How to determine the effectiveness of betting against shareholders or actual controllers
Author | Intellectual Property Center, Lawyer Wang Qionghua
The "betting agreement", also known as the valuation adjustment agreement, refers to the agreement between the investor and the financier to adjust the valuation of the future target company in order to solve the uncertainty of the target company's future development, information asymmetry and agency costs between the two parties to the transaction, including equity repurchase, monetary compensation, etc[1]。
It is more common in Private Equity, Venture Capital, and major asset restructuring and overseas M & A transactions of listed companies.
From the perspective of the subject of entering into a "betting agreement", there are forms of "betting" between the investor and the shareholders or actual controllers of the target company, "betting" between the investor and the target company, "betting" between the investor and the shareholders of the target company, and "betting" of the target company. How should the investor and the shareholders or actual controllers of the target company "bet"? Let's take a look at the following case.
Brief Introduction to the Case
On September 18, 2015, the applicant (A partnership) increased its capital to Company D by 10 million yuan, and agreed on the relevant performance betting conditions. According to the Capital Increase Agreement signed by the applicant and Company D, the first respondent (B natural person), etc., and its Supplementary Agreement, if Company D fails to complete the relevant performance commitments, the first respondent shall repurchase the applicant's equity in Company D at an annual interest rate of 15% based on
10million yuan.
On July 31, 2019, due to the failure of Company D to complete the relevant performance commitments, the applicant and the first and second respondents (C Partnership, hereinafter collectively referred to as the "Respondent" with the first respondent) signed an "Equity Repurchase Agreement", which stipulates: (1) The respondent repurchases the equity of Company D held by the applicant at an annual interest rate of 10%, and pays the equity repurchase payment to the applicant in batches on September 30, 2019 and December 31, 2019; (2) If the applicant fails to pay the current repurchase payment on September 30, 2019, the applicant has the right to require the respondent to pay the current repurchase payment once Pay the full repurchase amount and pay the overdue liquidated damages at an annual interest rate of 14% of the unpaid repurchase amount.
Since the respondent did not pay the current repurchase payment on September 30, 2019, nor did it pay the full repurchase payment and overdue liquidated damages as agreed upon at the request of the applicant, the applicant applied to the Shenzhen International Arbitration Court for arbitration in accordance with the arbitration clause, and made the following arbitration request:
1. The respondent repurchases the equity of Company D held by the applicant as agreed.
2. The respondent paid the applicant 1,1916436.57 yuan for the repurchase (from September 28, 2015 to September 30, 2019, a total of 1,463 days).
3. The respondent pays the applicant a liquidated damages of 351,942.98 yuan (temporarily counted from September 30, 2019 to December 16, 2019, a total of 77 days, and is required to be calculated until the respondent actually pays the full repurchase amount).
4. The respondent shall bear the arbitration fee, property preservation fee and attorney's fee in this case.
II. The legal effect of the contract
One of the focuses of the dispute in this case is whether the gambling agreement involved in the case is a valid contract?
The applicant believes that:If the applicant and the shareholders of the target company agree that the target company fails to complete the performance indicators, commitment targets and other specific matters within the specified time limit, the shareholders of the company shall repurchase the investors' equity at the agreed price, which is a common practice in the field of direct financing. Its essence is the consensual act of judging the risk of capital value in commercial operations, which does not violate the mandatory provisions of laws and administrative regulations, and will not produce unfair or harm the interests of the company, other shareholders and the company's creditors.
Both parties to the contract are equal and rational business conduct subjects. After the investors invest in the shares, the target company has realized the opportunity for financing the development of the enterprise, and the shareholders can also enjoy the share appreciation income brought about by the growth of the enterprise. The repurchase terms agreed upon by both parties are the true meaning of both parties. Autonomy of will and good faith are the basic principles stipulated in the civil law of our country. Both parties should fully perform the agreement in accordance with the principle of good faith.
The respondent believes that:The applicant does not bear the business risk and enjoys a fixed return. The capital increase is actually a loan, so it is an invalid contract.
Opinion of the arbitral tribunal:
The performance commitment and compensation repurchase clauses in the "Equity Repurchase Agreement" and the "Capital Increase Agreement" and the "Supplementary Agreement" in this case are a form of the so-called "gambling agreement" in business practice, that is, the investor and the target company's shareholders and/or actual controllers agree that if the target company fails to complete the specific items such as the performance indicator commitment target within the specified time limit, the company's shareholders and/or actual controllers shall repurchase the investor's equity at the agreed price or provide certain compensation.
It is a common practice in the field of direct financing and investment in our country in recent years for investors to sign a bet agreement with the shareholders and/or actual controllers of the target company. The purpose is to solve the problems of uncertainty, information asymmetry and agency costs between the investment and financing parties about the future development of the target company. When the target company fails to meet the performance goals, the investment and financing parties adjust the rights, obligations or interests between the two parties through repurchase of equity, transfer of equity, cash compensation, etc.
This is not a private lending relationship between the two parties, but an extension of the investment and financing relationship. The investor is a registered shareholder of the company and has handled the industrial and commercial registration during the period from investment and share purchase to withdrawal. Its investment purpose is to achieve the expected results of the company's business activities, so it should not be regarded as "clear shares and real debts".
As an agreement reached by consensus between the investment and financing parties on an equal and voluntary basis, a gambling agreement has effectively established a contractual relationship from the perspective of contract law. Whether it is invalid because of violating the mandatory provisions of laws or administrative regulations mainly involves the application of Article
20(1) of the Company Law.
The clause stipulates: "Shareholders of a company shall abide by laws, administrative regulations and the articles of association of the company, exercise their rights according to law, and shall not abuse their rights to harm the interests of the company or other shareholders; they shall not abuse the independent status of the company as a legal person and the limited liability of shareholders to harm the interests of the company's creditors." In practice, whether a gambling agreement has consequences that harm the interests of the company, other shareholders and the company's creditors depends first on whether the person obligated to gamble is the target company's shareholders, the actual controller or the bid company itself.
If the target company is the obligor of the bet, the application of Article 20 (1) of the Company Law will be triggered, and further consideration needs to be given to whether the bet obligation set to the target company is unfair and unreasonable, which harms the interests of the company, other shareholders and company creditors, such as causing shareholders to illegally withdraw their capital.
On the contrary, if the betting agreement is signed between shareholders or between shareholders and actual controllers, and only the shareholders or actual controllers bear the obligations under the betting agreement, without directly imposing obligations on the bidding company, the application of Article 20 (1) of the Company Law is usually not triggered.
The repurchase obligor stipulated in the Equity Repurchase Agreement in this case - that is, the second respondent and the first respondent are the shareholders and actual controllers of the target company D. Strictly speaking, the "equity repurchase" stipulated in the agreement is not a "acquisition" under Articles 74 and 142 of the Company Law, but a share transfer between shareholders or between shareholders and the actual controllers of the company. Therefore, the provisions of Article
20of the Company Law do not apply.
The same is true of the repurchase obligations set for the first respondent in the Capital Increase Agreement and its Supplementary Agreement.
In summary, the repurchase agreement in the Equity Repurchase Agreement and related agreements is a contract signed by the applicant and the first and second respondents through voluntary negotiation, which reflects the true meaning of both parties and does not violate the mandatory provisions of our country's laws and administrative regulations.
III. Conclusion: A betting agreement with shareholders and actual controllers of the target company as obligors is effective in principle
This case is a repurchase-type gambling agreement dispute with the shareholders and actual controllers of the target company as the obligors, and the legal effect of the gambling agreement is a common dispute issue in such disputes. Since the "Haifu case", judicial practice has gradually established that the gambling agreement with the shareholders and actual controllers of the target company as the obligors is valid in principle.
However, it is still possible to explore why this type of vs. betting agreement is effective in principle and can be actually performed, and whether there are exceptions.
In the "Haifu case", the investor Haifu Company signed a gambling agreement with the target company Siheng Company and its shareholder Dia Company, and later claimed that Siheng Company and Dia Company should pay performance compensation on the grounds that Siheng Company's net profit target did not meet the standard.
The Supreme People's Court held that the gambling clause with the target company Shiheng Company as the obligor was invalid because it "enabled Haifu Company to obtain a relatively fixed return on its investment, which was divorced from Shiheng Company's operating performance and harmed the interests of the company and the company's creditors." The gambling clause with the target company's shareholder Dia Company as the obligor was valid because it "does not harm the interests of the company and the company's creditors, does not violate the prohibitive provisions of laws and regulations, and is the true intention of the parties."
In the Haifu case, the Supreme People's Court relied primarily on Article 20 (1) of the Company Law, which provides that the interests of the company, other shareholders, or the company's creditors shall not be harmed, and Article 52 (5) of the Contract Law, which provides that contracts that violate mandatory provisions of laws and administrative regulations are invalid.
The basic idea is to determine whether the relevant gambling agreement constitutes a situation that damages the interests of the company, other shareholders or the company's creditors as stipulated in Article 20 (1) of the Company Law. If so, the gambling agreement is found to be invalid in accordance with Article 52 (5) of the Contract Law. This line of thinking was also followed in this case.
Different from the betting agreement with the target company as the obligor, the betting agreement with the target company's shareholders and actual controllers as the obligors is considered valid in principle and can be actually performed because it does not involve the principle of capital maintenance and usually does not involve the interests of the company, other shareholders or company creditors.
However, in special cases involving state-owned enterprises, foreign-invested enterprises, listed companies, and the raising of Private Offering Funds, the validity of the betting agreement with the shareholders and actual controllers of the target company as the obligors may still be controversial.
[1] Article 2 (1) of the National Court Civil and Commercial Trial Work meeting notes on the effectiveness and performance of the "gambling agreement"
Lawyer Profile
Wang Qionghua, Lawyer
, Partner Lawyer
Secretary General, Copyright Law Professional Committee of Shenzhen Law Association
Secretary General of Zhiheng Intellectual Property Center, Deputy Director of Copyright Committee
Areas of expertise:
Intellectual property compliance, intellectual property cross-protection and defense
Emerging frontier technology comprehensive legal services
Civil and commercial litigation, arbitration, corporate legal counsel
Publication representative:
"Long'an Lawyers Interpretation of the Civil Code" Contract Compilation
"Internet Law Course"
Anti-Monopoly Lawyer Practice for Mergers and Acquisitions in China
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