Interpretation Of The Company Law Of Private Equity Investment Contracts

Since the 1990 s, private equity as a new type of investment vehicle began to grow in China. With the rapid growth of China's economy, from nonexistence to pass into existence, and from small-scale attempt to rapid development of various types of investment, whether foreign private equity funds or local RMB private equity funds are more and more attention of academics and practitioners, aroused widespread discussion. In the United States where private equity investment is the most developed, after nearly a century of development, with its unique legal system as the basis, whether investment types, investment operations or legal provisions, legal supervision have formed a relatively complete matching system. Especially for the prominent principal-agent problem caused by the extreme information asymmetry in private equity investment, it has formed a mature system of private equity investment contract terms. By financing agreement, share subscription agreement, shareholders agreement, the articles of association and other legal documents, and having the unique complex investment vehicles as the carrier, many specific investment provisions in the investment contracts are designed by considering the allocation of the economic income and control rights as the core elements, which will be used to solve the incentive and constraint on the target enterprise, reduce the agency cost, and protect investment interests.In view of the important role of the above provisions to protect the interests of private equity investors, many provisions are used by private equity investors directly in the domestic investment. However, in view of the different legal environment between the two countries, some provisions which are directly applied in our country may encounter legal obstacles and negative evaluation. The case of “Haifu Private Equity Founds V. Gansu Shi Heng Company” happened last year is known as China's “the first case of agreement on gambling”, which is the tip of the iceberg about the conflicts between the private equity investment contract and the local law. Agreement on gambling is just one onf the terms of private equity investment contract. The private equity investment contract is the complete terms system which reduces agent cost, realizes the incentive and constraint on the target enterprise, and uses investment protection as the core. In addition to the agreement on gambling causing the people wide discussion and attention, there are many other contract terms around the reduction of moral hazard, the maintenance of economic benefits, reasonable implementation of allocation of control rights. The articles are designed in private-equtiy inventment contract, and what is their basis, what are they unique about the significance and role, whether they are integration of China's legal system, especially corporate law, what issues and reflection they can bring to the company law reform in China. These problems are the core of which this article aims to discuss.In this article, besides the introduction and conclusion, the main content is divided into four chapters. This article will discuss four problems, they are considering elements of private-equity investment contract, the carrier of private-equity investment contract—selection of investment vehicles, the core provisions of private-equity investment contract and the existing company law, and private-equity investment contract with the company law reform.Chapter ?mainly discusses the theoretical basis and focusing on points of private-equity investment contract designing, and solves the problem of what the contract “ought to” be designed. Thinking about why there are so many unique terms in private-equity investment to become the industry practice, and included into the industry guidance documents complied by the National Venture Capital Association. Also explaining the reason why the investment and financing both sides in the practice of private equity investment in China are unwilling to give up the use of these terms, even though they and legal service workers both know there are conflicts with certain provisions of the existing law, preferring to adopting a variety onf alternatives, such as passing obligations to other subjects or fighting the edge ball to the law. So as to providing a theoretical basis for the later dicussion about determining the effectiveness of the relevant provisions and the proposed changes of strengthening company law's adaptability.Chapter ? discusses the carrier of private equity investment contract——the application of inventment instruments. The most widely applicable tools in foreign inventment in private equity are convertible preference shares and convertible bonds, because these two complex finacial instruments have the feature of “conversion” which makes them the advantages of both equity and debt, can effectively avoid investment risks, reduces agency costs and provides appropriate incentives to the agent. However, according to our current “Company Law” and “Securities Act” stipulation, there are legal obstacles when private equity investment designs investment contract by taking the above two as an investment tool. This chapter explores the significance of these two investment vehicles for private equity respectively from the perspectives of preference shares and convertible bonds, and deems that China's Company Law should establish the system of classes of shares, and relaxing restriction on the subjects and ways of convertible bonds issuance to eliminate the legal obstacles to private equity investment applying preferred stocks and convertible bonds.Chapter ? mainly involves the relationship between the core terms of private equity investment contact and the exiting company law.In view of the investor concerns, the terms network of private equity investment can be divided into two categories. One categoty is the terms involved in the distribution of economic benefits of the target enterprise, mainly including priority divedend provisions, preference liquidation clauses, repurchasing stocks provisions, valuation adjustment provisions, and so on. The other category terms are related to the distribution of control rights of the target enterprise's internal governance, mainly including drag-along right and tag-along right clauses, protective provisions and controlling board provisions. These provisons have certain degree of conflicts with the existing company law, thus making them questionable effectiveness. But designing these provisions concern the safety of the investors' pricipal, security of investment benefits, and help to reduce the principal-agent cost of private equity investments. So they are the summary about the long-term practice of experience of private equity investment. If abandoning the above provisions, the interests of investors can not be guatanteed inevitably, investment activities can not be carried out smoothly, and eventually lead private equity investment to failure.Therefore, this chapter focuses on the discussion about the legal structure, design effect of these particular provisions, judging their legal force and thinking about the lack of the present company law.On the basis of the foregoing discussion, the final chapter relates to the nature of the problem:Private Equity Investment Contract and Company Law Reform. The clauses privately agreed of private equity investment contract in addition to the existing company law, from the face of which are “autonomous misconducts”to circumvent the exsiting laws. However, this behavior reflects the real needs of market subjects and practices, so legislation shouldn't summarily reject but absorb the reasonable elements to reflect on the deficiency of the existing company law and institutional change and reform. The center of reform is to create the system of classes of shares, only because the system of classes of shares is dintroduced, allowing different categories of shareholders who enjoy differen rights of shareholders, the special investment demands of private equity investors are in order to legally established and met. The main line of reform is to adjust the company's legal form. When changing the present dichotomy of limited liability companies and joint stock limitied companies to the division standards of closed and open, we can set up legal norms more clearly and targeted. The closed company should be given more autonomy by law, which provides the legal basis for private equity investment designing the contract terms freely when investing the closed company.In a word, private equity investment agreements are the optimal choice which market rational commercial subjects make under autonomy of both sides after balancing the both interests. Their terms contents fill the needs and objectives of the commercial subjects' free exercise. The Law especially Company Law should conform to the development path of reducing the mandatory norms and increasing arbitrary norms, create more liberal environment for the activities of the both parties of investment and financing, and improve the adaptability of Company Law in order to meet the personalized needs of subjects in the particular economic activities.