The Legitimacy Problem Of Valuation Adjustment Mechanism Contract

The final verdict made by the Supreme Court has ended the lawsuits between Hai Fu Investment Co. and Gan Su Co. However, the legal problem of the Valuation adjustment mechanism contract is still being discussed in all the fields, such as Investment and financing, Academic, and no answer was concluded for now. Most of the papers, information or details just focus on what kind of the Valuation Adjustment Mechanism is legal or illegal. Yet a few problems which are significant have been neglected---what is the legal nature of VAM contract? The reasons for VAM contract and why Chinese companies are declined to finance from private equity fund, accepting the VAM contract in most cases? Is the VAM contract necessary for parties to made?In personal view, problems above are the pre-condition of the legitimacy of VAM contract. Therefore, from the perspective of the legal nature of VAM contract, we are going to make comparisons among VAM contract and the guaranty contract, the future contract and the conditional contract. Take the guaranty contract as an example, from the first part, there will be no guaranty legal relationship without the legal relationship of major debt. However, private equity investment does not create any debt or credit, it is purely an equity investment. Secondly, in terms of the contents of contract, the fundamental purpose of guaranty contract is to realize the major legal credit. Although a kind of "promise" made by the target company is quite similar to the characters of guaranty contract, it is still different. Such "promise" is made to offer the two parties or more in the contract to adjust the equity price again, rather than guaranty any major credits. What is more, without clear agreement in the contract, when the financial indicators are not satisfied, there will be no need for the target company to undertake the unlimited joint and several liability even if the shareholders refuse to perform or fail to perform the liabilities of the VAM contract. In all, Valuation Adjustment Mechanism cannot be classified to the guaranty contract, future contract or the conditional contract.In the second part of the article, the necessity and importance of Valuation Adjustment Mechanism contract has been proved. Specifically, VAM contract is conducive to resolve the asymmetry information between investors and financiers. Compared with the investors, the financiers owns more information, such as asset debt report, cash flow report and other undisclosed information. However, all the information will be reflected through the equity price, no matter of the disclosed ones or undisclosed ones. And the Valuation Adjustment Mechanism contract indirectly helps to resolve it and make the two parties reach the agreement. Secondly, the uncertainty can be reduced with the help of VAM contract, because both the asymmetry information and uncertainty will be reflected through the equity price. Moreover, combined with Coase’s property right theory and Williamson’s market economies theory, the VAM contract is conducive to lower the transaction costs of investors and financiers. Both investors and financiers benefit from the Valuation Adjustment Mechanism contract to adjust the equity price which was made before the signature of the private equity investment contractIn the third part of the article, different kinds of valuation adjustment mechanism contract will be discussed respectively. In terms of the VAM contract between investors and shareholders, such valuation adjustment mechanism contract shall be legal. Because it is the result of truly expressions from each parties and no illegal problems are found. However, in terms of the VAM contract between investors and the target company, the author suggests to analyze it specifically. The VAM contract will be illegal if any legal rights and benefit of creditors is going to be harmed. Besides, in the author’s view, the contract law and regulations shall be adapted in priority when analyzing the legitimacy problem of the VAM contract, but the company law and regulations are also needed. What is more, the principle of risk-sharing and profit distribution will not be breached when the two parties accept the VAM contract. Also, the acceptance of VAM contract is not the way of abuse of shareholders rights.Finally, based on the research made above, author thinks the VAM contract shall be specified through the coming three way---the legal principle aspect, the legal regulation aspect and the value of VAM contract. The contract spirit and the principle of freedom trading shall be respected on the precondition of no legal rights and benefits of creditors or any other third party will be harmed. Only in these way can it enhance the development of VAM contract and the growth of Chinese companies, as well as the Chinese economies in new era.