[Abstract]
A limited partnership agreement may freely stipulate how profit and income is to be distributed. Notably, the law does not prohibit the valuation adjustment mechanism (“VAM”). If the limited partners of a private equity limited partnership reach a VAM agreement involving share transfers and difference compensation, such agreement should be held valid as long as it complies with the law and the partnership agreement in regard to the parties, details, and method of performance of the VAM arrangement and does not breach financial regulations such as any commitment by the fund management company of an investment return. A particular VAM arrangement may be confirmed by the partnership agreement or partners in various ways. Confirmation, of a transfer of partnership shares, by unanimous consent as provided in the partnership agreement may be substituted by other forms of confirmation.
[Keywords]
Private equity limited partnership; VAM among partners; partnership shares transfer
Plaintiff: Chang’an Assets Management Co., Ltd., domiciled in Hongkou District, Shanghai.
Legal Representative: Yuan, Chairman.
Defendant: Great Wall Film & Culture Group Co., Ltd., domiciled at Wenyi West Road, Hangzhou, Zhejiang.
Legal Representative: Zhao (X Hua), Executive Director.
Defendant: Zhao (X Yong).
Defendant: Chen.
The Plaintiff Chang’an Assets Management Co., Ltd. (“Chang’an Assets”) filed a lawsuit in the Shanghai Financial Court (the “Court”) against the Defendants Great Wall Film & Culture Group Co., Ltd. (“Great Wall Film”), Zhao, and Chen on the grounds of contract dispute.
The Plaintiff Chang’an Assets asserts that:
It is a Class A Investor and limited partner of Zhuji Tiankong Chang’an Equity Investment Partnership (Limited Partnership) (the “Fund”) with a capital contribution of RMB 86,610,000. The Defendant Great Wall Film is a Class B Investor and limited partner of the Fund. Zhao is the de facto controller of Great Wall Film and was its legal representative before July 19, 2018. Chen is the spouse of Zhao. On October 25, 2016, Chang’an Assets and Great Wall Film entered into an Unconditional Acceptance and Difference Payment Contract (Contract No. CCBG160901CE) (“Unconditional Acceptance Contract”), under which Great Wall Film undertakes to unconditionally accept the Fund shares held by Chang’an Assets as required by Chang’an Assets upon the occurrence of the circumstances agreed thereunder. On the same day, Chang’an Assets executed two Guarantee Contracts (Contract No. CCBG160902BZ1 and CCBG160903BZ2) with Zhao and Chen respectively, under which Zhao and Chen guaranteed, on a joint and several basis, the performance of Great Wall Film’s obligations under the Unconditional Acceptance Contract.
Pursuant to Article 1(1) of the Unconditional Acceptance Contract, during the existence of the Fund, Chang’an Assets is entitled to demand Great Wall Film to accept its shares and Great Wall Film, upon receiving this demand, is to unconditionally accept the shares as required by Chang’an Assets, if: (1) The Listed Companies (i.e., listed companies under Great Wall Film’s de facto control, including without limitation Great Wall Movie and Television Co., Ltd., Great Wall International ACG Co., Ltd., and Hangzhou TianMuShan Pharmaceutical Enterprise Co., Ltd.) fail to obtain the approval of the China Securities Regulatory Commission (“CSRC”) or of other competent authorities regarding the acquisition of the Target Company (i.e., Dunhuang Great Wall Tourism & Cultural Innovation Park Co., Ltd., not a party in the present case but a wholly owned subsidiary of the Fund) within 30 months of the date when the initial contribution by Class A investors of the Fund is credited into the account; or the Listed Companies fail to complete the acquisition of the Target Company within 30 months of the date when the initial contribution by Class A investors of the Fund is credited into the account; or the Fund fails to complete the transfer of all the equity interest it holds in the Target Company for any other reason; … (13) Chang’an Assets reasonably believes that Great Wall Film or the Target Company or its original shareholders are otherwise harming the interest of Chang’an Assets.
Following the execution of the Unconditional Acceptance Contract, the initial contribution from Chang’an Assets was credited into account on December 29, 2016. Based on the 30-month window provided under the Unconditional Acceptance Contract, the Listed Companies should complete the acquisition of the Target Company before June 29, 2019. In addition, pursuant to the Conditional Acquisition Agreement (Contract No. TKCA160906SG) executed by Great Wall Film and the Fund in December 2016, the acquisition of the Target Company should be initiated within 24 months of the execution of the Equity Interest Transfer Agreement dated December 2016 (i.e., no later than December 2018). However, as of the filing date of this lawsuit, the acquisition process had yet to start. In fact, the Listed Companies are no longer positioned to complete the acquisition before June 29, 2019, which in substance constitutes the circumstance under Item (1) of Article 1(1) of the Unconditional Acceptance Contract.
On January 17, 2019, Chang’an Assets sent the Contract Performance Notice to Great Wall Film, requiring Great Wall Film to immediately fulfill the obligation of unconditional acceptance, among others, under the Unconditional Acceptance Contract. After receiving the Contract Performance Notice, Great Wall Film responded with the Response to the Contract Performance Notice on January 29, 2019, confirming that it would fulfill the corresponding repurchase obligations under the Unconditional Acceptance Contract. In accordance with Article 1(1) of the Unconditional Acceptance Contract, Great Wall Film is obligated to pay Chang’an Assets a repurchase price of RMB 106,156,917.50.
In addition, according to the Guarantee Contracts executed by Chang’an Assets with Zhao and Chen, Zhao and Chen are jointly and severally liable for the payment and damages owed to Chang’an Assets under the Unconditional Acceptance Contract and for all expenses incurred by Chang’an Assets to enforce its claims and its rights as pledgee (including without limitation litigation expenses, arbitration fees, preservation fees, travel expenses, enforcement fees, valuation fees, auction fees, notary fees, delivery fees, announcement fees, and attorney’s fees). Accordingly, Zhao and Chen are jointly and severally liable for the repurchase price for partnership shares, damages, attorney’s fees, case filing fees, preservation fees, and other relevant fees and expenses to be paid or compensated by Great Wall Film to Chang’an Assets in this case.
Therefore, Chang’an Assets brought this lawsuit to request the Court to order:
1. Great Wall Film to pay Chang’an Assets the repurchase price for Fund shares of RMB 106,156,917.50 (all amounts below are in Renminbi);
2. Great Wall Film to indemnify Chang’an Assets against the losses incurred by its breach of contract (calculated on the basis of RMB 106,156,917.50 at an interest rate of 0.05% per day from February 2, 2019 to the actual date of payment);
3. Zhao and Chen to be jointly and severally liable for the payment obligations of Great Wall Film under the above two requests; and
4. Great Wall Film, Zhao, and Chen to be jointly liable for all litigation expenses including the attorney’s fee of RMB 676,698.04, the case filing fee, and the preservation fee of RMB 5,000, among others.
The Defendant Great Wall Film contends that:
1. The legal matter underlying in this case is dispute over the transfer of partnership shares under the Partnership Agreement. Article 6.6 (risk control provision) of the Partnership Agreement, which pertains to this case, expressly provides that the Unconditional Acceptance Contract and the Guarantee Contracts are an integral part of and subsequent to the Partnership Agreement. The Unconditional Acceptance Contract is an agreement between Chang’an Assets and Great Wall Film on the transfer of partnership shares and is subject to the provisions of the Partnership Agreement and the Partnership Enterprise Law of the People’s Republic of China (the “Partnership Law”).
2. The Unconditional Acceptance Contract involved in this case should be held invalid in accordance with the law as it violates the mandatory rules that risks are to be borne by partners jointly. Article 33(2) of the Partnership Law prescribes that a partnership agreement may not require all losses to be borne by a subset of the partners. Consequently, Great Wall Film’s undertaking under the Unconditional Acceptance Contract to unconditionally accept the transfer of Fund shares based on Chang’an Assets’ capital contribution and make up for a minimum investment return is evidently in breach of the mandatory risk sharing provision of the Partnership Law. As Article 52(5) of the Contract Law of the People’s Republic of China states that any contract in breach of any mandatory provision of laws or administrative regulations is invalid, the Unconditional Acceptance Contract should thus be held invalid.
Furthermore, the Unconditional Acceptance Contract also breaches the rule that a private equity fund may not promise minimum returns. Article 15 of the Interim Measures for the Supervision and Administration of Private Investment Funds expressly prohibits the management company and distributors of a private equity fund from guaranteeing immunity of principal from loss or a minimum investment return. In the Unconditional Acceptance Contract under the Partnership Agreement, Great Wall Film’s commitment to unconditionally accept the transfer of Fund shares based on Chang’an Assets’ capital contribution and make up for a minimum investment return is, in essence, an undertaking to limited partners on minimum return. In accordance with Article 31 of the Minute of the National Courts’ Conference on Civil and Commercial Trials (Fa [2019] No. 254), a civil juristic act in breach of the foregoing regulations is to be held invalid pursuant to Article 153(2) of the General Principles of the Civil Law of the People’s Republic of China.
3. Even without regard to the foregoing, Chang’an Assets’ claims would still be meritless because they comply with neither the provisions of the Partnership Agreement nor those of the Partnership Law. The share transfer contract does not conform to the conditions and procedures established in the Partnership Agreement. First, Articles 12.1.3 and 12.1.4 of the Partnership Agreement expressly state that a valid request for transfer of partnership shares must be put to a vote and obtain the unanimous consent of the partners representing all voting powers. Second, the share transfer does not conform to the law, either. Article 22 of the Partnership Law provides that in a transfer of all or part of partnership shares between partners, the other partners should be notified. However, none of the evidence submitted in this case specifically documents that Chang’an Assets has delivered such a notice to the other partners. Therefore, the conditions for transfer under the share transfer contract were not met.
4. With respect to the attorney’s fees, the agreements between Chang’an Assets and Great Wall Film do not contain direct and explicit provisions on the allocation of attorney’s fees. Great Wall Film is also not a party to the two Guarantee Contracts and, therefore, not bound by the provisions of those contracts regarding attorney’s fees. Therefore, Chang’an Assets’ request that Great Wall Film should bear the attorney’s fees is factually and legally groundless and should be dismissed.
During the trial, the Court found the following facts:
Plaintiff Chang’an Assets is a Class A Investor and limited partner of a private equity investment limited partnership (the “Fund”) and Defendant Great Wall Film is a Class B Investor and limited partner of the Fund. On October 25, 2016, Chang’an Assets and Great Wall Film entered into the Unconditional Acceptance Contract, under which Great Wall Film undertakes to unconditionally accept the Fund shares held by Chang’an Assets upon the occurrence of the circumstances agreed thereunder. On the same day, Chang’an Assets executed two Guarantee Contracts with Zhao and Chen respectively, under which Zhao and Chen guaranteed, on a joint and several basis, the performance of Great Wall Film’s obligations under the Unconditional Acceptance Contract.
Circumstances specified in the Unconditional Acceptance Contract that would trigger the transfer of Fund shares include: During the existence of the Fund, the Listed Companies (i.e., listed companies under Great Wall Film’s de facto control) fail to obtain the approval of the CSRC or of other competent authorities regarding the acquisition of the Target Company (a wholly owned subsidiary of the Fund) within 30 months of the date when the initial contribution by Class A investors of the Fund is credited into the account; or the Listed Companies fail to complete the acquisition of the Target Company within 30 months of the date when the initial contribution by Class A investors of the Fund is credited into the account; or the Fund fails to complete the transfer of all the equity interest it holds in the Target Company for any other reason. Based on the 30-month window provided under the Unconditional Acceptance Contract, the Listed Companies should complete the acquisition of the Target Company before June 29, 2019. But as of the filing date of this lawsuit, the acquisition process had yet to start.
In addition, the Partnership Agreement stipulates that a valid request for transfer of partnership shares must be put to a vote and obtain the unanimous consent of the partners representing all voting powers. The Partnership Agreement further stipulates that following consultation, the partners may amend the Partnership Agreement or provide for matters not covered in the Partnership Agreement by entering into supplemental agreements. It was also agreed in the Partnership Agreement that its appendices are a part of, and have the same legal effect as, the Partnership Agreement. In addition, pursuant to the Partnership Agreement, if the annualized investment return of the Class A shares is lower than the expected minimum investment return, the relevant obligors are to fulfill their obligations of compensation and guarantee in accordance with the Unconditional Acceptance Contract and the Guarantee Contracts.
Article 6.6 of the Partnership Agreement states that in order to ensure the safety of the investment principal and expected minimum investment return of Class A Investors, the Unconditional Acceptance Contract numbered CCBG160901CE between the Class A Investors and the Class B Investors, and the Guarantee Contracts numbered CCBG160902BZ1 and CCBG160903BZ2 between the Class A Investors and Zhao, Great Wall Film’s de facto controller, and his spouse respectively, are deemed to be an integral and irrevocable part of the Partnership Agreement.
Article 7.1.1 provides that all partners of the Limited Partnership agree that the expected minimum annualized investment return of Class A shares is 11% and that in extreme circumstances, the Class A Investors may not be able to earn the expected return or may even lose the investment principal.
Article 7.2 provides that when the Limited Partnership is being liquidated, the cash in its escrow account is to be distributed in the following order: (1) the investment principal of Class A Investors and a base return at the annualized rate of 8%; (2) the investment principal of Class B Investors and a base return at the annualized rate of 8%; and (3) the investment principal of Class C Investors and a base return at the annualized rate of 8%. Subsequent to the distributions in (1) to (3), the remaining amount is the excess earnings, of which 20% is allocated to the general partners as the performance and management fee, 35% to the Class A Investors, and 45% to the Class B Investors. (4) If the annualized investment return of Class A shares (consisting of the base return and the extra earnings) is lower than the expected minimum investment return, the relevant obligors are required to fulfill their obligations of compensation and guarantee in accordance with the Unconditional Acceptance Contract executed by the Class A Investors and Great Wall Film and the Guarantee Contracts executed by the Class A Investors with Zhao, Great Wall Film’s de facto controller, and his spouse as set forth under Article 6.6 of the Partnership Agreement.
Article 7.3 pertains to the assumption of investment risk and losses. In particular, if within 36 months of the establishment of the Limited Partnership, Class A Investors (limited partners) do not receive its principal and the expected minimum investment return in full and Great Wall Film fails to repurchase shares from the Class A Investors pursuant to the Unconditional Acceptance Contract, all partners will irrevocably agree to immediately realize all non-cash assets of the Limited Partnership, until its cash assets are sufficient to cover the full investment principal and expected minimum investment return of the Class A Investors.
Article 10.1.4 provides a list of matters that, when put to a vote at a partners meeting, would require the unanimous consent of the partners representing all voting powers or, in lieu of the partners meeting, with a written unanimous consent signed by, and affixed with the seals of, all such partners.
Article 12.1.1 stipulates that after 36 months of the establishment of the Limited Partnership, Class A Investors are entitled to require Class B Investors to repurchase the Class A shares they hold.
Article 12.1.4 stipulates that a valid request for transfer of partnership shares requires a vote and the unanimous consent of the partners representing all voting powers.
Article 16.1 stipulates that the partners may, following consultation, amend the Partnership Agreement or provide for matters not covered in the Partnership Agreement by entering into supplemental agreements, and that in the event of any discrepancy between the added or amended provisions and the Partnership Agreement, the added or amended provisions prevail.
Article 16.2 stipulates that the appendices thereto constitute an integral part of, and have the same legal effect as, the Partnership Agreement.
On September 4, 2017, Chuzhou Chuangchi Tiankong Investment Management Co., Ltd. (“CCT”), Hangzhou Boxin Investment Management Co., Ltd. (“Hangzhou Boxin”), Chang’an Assets, and Great Wall Film entered into the Supplemental Agreement (IV) to the Zhuji Tiankong Chang’an Equity Investment Partnership (Limited Partnership) Agreement, which made CCT and Hangzhou Boxin the executive partners of the Fund and revised Article 12.1.3 of the Partnership Agreement.
The revised Article provides that where a limited partner (transferor) intends to transfer all or part of its partnership shares, a “valid request” for the transfer must meet all of the conditions listed thereunder, including: (3) At the time that the transferor submits the above transfer request, the proposed transferee has already submitted to the executive partners a letter of undertaking to the effect that it agrees to be bound by and comply with the Partnership Agreement and to assume the subsequent capital contribution obligations of the transferor (if any), as well as other documents, certificates and information deemed necessary by the general partners; (4) At the time that the transferor presents the above transfer request, the proposed transferee has undertaken in writing that it will bear all costs incurred by the Limited Partnership and the general partners for the transfer.
The Supplemental Agreement (IV) further provides that it prevails to the extent of any discrepancy between it and the original Partnership Agreement or other previous supplemental agreements, while the original Partnership Agreement controls with respect to the remaining matters; and that the Supplemental Agreement (IV) becomes effective from the date it is duly signed and sealed by all of the parties.
In December 2016, Great Wall Film and the Fund entered into the Conditional Acquisition Agreement (Contract No. TKCA160906SG). Clause 2.1.1 of Article 2 (Acquisition) provides that, if the Listed Companies fail to obtain the approval of the CSRC or of other competent authorities regarding the acquisition of the Target Company within 30 months of the date when the initial contribution by Class A investors of the Fund is credited into the account; or the Listed Companies fail to complete the acquisition of the Target Company within 30 months of the date when the initial contribution by Class A investors of the Fund is credited into the account; or the Fund fails to complete the transfer of all the equity interest it holds in the Target Company for any other reason, then the Fund is entitled to demand Great Wall Film to acquire all equity interest in the Target Company held by the Fund and Great Wall Film must do so unconditionally.
In December 2016, Dunhuang Silk Road Cultural Heritage Exhibition City Co., Ltd., Hangzhou Wentao Equity Investment Fund Partnership (Limited Partnership), Hangzhou Wulue Equity Investment Fund Partnership (Limited Partnership), and Great Wall Film executed the Equity Interest Transfer Agreement (Contract No. TKCA160902ZR) with the Fund and Dunhuang Great Wall Tourism & Cultural Innovation Park Co., Ltd. (not a party in this case), which obligates Great Wall Film to initiate the acquisition of the Target Company before December 2018.
Chang’an Assets executed two Guarantee Contracts (Contract No. CCBG160902BZ1 and CCBG160903BZ2) with Zhao and Chen respectively, under which Zhao and Chen guaranteed, on a joint and several basis, the performance of Great Wall Film’s obligations under the Unconditional Acceptance Contract. The guarantee covers the payment obligations of the debtor under the principal contracts, including without limitation those under the Unconditional Acceptance Contract, as well as the following amounts payable by the debtor under the principal contracts: penalty for breach of contract, liquidated damages, amount advanced by creditor on behalf of the debtor, and all expenses incurred by the creditor to enforce its claims and its rights as pledgees (including without limitation litigation expenses, arbitration fees, preservation fees, travel expenses, enforcement fees, valuation fees, auction fees, notary fees, delivery fees, announcement fees, and attorney’s fees). Among the various payment items covered by the guarantee, guarantors Zhao and Chen are to prioritize payment of the expenses incurred by Chang’an Assets to enforce its claims and its rights as pledgee.
Article 3 of the two contracts stipulates that the guarantee is in effect from the effective date of the Guarantee Contracts to the second anniversary of the expiration date of the obligation performance period under the principal contracts. Article 7 concerns the acceleration of guarantee. Specifically, where Chang’an Assets accelerates the debts in accordance with the principal contracts, it has the right to require Zhao and Chen to fulfill the obligations of guarantee, and Zhao and Chen is to do so as required by Chang’an. Article 9 provides that any notice or communication under the contracts should be sent to the other party in accordance with the mailing address, telex number, or other contact information as recorded on the cover page of the contracts. The address provided in the contracts is Unit 1-602, Building 4, Dejia Apartment East Zone, Xihu District, Hangzhou.
The Shanghai Financial Court holds that the focus of controversy in this case is the nature and validity of the Unconditional Acceptance Contract. In essence, the legal matter to be resolved is the internal transfer of the shares of a private equity fund limited partnership triggered by a VAM arrangement among the limited partners. The Partnership Enterprise Law of the People’s Republic of China does not prohibit the transfer of partnership shares between partners, and VAM neither violates the principles of profit and loss allocation under the Partnership Law nor violates the regulatory rule under Article 15 of the Interim Measures for the Supervision and Administration of Private Investment Funds, i.e., the management company and distributors of a private equity fund may not guarantee immunity of principal from loss or a minimum investment return. Accordingly, the Unconditional Acceptance Contract does not contain any element that would invalidate it under Article 52 of the Contract Law of the People’s Republic of China, and should hence be held valid. In addition, the Partnership Agreement has made it clear that the Unconditional Acceptance Contract, as an attachment thereto, is an integral part of it. Given that the Partnership Agreement has entered into force with the signatures of all partners, those same signatures ought to be viewed as confirmation that the Unconditional Acceptance Contract is legally binding on all partners, and as a substantive unanimous consent of all partners regarding the content therein. Therefore, no additional voting procedure as provided under the Partnership Agreement is necessary for the transfer of partnership shares in the present case.
For the above reasons, the Shanghai Financial Court entered the following judgment: The Defendant Great Wall Film is to pay Chang’an Assets the repurchase price for the Fund shares and compensate the latter for the losses arising from the breach of contract (calculated on the basis of the repurchase price of Fund shares at an interest rate of 0.05% per day from February 2, 2019 to the actual date of payment); the Defendants Zhao and Chen are to be jointly and severally liable for guaranteeing the payment of the above debts of Great Wall Film.
The parties did not appeal the judgment, which has since entered into force.
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