KEY LEGAL CONSIDERATIONS UPON THE CONVERSION OF FOREIGN LOAN INTO CAPITAL CONTRIBUTION

The conversion of foreign loan into capital contribution is a debt repayment mechanism widely adopted by enterprises as a means to optimize capital flows and promptly address operational funding needs. However, this is not merely a financial decision; it constitutes a complex cross-border transaction governed concurrently by laws on enterprises, investment, and foreign exchange control. Any lack of due diligence or failure to adhere to prescribed legal procedures may result in the refusal of competent authorities to recognize the capital contribution, thereby giving rise to significant operational risks for the enterprise.

Is “debt repayment” in the form of conversion of foreign loan into capital contribution lawful?

Mobilizing capital to support business operations through foreign loans is a legitimate and practical need of many enterprises. Such loans are typically established through loan agreements or contracts, and, where required by law – particularly in the case of medium or long term loans must be registered with the competent state authority. To ensure the transparency and legality of foreign currency transactions, it is standard practice that all inflows and outflows related to foreign loans, including both disbursement and repayment, must be conducted via a designated loan account opened at a licensed bank.

However, in line with practical business needs and based on mutual agreement, the Vietnamese enterprise as the borrower and the foreign lender are entitled to directly offset outstanding loan obligations by converting the foreign loan into an equivalent amount of charter capital in the enterprise. Instead of receiving repayment of the loan principal and interest through conventional means, the lender receives ownership rights over corresponding shares or equity interests and thereby becomes a shareholder or member of the company.

In essence, this arrangement may be understood as a process of issuing additional shares or increasing charter capital for the purpose of debt repayment.
However, the payment for the subscription of shares or equity interests is offset directly against the value of the outstanding loan, rather than arising any cash flow through the enterprise’s bank account.

Clause 2, Article 34 of Circular No. 12/2022/TT-NHNN:

“Article 34. Cases in which withdrawal of loan proceeds or debt repayment is not carried out through foreign loan accounts

…

2. Cases in which debt repayment is not required to be conducted via a foreign loan and debt repayment account:

a) Repayment in the form of supplying goods or services to the lender;

b) Repayment through an agreement between the lender and the borrower to convert the outstanding debt into shares or contributed capital of the borrower;

c) Repayment through an agreement between the lender and the borrower to swap the outstanding debt into shares or contributed capital owned by the borrower;

d) Repayment of medium- and long-term foreign loans through direct offsetting of receivables with the lender;

đ) Repayment conducted via an offshore account of the borrower (in cases where the borrower is permitted to open an offshore account to execute the foreign loan).

…”

Key legal considerations upon the conversion of foreign loan into capital contribution?

Legality of the foreign loan

The foreign loan subject to conversion must satisfy the legal requirements regarding its form, time of execution, and, where applicable, registration with the State Bank of Vietnam. In addition, the borrowing enterprise must strictly comply with the requirement to use the loan proceeds for lawful and registered purposes.

Transactions via foreign loan and debt repayment account

All inflows and outflows related to the foreign loan must be conducted through a designated loan account opened at a licensed bank, in accordance with applicable regulations. It should be noted that when repayment is made in the form of conversion of foreign loan into capital contribution, the enterprise as the borrower is responsible for notifying and providing sufficient evidence to the account-servicing bank to justify the debt repayment conducted without the use of a bank account.

Internal approvals to be obtained

The enterprise must obtain all necessary internal approvals (consistent with its corporate form) for the proposed handling of the loan, charter capital increase, changes in equity ownership ratios, etc., especially in cases where the conversion of a foreign loan into capital results in a change to the ownership structure. Importantly, the projected ownership ratio of the foreign shareholder/member following the conversion must comply with the foreign ownership limits stipulated under investment laws.

Amendment to loan terms and conditions

An agreement to amend the terms and conditions of the loan must be clearly documented based on mutual consent between the borrower and the lender, and duly approved internally by each party. Based on such agreement, the borrower is required within 30 working days from the date of execution to register the change to the loan (applicable to medium and long term loans) with the State Bank of Vietnam in accordance with the relevant regulations.

Legal procedures to be undertaken upon conversion of foreign loan into capital contribution

To complete the conversion of a foreign loan into capital contribution, the enterprise must comply with all relevant legal procedures, which may vary depending on the specific circumstances. These procedures may include the entire or some of: (i) Application for approval of the foreign investor’s capital contribution or purchase of shares/capital contribution in Vietnamese enterprise; (ii) Registration of changes to the foreign loan with the State Bank of Vietnam; (iii) Amendment to the Enterprise Registration Certificate to reflect the charter capital increase and updated shareholder/member information; Amending the Investment Registration Certificate, if applicable. It should be noted that, during the implementation of these procedures, the competent regulatory authorities may request the enterprise to provide explanations or supporting documents concerning the convertible loan or the capital increase transaction.

Enterprises are strongly advised to proactively review and assess all relevant legal issues and to duly complete all procedural requirements with the competent authorities. Where necessary, legal consultation should be sought at an early stage in order to minimize risks and ensure the legality and smooth execution of the conversion process.

>> WHEN TO APPLY FOR A FOREIGN LOAN? https://linconlaw.vn/when-to-apply-for-a-foreign-loan/

>> PROCEDURE FOR FOREIGN LOAN APPLICATION https://linconlaw.vn/procedure-for-foreign-loan-application/