"Betting", as we commonly refer to it, actually refers to a series of financial clauses formulated by investors and financiers in financing agreements to ensure their own interests based on uncertainty about the future. The parties agree on a desired outcome (such as achieving a listing or doubling of performance). If the desired outcome is ultimately achieved, it can be considered that the financing party has successfully wagered, and the parties fulfill their obligations and exercise their rights in accordance with the agreement; If the expected result is not achieved, the financing party fails to bet, and the investor has the right to exercise the corresponding rights agreed in the contract.

 

From the perspective of the subject of gambling, in practice, there are no more than three types of gambling situations distinguished by the subject of gambling: the investor and the target company gambling, the investor and the original shareholder gambling, and the investor simultaneously gambling with the target company and the original shareholder.

 

From several gambling cases handled by the author's team before, it can be seen that the more controversial gambling model among various parties is "gambling between investors and target companies". The issue of determining the effectiveness of such gambling clauses has undergone significant changes in judicial practice, and gambling obligors often hope to seek opportunities from the issue of effectiveness.

 

According to the "Haifu Case" (Supreme People's Court (2012) MTZ No. 11), the first case against gambling in 2012, "the compensation clause between the investor and the target company is invalid if it allows the investor to obtain relatively fixed returns.", By 2016, the "Hanlin Case" [Supreme People's Court (2016) Supreme Court Min Zai No. 128] had focused the dispute on "the effectiveness of the guarantee terms" rather than directly facing the gambling terms between the investor and the target company, and ultimately determined that the guarantee terms involved in the case were legal and valid. By 2019, the "Huagong Case" [Jiangsu Provincial High People's Court (2019) Su Min Zai No. 62] recognized the repurchase obligation of the target company, And confirm that the gambling terms between the investor and the target company are valid. From the above judicial precedents, it can be seen that before the release of the "Minutes of the National Court Civil and Commercial Trial Work Conference" (hereinafter referred to as the "Nine People's Minutes") at the end of 2019, various courts also experienced a process of "reversal" and "subversion" in determining the effectiveness of the "investor vs. target company bet" clause.

 

"The Nine Minutes of the People's Republic of China" on the Effectiveness and Performance of the Betting Agreement clearly stipulates that: "5. [Betting with the Target Company] If the investor and the target company conclude a" Betting Agreement "without legal invalidity, the target company only claims that the" Betting Agreement "is invalid based on the existence of equity repurchase or monetary compensation agreements, and the people's court does not support it, but the investor claims that the" Betting Agreement "is actually performed, The people's court should examine whether it complies with the mandatory provisions of the Company Law on "shareholders shall not withdraw their capital contributions" and share buybacks, and decide whether to support their litigation claims.

 

"If the investor requests the target company to repurchase its equity, the people's court should review it in accordance with the mandatory provisions of Article 35 of the Company Law on" Shareholders shall not withdraw their capital contributions "or Article 142 of the Company Law on share repurchase.". After review, if the target company has not completed the capital reduction procedure, the people's court shall reject its lawsuit request.

 

If the investor requests the target company to assume the obligation of monetary compensation, the people's court should review it in accordance with the mandatory provisions of Article 35 of the Company Law on "Shareholders shall not withdraw their capital contributions" and Article 166 of the Company Law on profit distribution. "Upon examination, if the target company has no profits or although it has profits, it is insufficient to compensate the investor, the people's court shall reject or partially support its litigation claim.". In the future, when the target company has profits, the investor can also file a separate lawsuit based on this fact.

 

From the perspective of the "Nine People's Minutes", the Supreme People's Court has unified the issue of determining the effectiveness of gambling clauses between investors and target companies in the form of official documents. At the same time, in terms of actual performance, it is clearly pointed out that the court should review whether it complies with the mandatory provisions of the Company Law on "shareholders shall not withdraw their capital contributions" and "share repurchase/profit distribution".

 

After the release of the "Nine People's Minutes", the Supreme People's Court issued the (2020) Supreme Court Minshen No. 1191 ruling in March 2020, Among them, it is believed that "whether the company's equity can be repurchased should be reviewed in two aspects: the validity of the Supplementary Agreement; and the performance based on the premise of the validity of the contract. The original judgment did not state that the Supplementary Agreement meets the legal situation of invalidity of the contract, and the contract itself should be recognized as valid. As for the Supplementary Agreement There are various possibilities, not inevitability, for whether the agreed share repurchase can actually be fulfilled. There are uncertainties regarding whether the share repurchase has been approved by more than two-thirds of the voting shareholders, whether the target company has completed the capital reduction process, and whether creditors agree. In the original judgment, it was indeed inappropriate to directly determine that the contract itself must be invalid without hearing the above facts. "However, in view of the fact that the Verification Investment Center did not claim that the container shipping company had completed the capital reduction process, nor did it submit evidence of the capital reduction, the original judgment was not inappropriate in terms of the handling of the substantive results (the original judgment rejected all appeals by the Verification Investment Center to require the container shipping company and Longke to jointly pay the equity repurchase payment of the Verification Investment Center, and to require Longke to repurchase the equity of the container shipping company held by the Verification Investment Center).".

 

In addition, in June 2020, the Supreme People's Court issued the (2020) Supreme Law Minshen No. 2957 ruling, which held that the Supplementary Agreement involved in the case was a true expression of intent by all parties, did not violate the mandatory provisions of laws and administrative regulations, and did not have any invalid contract as stipulated in Article 52 of the Contract Law of the People's Republic of China, which should be legal and valid. The original judgment was accurate in determining this. In addition, due to the failure of the bet between the investor Yinhaitong and the target company Xilong Company, Xilong Company requested Xilong Company to repurchase its shares, which should not violate the mandatory provisions of "shareholder withdrawal of capital contributions". Xilong Company, as a joint stock limited company, repurchase of shares is a case of capital reduction, which requires a resolution of the shareholders' meeting, and should complete the capital reduction procedure in accordance with Article 177 of the Company Law. However, due to the failure of Xilong Company to complete the aforementioned procedures, it was not improper for the original judgment to dismiss the lawsuit request of Yinhaitong requesting Xilong Company to repurchase shares.

 

The aforementioned two rulings indicate that the Supreme People's Court has also conducted a substantive review of the performance of the target company's participation in the bet agreement by examining whether it complies with the two aspects of "shareholders shall not withdraw their capital contributions" and "mandatory provisions on share repurchase/profit distribution". This will also give some inspiration to the parties to the agreement that have signed and are about to sign the gambling terms. We also propose the following practical suggestions based on the issues raised in the jurisprudence for your reference.

 

Practical recommendations

 

From the perspective of the investor, considering the difficulties and pain points of subsequent dispute resolution, it is recommended to refer to the following suggestions when designing the gambling terms to avoid the "difficulty of recovery" in the event of future gambling failures:

 

Be cautious about betting against the target company. Although the "Nine People's Minutes" affirmed the effectiveness of the "gambling agreement between the investor and the target company", there are still significant practical obstacles if it involves actual performance. For example, if the target company is required to repurchase its equity, it is necessary for the company to complete the capital reduction process first, and it does not involve "withdrawing capital contributions"; If the target company is required to assume monetary compensation obligations, it is necessary to review the company's profit distribution issues and do not involve "withdrawing capital contributions". Therefore, in comparison, "gambling with the target company" is still more difficult in practice than "gambling with the original shareholders of the company".

 

If you are gambling with the target company, it is recommended to prepare for the pre process in advance. As mentioned earlier, in accordance with the different gambling methods with the target company, namely, the agreement on repurchase of equity and monetary compensation, in order to enable the court to further support the investor's litigation request on the premise of determining the effectiveness of the gambling terms with the company, it is recommended to urge the target company to perform the relevant pre procedures in advance based on the actually signed gambling terms, in order to avoid the failure of future litigation support.

 

It is recommended to agree that the controlling shareholder and actual controller of the company should bear joint and several liability for the losses of the investor, or require the controlling shareholder and actual controller to purchase the investor's equity at the agreed price. Once monetary compensation or equity buyback conditions are triggered and there are obstacles to recovery from the target company, the investor can step back and require the controlling shareholder and actual controller to assume joint and several liabilities.

 

The agreed interest should not be too high. In judicial practice, it is generally believed that although "gambling agreement" is not private lending, as a means of financing, the interest rate of "gambling agreement" should not be divorced from the average financing cost in real economic activities. Therefore, in the trial, the Supreme People's Court's Provisions on Several Issues Concerning the Application of Law to the Trial of Private Loan Cases in force at the time will be generally referred to. Therefore, when designing gambling terms, It is also recommended to control the interest rate of cash compensation within the scope of the judicial interpretation of private lending.

 

5. Claim rights through litigation and other means in a timely manner. Gambling obligors often sign gambling terms with more than one investor. In practice, investors often hesitate based on their reasonable trust in the financing party, and when they finally decide to sue, other investors have already heard the rumors of suing in advance, which may ultimately lead to the inability of the target company and its shareholders to repay their subsequent judgment obligations in the future. Therefore, it is recommended to seize the opportunity during the later consultation process and claim rights through judicial means in a timely manner.

 

Attachment 1: Laws and Regulations

 

Company Law of the People's Republic of China

 

Article 35 After the establishment of the company, shareholders shall not withdraw their capital contributions.

 

Article 142 A company shall not acquire its own shares. However, one of the following circumstances shall be excluded:

 

（1） Reduce the registered capital of the company;

 

（2） Merger with other companies holding shares in the company;

 

（3） Using shares for employee stock ownership plans or equity incentives;

 

（4） Shareholders request the company to purchase their shares due to their objections to the company's merger or division resolution made at the shareholders' meeting;

 

（5） Converting shares into convertible corporate bonds issued by a listed company;

 

（6） Listed companies are necessary to maintain the company's value and shareholders' equity.

 

Where a company purchases its own shares due to the circumstances specified in Items (1) and (2) of the preceding paragraph, a resolution of the shareholders' meeting shall be adopted; "If a company acquires its own shares due to the circumstances specified in Items (3), (5), and (6) of the preceding paragraph, it may, in accordance with the provisions of the company's articles of association or the authorization of the shareholders' meeting, adopt a resolution at a board meeting attended by more than two-thirds of the directors.".

 

After the company purchases its own shares in accordance with the provisions of the first paragraph of this article, if it falls under the circumstances of item (1), it shall cancel it within ten days from the date of acquisition; In the case of items (2) and (4), the transfer or cancellation shall be made within six months; In the case of items (3), (5), and (6), the total number of shares of the company held by the company shall not exceed 10% of the total issued shares of the company, and shall be transferred or cancelled within three years.

 

"Where a listed company purchases its own shares, it shall perform its information disclosure obligations in accordance with the Securities Law of the People's Republic of China.". "Where a listed company acquires its own shares under the circumstances specified in Items (3), (5), and (6) of Paragraph 1 of this Article, it shall do so through public centralized trading.".

 

A company may not accept its own shares as the subject matter of a pledge.

 

Article 166 When distributing the after-tax profits of the current year, a company shall allocate 10% of the profits to the company's statutory reserve fund. If the cumulative amount of the company's statutory reserve fund exceeds 50% of the company's registered capital, it may not be withdrawn.

 

If the company's statutory reserve fund is insufficient to cover the losses of previous years, the profits of the current year shall be used to cover the losses before withdrawing the statutory reserve fund in accordance with the provisions of the preceding paragraph.

 

After withdrawing the statutory reserve fund from the after-tax profits, the company may, upon a resolution of the shareholders' meeting or shareholders' meeting, also withdraw the discretionary reserve fund from the after-tax profits.

 

The remaining after-tax profits after the company has made up its losses and withdrawn its reserve fund shall be distributed by a limited liability company in accordance with the provisions of Article 34 of this Law; "A joint stock limited company shall distribute shares in accordance with the proportion of shares held by its shareholders, except where the articles of association of the joint stock limited company provide that distribution shall not be based on the proportion of shares held.".

 

"If the shareholders' meeting, shareholders' meeting, or board of directors, in violation of the provisions of the preceding paragraph, distributes profits to shareholders before the company makes up for losses and withdraws the statutory reserve fund, the shareholders must return the profits distributed in violation of the provisions to the company.".

 

The shares of the company held by the company shall not be distributed for profit.

 

"Minutes of the National Conference on Civil and Commercial Trial Work of Courts" (referred to as "Nine People's Minutes")

 

（1） On the Effectiveness and Performance of the "Betting Agreement"

 

5. [Betting with the Target Company] Where the "Betting Agreement" entered into between the investor and the target company does not have legal reasons for invalidity, the target company only claims that the "Betting Agreement" is invalid on the basis of the existence of equity repurchase or monetary compensation agreements, and the people's court does not support it, but the investor claims that it is actually performed, The people's court should examine whether it complies with the mandatory provisions of the Company Law on "shareholders shall not withdraw their capital contributions" and share buybacks, and decide whether to support their litigation claims.

 

"If the investor requests the target company to repurchase its equity, the people's court should review it in accordance with the mandatory provisions of Article 35 of the Company Law on" Shareholders shall not withdraw their capital contributions "or Article 142 of the Company Law on share repurchase.". After review, if the target company has not completed the capital reduction procedure, the people's court shall reject its lawsuit request.

 

If the investor requests the target company to assume the obligation of monetary compensation, the people's court should review it in accordance with the mandatory provisions of Article 35 of the Company Law on "Shareholders shall not withdraw their capital contributions" and Article 166 of the Company Law on profit distribution. "Upon examination, if the target company has no profits or although it has profits, it is insufficient to compensate the investor, the people's court shall reject or partially support its litigation claim.". In the future, when the target company has profits, the investor can also file a separate lawsuit based on this fact.

 

Attachment 2: Case Sources

 

(2012) MTZ No. 11 [Civil Judgment on Capital Increase Dispute between Gansu Shiheng Nonferrous Resources Reuse Co., Ltd., Hong Kong Diya Co., Ltd., Suzhou Industrial Park Haifu Investment Co., Ltd., and Lu Bo]

 

2. (2016) Supreme People's Court No. 128 [Civil Judgment on Retrial of Equity Transfer Dispute between Qiang Jingyan and Cao Wubo]

 

3. (2019) Su Min Zai No. 62 [Civil Judgment for Retrial of Dispute over Acquisition of Shares between Jiangsu Huagong Venture Capital Co., Ltd. and Yangzhou Forging Machine Tool Co., Ltd., Pan Yunhu, etc.]

 

4. (2020) No. 1191 [Xinyu Zhentou Yunlian Growth Investment Management Center, Guangdong Cargo Container Information Technology Co., Ltd. New Capital Subscription Dispute, Sales Contract Dispute Retrial Review and Trial Supervision Civil Ruling Letter]

 

5. (2020) No. 2957 [Civil Ruling on Review and Trial Supervision of the Dispute over Equity Transfer between Beijing Yinhaitong Investment Center and Xinjiang Xilong Geotechnical New Materials Co., Ltd.]

 

(This article is translated by software translator for reference only.)