Professional Interpretation

Abstract: On April 3, 2019, Jiangsu Higher People's Court made a retrial judgment on Jiangsu Huagong Venture Capital Co., Ltd. and Yangzhou Forging Machine Co., Ltd., Pan Yunhu and other companies, over requesting the company to acquire shares (hereinafter referred to as “Hua Gong Case”). The VAM clause of the purchase obligation is valid. The Huagong case has made a breakthrough in the "Company's VAM clause is invalid" rule, which was established in the Haifu case. This case is an influential precedent for the judgment of the VAM clause in the dispute settlement of private equity funds and the terms of the relevant agreements in private equity investment.

I. PE's background on the dispute over the validity of the VAM contract terms

The VAM agreement is a value adjustment mechanism and contract arrangement commonly used in private equity investment (PE). The core clause is to make a positive or negative agreement on whether the target company can achieve a certain performance. When the goal is reached, the investor continues to hold shares and obtain profits; when the goal cannot be reached, the financing party repurchases the equity of the target company held by the investor at a premium or to makes corresponding compensation. In practice, VAM is generally divided into three situations: VAM with shareholders, VAM with the target company, and VAM with the target company and its shareholders at the same time. Because the VAM with the target company and its shareholders simultaneously requires the parties to bear joint and several liability. In essence, it still determines whether the corresponding entity can fulfill the terms of the VAM contract. Therefore, the discussion on the effectiveness of the VAM clause in practice is mainly divided into two cases: the validity of the VAM clause and the effectiveness of the VAM clause with the target company. .

II. Haifu case - the performance compensation clause "is ineffective against the company, and effective against the shareholder"

The first and second trials of the case did not support the investor's claim. After the retrial, the Supreme Court finally revoked the second-instance judgment and sentenced the original shareholder to pay the new investor a compensation fee of RMB 1998.095 million.

The Haifu case is hailed as the most important precedent of China's PE VAM clause. The principle of “effective against VAM with target companies and effective against VAM with shareholders” has become the industry's general consensus on the choice of VAM objects.

In the Huagong case, investor Jiangsu Huagong Venture Capital Co., Ltd. and the target company Yangzhou Forging Machine Co., Ltd. signed a VAM agreement, stipulating that if Yangzhou Forging Machine Tool Co., Ltd. failed to list on the domestic capital market or Yangzhou before December 31, 2014 The main business, actual controller and board members of Forging Machine Co., Ltd. have undergone major changes. Jiangsu Huagong Venture Capital Co., Ltd. has the right to request Yangzhou Forging Machine Tool Co., Ltd. to repurchase all Yangzhou held by Jiangsu Huagong Venture Capital Co., Ltd. in cash. For the shares of Forging Machine Co., Ltd., the repurchase price is the investment principal plus a fixed return of 8% annual return. The repurchase conditions agreed in the post-contract were made, and the parties disputed accordingly.

After the first and second trials of the Huagong case, the Jiangsu Higher People's Court made a final judgment, arguing that the relevant agreement on the VAM agreement was a manifestation of individual autonomy and should be respected. The VAM agreement belongs to the contractual legal relationship between the investor, the target company and the old shareholder, and the contract law is applied. The equity repurchase clause belongs to the agreement on the price adjustment mechanism. The content does not violate the relevant provisions of the Contract Law

The Huagong case is a typical case of the recent effectiveness of the VAM contract clause, which has aroused widespread concern in the industry. The Huagong case affirmed the validity of the terms of the VAM contract and believed that it was not necessarily invalid against the target company. It is particularly noteworthy that in the judicial judgment of the Huagong case, it is emphasized that the limited liability company will repurchase the company's shares after performing the statutory procedures, and will not harm the interests of the company's shareholders and creditors, nor will it constitute the principle of maintaining the company's capital. The view of the violation provided a theoretical basis for the final judgment of the case.

III. References to judicial referee cases in dispute settlement of VAM contracts

Despite the existence of typical judicial precedents such as the Haifu case and the Huagong case, judicial practice cannot arbitrarily determine the legal effect of the VAM contract clause, and conclude that the effect of the VAM contract clause cannot be separated from the nature of the VAM agreement. Whether the purpose of the agreement is to be achieved, whether such a purpose is legal and reasonable, these should be the foothold of determining the validity of the VAM contract clause, and cannot simply judge the identity of the VAM agreement. Under the premise of comprehensive consideration of whether the performance of the VAM contract terms violates the interests of the target company or the target company creditors, combined with the basic principles of the process of justice that encourages transactions, respects party autonomy, safeguards public interests, and guarantees commercial transactions To comprehensively judge the legal effect of the case on the terms of the VAM contract, and analyze the specific issues in the dispute resolution of the VAM contract.