Case review: gifts of equity v equity transfer without consideration

By Gong Jiong, Leaqual Law Firm
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In a particular case, an equity transfer agreement (ETA) executed by a father and son provided that the father transfer 30% out of 51% equity interest he held in a mining company (a subscribed capital contribution of RMB15 million [USD2.2 million]) to his son without consideration. Subsequently, the father, disappointed by his son’s misbehaviour, refused to co-operate in the transfer. The son then named the mining company and his father as co-defendants and requested an order demanding the mining company and his father to place the 30% equity interest under his name.

Gong Jiong, Leaqual Law Firm
Gong Jiong
Associate
Leaqual Law Firm

Did the father’s actions constitute a breach of contract? What defence could the father take to turn the situation in his favour? Was the ETA an agreement for a transfer of equity without consideration, or a “gift of equity”?

Gift of equity means a shareholder grants free equity to another person. Under an equity gift contract, the shareholder gives the equity as a gift and the other party receives the benefits only; there should not be any dispute. In judicial practice, it is common for parties to enter into equity transfer contracts at zero consideration. However, a dispute can arise between the parties afterwards over the equity delivery (the amendment to the registration).

The above-mentioned case is adapted from a real case in which the author’s firm acted as counsel. We succeeded in having the equity transfer without consideration under the ETA constituted as a gift of equity, winning for the shareholder the revocation of the equity gift and the opportunities for a new arrangement for the succession of the corporations. Below is the legal analysis of the case and the litigation strategy the firm adopted.

BASIS FOR GIFT OF EQUITY CLAIM

The Company Law and the judicial interpretations are silent on the gift of equity. Article 657 of the Civil Code states: “Under a gift contract, a donor gives his or her property to a donee without consideration and the donee expresses his or her acceptance of the gift.” As equity can be the thing gifted, this provision is the basis for a claim of a gift of equity.

RIGHTS TO REVOKE GIFT OF EQUITY

Upon the ETA constituting a gift of equity, the father had the following rights to revoke the gift:

(1) Discretionary right of revocation. Article 658 of the Civil Code says: “The donor may revoke his or her gift before the rights in the gifted property have passed to the donee.” The father could have exercised this legal right to revoke the ETA before the 30% equity interest was delivered (the registration had been amended) without constituting a breach of contract. However, if the ETA had been notarised, the discretionary right of revocation would no longer be applicable.

(2) Statutory right of revocation. Article 663 of the Civil Code provides that if the 30% equity interest had been delivered (the amendment to the registration has been in effect), the father could exercise this right within one year from the date he learned, or ought to have learned, of the cause of revocation, and demand return of the equity. However, one of the following conditions has to be satisfied: the son materially infringed the lawful rights and interests of the father or his immediate relatives; the son failed to fulfil his obligations of supporting his father; or the son failed to perform his obligations specified in the gift contract.

LITIGATION STRATEGIES

The donor should proactively exercise the right of revocation for the ETA since the court has no obligation of clarification and will not voluntarily authorise the revocation if the donor doesn’t request it.

Before delivering the 30% equity interest, the father could exercise his discretionary right of revocation in court. This right would enter into effect when the intent reached the son. The ETA would become null and void, and the rights and obligations of the parties would cease at such time, with the equity continuing to belong to the father and the son’s right to the claim being extinguished simultaneously.

The firm agreed that a countersuit to claim such right was the safest way, and the defence could be mounted. Pursuant to article 42 of the Minutes of the National Work Conference on Civil and Commercial Adjudication by Courts, once the father argued for revocation of the gift, the People’s Court would review whether there were basic facts supporting the revocation of the ETA and render a judgment, and could not deny such a review or the claim solely because the father had not instituted a legal action or countersuit.

A transfer of equity without consideration is different from a gift of equity. For equity transfer, the shareholder has the obligation and responsibility to deliver the equity by the Company Law. For a gift of equity, the shareholder has the right to revoke the gift by the Civil Code.

In judicial practice, the court generally refers to the contract and the consideration when distinguishing a gift of equity and an equity transfer without consideration. If the agreement is titled an equity transfer, it expresses a transfer rather than a gift, specifying the effective date of the equity transfer, the performance term, liability for breach of contract, etc. Zero consideration refers solely to the amount for the equity transfer, but the transferee still bears an actual payment obligation or operating responsibilities. It is an equity incentive or bonus for the transferee, provided by the adjudication opinion in the case of Yuan Junshan v Zhang Gui (2021).

The son argued that the ETA was a transfer of equity with zero consideration, rather than a gift of equity, and was a comprehensive arrangement reached between the parties regarding the future operation of the family business and debt repayment. However, the ETA never specified the performance term for the equity transfer or the liability for breach of contract. In terms of the consideration, the son never participated in the actual operation of the mining company. The court rejected his claim.

In judicial practice, the author would recommend that if parties intend to transfer equity with zero consideration, they can duly arrange the contract terms to serve different objectives of a transfer or a gift, referring to critical points of the adjudication by the court, expressly specifying the commercial background of the contract. Therefore, the performance risks will be effectively reduced.

Gong Jiong is a associate at Leaqual Law Firm

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