Equity repurchase is a common arrangement in state-owned asset investment, but some believe a forced repurchase triggered by a default of the repurchase party is akin to an equity transfer by agreement, which may contravene regulations
In an equity investment of state-owned assets, it is common for investors to make an agreement with the original shareholder of the target company, or the designated third party, in terms of a share repurchase to guarantee a later exit of state-owned assets investment.
Regarding the method of a share repurchase, considering the regulatory requirements on state-owned assets, the parties may also agree that the repurchase party has the obligation to bid for the equity through the property right transaction agency. However, if the repurchase party subsequently defaults and fails to bid, or the transaction cannot occur because the equity cannot be evaluated, and the investor requires the repurchase party to assume breaching liabilities, continue to fulfil its obligation as the transferee and pay the purchase price directly, such request is understood by some as equivalent to a request for equity transfer by agreement.
Article 54.2 of China’s Law on State-Owned Assets in Enterprises provides that, except where state-owned assets may be transferred directly by agreement according to state regulations, the transfer of such assets should be made openly at a legally established property rights exchange. Similar requirements can also be found in the Administrative Measures for the Transfer of State-Owned Assets in Financial Enterprises, and the Notice on Regulating Matters Relating to the Transfer of Assets by State-Owned Financial Institutions.
If the equity cannot enter the market, or the repurchase party fails to bid as described above, will the investor violate regulatory requirements on state-owned assets by requesting the repurchase party to accept the equity transfer by agreement? Will relevant circumstances constitute a “transaction in a seriously illegal manner”, as defined in the Minutes of the National Working Conference on the Trial of Civil and Commercial Cases by Courts, thus rendering relevant agreements void?
As the authors understand, an equity repurchase through direct transfer by agreement in the above-mentioned circumstances shall not be regarded as a violation of the state-owned assets regulatory requirements, and should be deemed legal and valid.
When a repurchase is triggered and the transaction cannot be made by bidding, if the repurchase party is not allowed to accept the equity transfer by agreement, it would adversely affect the preservation and appreciation of state-owned assets, going against the regulatory purpose.
From the perspective of teleological interpretation, one purpose of supervising the method of state-owned asset transaction is to ensure their preservation and appreciation, thereby preventing them being transferred privately by agreement at an unfair or less competitive price. Where the repurchase clause is triggered, the target company may be experiencing underperformance, violations of laws and regulations, asset depreciation, or suspension of production or business. This means that the value of equity derived from state-owned asset investment has been severely reduced and will depreciate further over time.
When the repurchase party refuses or is unable to participate in the bidding due to its unwillingness to co-operate with the evaluation, if the repurchase party’s acceptance of equity transfer by agreement is considered to be violating regulatory requirements, the investor will be unable to transfer the equity or perform the exit mechanism under the repurchase clause.
Even if the equity is able to re-enter the market later, it would be difficult to attract any transferee, or its bidding price would keep falling as the equity depreciates further. In this way, the lawful rights and interests of state-owned assets will be damaged, against regulatory intention.
Many regulations on the investment of state-owned assets have made special provisions to allow the establishment of exit mechanisms of an equity repurchase and repurchase through direct transfer by agreement. For state-owned financial institutions, article 3 of the Notice on Regulating Matters Relating to the Transfer of Assets by State-Owned Financial Institutions expressly provides that state-owned assets shall exit pursuant to a relevant investment agreement or contract, and may be directly transferred by agreement after being reviewed and approved by the state-owned financial institution, according to the authorisation mechanism.
If exit conditions and methods are specified in the investment agreement and contracts at time of investment, the investor may exit according to such contracts. Similar stipulations can be found in the Interim Measures of Beijing on the Administration of Industrial Venture Capital Guide Funds for Creating Strategic Emerging Industries, issued by the Beijing Municipal Commission of Development and Reform.
From these provisions, we see that equity transfer in the case of an equity repurchase is different from general asset disposal. Many special provisions have allowed the establishment of the exit mechanism of an equity repurchase and the repurchase through direct transfer by agreement.
By refusing to bid, the repurchase party has improperly obstructed the fulfilment of transfer conditions. Therefore, relevant conditions shall be deemed fulfilled, and the equity transfer price shall be paid. Article 159 of the PRC Civil Code provides that if a party, for its own account, improperly obstructs fulfilment of a condition, the condition is deemed fulfilled.
Therefore, the authors suggest relevant parties expressly agree in the repurchase clause that the repurchase party is obligated to bid at a price no less than the specified amount, and co-operate in making the evaluation report. If the repurchase party fails to bid or co-ordinate the evaluation, or evaluation is impossible due to management issues during its running of the enterprise, the investor is entitled to assert that the repurchase party has improperly obstructed fulfilment of transfer conditions, so that relevant conditions are deemed fulfilled, and the repurchase party shall pay the equity transfer price.
Additionally, when making investments, state-owned enterprises may consider adding in the repurchase clause that the repurchase party has the obligation to accept the equity transfer by agreement if it is unable to bid, or win the bidding through the property right transaction agency.
Such a clause shall be escalated to the competent authorities. If the repurchase party fails to bid, the investor may require by legal means (such as litigation or arbitration) that the repurchase party accept the equity transfer by agreement, because confirmation of judgment or arbital award can further reduce the risks of compliance.
Zheng Yeye is an associate at Tian Yuan Law Firm. She can be contacted at +86 188 1304 4692 or by e-mail at firstname.lastname@example.org