Study On The Legitimacy Of Contractual Control

On mid-June2011, Alibaba Group transfered the ownership of Alipay to another domestic-owned corporation which held by Ma Yun-Zhejiang Alibaba E-commerce Corporation. This business operation was opposed with Yahoo and Softbank’s suggestion that using contractual control mode to handle with Alipay. And Yahoo was not satisfied with this operation. Eventually, the three reached an agreement that the Alipay Holding corporation pays the Alibaba Group an one-off cash return when the Alipay Holding corporation is listing. Alipay event came to an end, but the use of the contractual control has aroused great concern. The legitimacy of the "contractual control" is the key."Contractual control" is one of the financial derivatives which made by Wall Street financial capitalists. It uses a package of contracts to achieve the interest of the entity’s control. This mode helps enterprises to achieve listing and financing goals, enhance the overall competitiveness; it helps the controller get benefit of control; it helps avoid the national industrial policy and bypass the M&A security review system. So this mode is used by many SMEs. The structure of the mode involves three parties:overseas listed shell company, the Wholly Foreign Owned Enterprise (WFOE) and a Variable Interest Entity (VIE). First, set up a listed shell company in tax haven and a wholly foreign-owned company in the territory:Then, reorganize the VIE to ensure that the ownership of VIE is in the hands of minority shareholders; Finally, WFOE makes contracts with VIE, thus the mode is set up.The success of the contractual control mode is good for achieving the interest of the using subject, but there are many problems. The legality of the mode is the core of all issues. China’s laws have no regulations on the contractual control’s legality and the relevant authorities attitude of the mode is expressly vague. Thus the contractual control may face default risk and legal risk. The provisions of the existing contract accountability can solve the dispute of breaching contracts. So the focus of this article is the legality of the contractual control.After analyzing the relationship between the contractual control and evasion of law, forcibly provision, the interest of public and the outflow of wealth, the author proposes a judicial judgment on contractual control, there are the measure of interest based on expanded interest of hierarchy theory and procedural considerations. Based on the expanded interest of hierarchy theory, the author makes two situations to explore the effectiveness of the control contracts. Using the contractual control mode to realize the purpose of listing and financing, to protect the effectiveness of the control contracts for national security is no harm and can protect the other interests, thus we should recognize the validity of the contracts.Using the contractual control mode to realize the purpose of reaping excessive profits, and even threatening and harming the interests of the state, at this moment, selecting the effectiveness of the contracts can achieve the protection of the interests of the parties and group interest, but will make the system interest and public interest compromised; choosing not to protect the effectiveness of the contracts, institutional interest and public interest are protected and the interest of the parties and group interest are not protected. Priority protection of the interest of the social and public interest determine that we should deny the effectiveness of the control contracts. As to the procedure, I believe that the judiciary in the trial of contractual control on the legality should judge in accordance with the following process:First, determine the contractual control user whether timely charge the obligation of disclosing the use of contractual control to stakeholders and asking for comments so that stakeholders can exercise decision-making power. Secondly, judge whether the agreements entered are appropriate and necessary, and taking into account the interest of the parties. Finally, we must consider the use of the mode whether enclosed with the provisions of the interest compensation mechanism which will be used to compensate the victims in the case of threatening or destroying the contractual control mode.Based on the rational and self-interested economic angle, the contractual control mode can solve the problem of insufficient financing channels, meet the needs of listing and financing; having clearly defined on contractual control, stakeholders can get a clear expectation; legalizing contractual control can show the positive externalities of contractual control and minimize the negative externalities. The spirit of contractual control is not only consisting with principles of contract freedom and honesty and encouraging the transactions on civil law, but also following the progressive liberalization of foreign policy in the context of WTO requirements. Therefore, I believe it is necessary to legalize the contractual control mode. Specific measures are as follows: learning the theory of different functions in the partners of the limited partnership to ensure the control of the VIE is owned by the main founders of Chinese enterprise; strengthen information disclosure obligations; merger and acquisition of domestic VIE which using contractual control mode when conditions are ripe.