In a VAM transaction, if an investor has not fully contributed capital, do they have the right to demand that the founding shareholders repurchase the equity based on the VAM clauses? In practice, there are few reference cases for such situations, and the law provides no explicit regulations. In this case, Zhenghan Law Firm represented the investor and, through a sophisticated interpretation and rigorous demonstration of the complex clauses in the VAM agreement, successfully persuaded the courts of both instances to determine that the conditions for equity buyback had been met. The court ruled that a shareholder who has not fully contributed capital should exercise the right to equity buyback to the extent of their actual contribution, ultimately securing a winning judgment for the investor.
This case was selected for the 2024 Shanghai Court “100 Excellence Cases.” (Click to view: How to Determine the Validity of an Equity Buyback Requested by a Shareholder Who Has Not Fully Contributed Capital? | Zhizheng – Case Analysis)
Case Review
In August 2019, the investor and the three founding shareholders of the target company signed a “Capital Increase Agreement” and a “Supplementary Capital Increase Agreement,” agreeing on a total investment of 6 million RMB to acquire 3% of the equity in the target company after the capital increase. Several VAM clauses were set in the agreement, stipulating that the investor has the right to demand the founding shareholders to repurchase all of their equity upon the occurrence of specific conditions (including the founding shareholders’ failure to pay in capital, engaging in horizontal competition, or providing guarantees in violation of regulations).
In September 2019, the investor paid 2 million RMB in capital increase funds to the target company and was registered as a shareholder holding 3% of the target company’s equity in January 2020.
However, after the registration of the equity change, the founding shareholders and the target company committed multiple breaches of contract, making it impossible to achieve the investment objectives. The investor subsequently sent a letter in accordance with the agreement demanding the founding shareholders fulfill their equity buyback obligations, but was refused. The core defense of the founding shareholders was that the investor had not fully paid the 6 million RMB capital increase, constituting a prior breach of the agreement, and therefore had no right to demand a buyback.
Litigation Challenges
The core focus of the dispute in this case was: whether an investor who has not fully performed their capital contribution obligations has the right to claim a buyback, and whether the conditions claimed by the investor to trigger the buyback were established?
Claiming an equity buyback in a VAM transaction is inherently challenging, involving debates such as whether the right to buyback is a formative right or a right of claim. It is even more difficult for an investor to demand that founding shareholders repurchase equity when they have not fully paid their capital contribution to the target company. This is especially true when the case involves multiple complex agreements where the investor’s right to buyback is interrelated with numerous clauses regarding the investor’s obligations. Although the buyback obligors in this case were involved in multiple triggering scenarios, the second instance of another investor’s buyback case had already been ruled to be remanded for retrial. The reason was that “the court of first instance should examine whether the degree of breach by the defaulting party is significantly minor and whether it affects the realization of the non-defaulting party’s contractual purpose, and determine whether the equity should be repurchased based on the principle of honesty and credit.” Based on this, effectively presenting the facts of the other party’s breach to the court and persuading the court that a shareholder who has not fully contributed capital also has the right to exercise the equity buyback right to the extent of their contribution was quite difficult in litigation.
Dispute Resolution
After accepting the investor’s entrustment, in response to the founding shareholders’ defense that our side did not enjoy the right to buyback because we had not fully contributed capital, we precisely proposed the core opinion of “separation of obligations.” We further pointed out that the investor’s capital contribution obligation and the founding shareholders’ buyback obligation are two independent legal relationships that cannot be offset against each other or serve as prerequisites for one another. Through a rigorous analysis of the agreement clauses, we clearly demonstrated to the court that the contract did not set “completion of all capital contributions” as a prerequisite for initiating a buyback.
To avoid falling into a passive debate over “whether the degree of breach was minor,” we adopted a proactive strategy. We systematically organized and deconstructed the VAM clauses involving multiple complex agreements, matching each buyback trigger scenario point-to-point with the specific breaches of the founding shareholders. Ultimately, we visualized and clarified the complex legal relationships and evidence chains with a highly concise “Overview Map of Buyback Trigger Scenarios,” allowing the court to intuitively see that the founding shareholders had committed serious breaches, which were clearly not minor, and that the buyback conditions had been clearly and unequivocally met.
This case went through first and second instances, and the court ultimately supported the representation opinions of Zhenghan Law Firm. The court held that for equity buybacks agreed upon in investment agreements between the parties, the true autonomy of will between equal subjects should be respected. As long as the agreed equity buyback clauses are triggered, the founding shareholders should fulfill the buyback obligation, but the scope of the buyback should be limited to the actual capital contribution of the investor.
