense reports, could not substantiate a valid debt.
2. Solvency and Creditor Protection
A debt-to-equity conversion is legally sound only if the company remains solvent and creditor interests are safeguarded. Courts evaluate the company’s financial condition at the exact time of the set-off. The objective is to prevent shareholders from evading contribution obligations during financial distress. Converting shareholder debt during insolvency risks favoring that shareholder over third-party creditors, compromising fair debt recovery.
Courts generally consider a company insolvent when enforcement proceedings against its assets have been formally suspended. Alternatively, they may conclude that a business cannot pay its debts if it has outstanding obligations and has ceased payments, as illustrated in the civil retrial review Su Min Shen No. 1584 (2026) before the Jiangsu Provincial High People’s Court.
3. Corporate Resolutions and Public Registration
Courts examine shareholder resolutions to confirm the procedural validity of conversions. To protect the interests of third parties, judicial precedent requires companies to amend their articles of association and register these changes with the relevant corporate registration authorities.
In deciding the sales contract dispute Ma Ning et al v Shouhe Jiye Building Materials (Beijing) Co (2021), the court established that converting shareholder debt into equity requires a formal resolution amending the company’s articles of association, followed by filing with the public company registry.
4. Conversion Agreements and Third-Party Valuation
In certain instances, courts also examine whether the converting shareholders executed agreements specifically dedicated to that purpose, in addition to requiring independent valuations to verify the accuracy of the amounts involved in the transaction.
Practical Takeaways
The recognition of debt-to-equity conversions under China’s new Company Law provides alternative mechanisms for structuring investments. However, the transaction’s security relies on thorough documentary evidence, transparency in public filings, and strict observance of the company’s solvency at the time of the transaction.
This content is for informational purposes only and does not constitute legal advice. For guidance on specific matters, consult a qualified lawyer.
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