Erke was originally an wholly foreign-owned enterprise. On September 14, 2010, it was transformed into a Sino-foreign equity joint venture and Lauritz Knudsen Electric Co. Pte. Ltd. (Singapore) (hereinafter referred to as “LKE”) was one of its joint venture partners. In October 2010, LKE and Shandong Huali Investment Co., Ltd. (hereinafter referred to as “Huali”) concluded an Agreement on Capital Increase and Share Expansion and they agreed that Huali would invest CNY 20 million in Erke and if LKE violated any term of the Agreement and caused failure to achieve the purpose of the Agreement, Huali had the right to terminate the Agreement and withdraw the funds invested for capital increase and share expansion. On December 6, 2010, both parties concluded another Agreement on Equity Transfer and agreed that considering that Erke would apply for being restructured to a joint stock limited company, (i.e. the target company) and Huali would own 8 million shares of the target company after the restructuring. After October 10, 2013, Huali had the right to raise a claim of transferring equity shares of the target company within the limit of the original amount of capital contribution and LKE committed to purchasing the shares to be transferred in its own name or by a designated third party in an unconditional manner. On January 27, 2011, all shareholders of Erke concluded an Agreement on Capital Increase and Share Expansion and Huali subscribed to the increased capital of Erke at a premium and Huali accounted for 10% of equities of Erke. When any circumstance as agreed in the Agreement occurred, Huali had the right to terminate the Agreement after notifying LKE and to withdraw the investment made under this capital increased and shares expansion. After the Agreement was approved by the competent authority, all parties began equity transfer registration whereby Huali held 10.001% of the sahres of of Erke and LKE owned 76.499% of the shares of Erke. On the ground that LKE refused to perform the obligations of capital increase as agreed and failed to perform the liability of guarantee for repurchasing shares, Huali filed a lawsuit with the Intermediate People’s Court of Zhuhai City, Guangdong Province and requested the Court to order that LKE should purchase the equities of Erke held by Huali and pay CNY 20 million and interest thereof.   

In the trial of first instance, the Intermediate People’s Court of Zhuhai City, Guangdong Province held that the claim of Huali that LKE should purchase the equities of Erke held by Huali lacked factual and legal basis. Therefore, the Intermediate People’s Court of Zhuhai City delivered a judgment that all claims of Huali should be dismissed. Huali refused to accept the judgment of first instance and appealed on the ground that the Agreement concluded by and between both parties was actually an agreement on adjustment of valuation of equity investment in nature and it had the right to claim for withdrawing equities when the financial stocks company failed to be listed on schedule.

In the opinion of second instance, the High Court of Guangdong Province held that the content of the Agreement on Equity Transfer was equity transfer affixed with factual conditions, namely, only after Erke was restructured into a joint stock limited liability company, Huali could transfer the equities of Erke it held to LKE. The stipulation of the Agreement on future facts did not violate the mandatory provisions of Chinese laws and administrative regulations and hence it should be identified as legally effective. An agreement on adjustment of valuation of equity investment was a clause of valuation adjustment prepared for the purpose of rationally controlling risks when an investment company invested in the target company. In general, both parties would agree on the business operation objective within a fixed term. If the enterprise failed to realize the business operation objective within a fixed term, one party should make payment or compensate for the losses of the other party. However, the restructuring of Erke to a joint stock limited company was not presented as the business operation objective in the Agreement on Equity Transfer. Furthermore, it was not stipulated in the Agreement that as the shareholder, LKE should assume the liability of repurchasing equities if the target company Erke failed to complete the shareholding restructuring. In the performance of the Agreement by both parties, there was breach of contract that would bring about termination of the Agreement. On June 9, 2011, Huali also obtained the equities of Erke. Therefore, the grounds relied upon by Huali for claiming the withdrawal of funds invested in the capital increase and share expansion in accordance with the Agreement on Equity Transfer and the Agreement on Capital Increase and Share Expansion lacked factual and legal basis. Hence, the High Court of Guangdong Province delivered a judgment to dismiss the appeal and affirm the original judgment. 

This is a case where a Chinese company invested in a Sino-foreign joint venture by means of equity transfer. Its typical significance lies in how to determine the nature of the clause on repurchase of equities as stipulated in the contract, whether it is a new investment and financing method (namely, an agreement on adjustment of valuation of equity investment), and whether such stipulation on the nature should be supported. Onthe one hand, the judgment affirms that for the purpose of adapting to the high financing demands of modern market economy, shareholders have the right to stipulate the content of adjustment of valuation of equity investment in an autonomous way; On the other hand, the judgment follows the principle that the consensus on adjustment of valuation of equity investment must be clearly stipulated in the contract. Under the circumstance where the Agreement on Equity Transfer involved did not set a business operation objective and did not stipulate that LKE should assume the liability of equity repurchase if Erke failed to complete the shareholding restructuring, it was determined that the true intention of both parties was restructuring Erke to a joint stock limited company. Therefore, the nature of the Agreement on Equity Transfer was equity transfer affixed with factual conditions. Before the prerequisite that Erke was restructured to a joint stock limited company was satisfied, Huali had no right to claim that LKE should repurchase equities. Through literal interpretation, the judgment of this case determined the intention of the parties on investment, effectively avoided random withdrawal of corporate capital, safeguarded stability in the joint venture relationship of Chinese and foreign investors, legally safeguarded the rights and interests of investors, and would play a significant role in the orderly development of new investment methods in the “Belt and Road”.