What the Soho China and Fosun case means for the real estate sector
August 22, 2013 | BY
clpstaff &clp articles &The case between Soho China and Fosun has shown that the transfer of equity without the consent of subsidiary equity-holders evades the right of first refusal. The Judgment may pose a threat to this practice
The two companies fought for the development rights of the most expensive piece of land in Shanghai before the Shanghai First Intermediate Court.
“The judgment ruled that the transfer of equity in a company without the consent of the company's subsidiary company's other equity-holders was considered as circumventing the other equity-holders' right of first refusal,” said Li Haifeng, a lawyer with Global Law Office in Beijing.
The dispute has been a topic of heated debate within the legal and business communities as it has far-reaching consequences for business practices, in particular in the real estate sector.
|Case facts
The multi-layer equity transactions in the case involved a range of affiliated parties belonging to four independent groups: Soho China, Fosun, Greentown and Zhengda.
Project company Zhengda won the development right over Land 8-1 in Shanghai. In April 2010, Fosun, Greentown, Zhengda and another company called Panshi formed a limited liability joint venture (JV), which subsequently took over the development right from the project company. Fosun owned 50% of the JV and the other three severally the remaining 50%. Later, Panshi was acquired by Zhengda and became a wholly-owned subsidiary of Zhengda.
On December 22 2011, Greentown and Zhengda jointly informed Fosun of their intention to transfer their 50% stake in the JV for a price of Rmb4.25 billion ($693 million) and requested Fosun to notify its decision whether to take the transfer before December 28 2011. Fosun did not consent by the deadline.
On December 29, Soho China and the respective parent companies of Greentown and Zhengda entered into an acquisition contract whereby Soho China would acquire 100% equity in Greentown and Zhengda for Rmb4 billion. The contract specifically required Greentown and Zhengda to divest their other assets so that the only remaining asset was their equity in the JV.
On the same day, Soho China and Greentown publicly disclosed that Soho China would own 50% indirect equity in the JV after the said equity transactions. Fosun then sued Soho China and the other parties involved in the equity transactions, asking for an annulment of the transactions.
|The Judgement
The Shanghai First Intermediate Court ruled in April 2013 that the series of transactions leading to Soho China obtaining 100% equity in Greentown and Zhengda were void because they were meant to circumvent Fosun's right of first refusal.
According to Article 72 of the PRC Company Law (中 华人民共和国公司法), if an equity-holder in a limited liability company wishes to transfer equity to a party that is not currently an equity holder of the company, it must get the consent of at least half of the other equity-holders. If an equity-holder does not reply within 30 days of receipt of the notice of transfer, it is deemed as consenting.
For those consented transfers, the existent equity-holders have the right to take the transfer on the same terms and conditions as offered by outside bidders (right of first refusal).
According to Article 52 (3) of the PRC Contract Law (中 华人民共和国合同法), “a contract is null if it falls under anyone of the following situations: … (3) pursue illicit purposes under the guise of an apparently licit façade.”
The Court held that the right of first refusal is a right provided by the law and hence any act meant to circumvent the right would carry an illicit purpose in the sense of Article 52 (3) of the Contract Law.
“The Court found that the series of arrangements of Soho China obtaining 100% equity in Greentown and Zhengda from these companies' respective parent companies had been conducted with the illicit purpose of circumventing Fosun's right of first refusal as an existent equity-holder in the JV and Fosun's such right had indeed been effectively frustrated,” said Li.
|Criticism
The Judgment has aroused heated debates about its legal correction and possible consequences. The debates focus on whether the circumvention of an equity-holder's right of first refusal would constitute illicit purpose under Article 52 (3) of the Contract Law.
Critics hold the view that the illicit purpose should be confined to violation of public policy or mandatory statutes only and not extended to private rights or interests such as the right of first refusal.
Supporters argue that illicit purpose is any purpose that is aiming for a result that runs counter to the purpose of any legal provision be it private or public, discretionary or mandatory.
“There is no logic, literary or policy support for the narrow interpretation as held by the critics. Every statutory provision carries a purpose that may allow the concerned parties to derogate from voluntarily, but does not allow acts of non-concerned parties to render it futile,” said Li.
|Mitigating risk
The Judgement is still subject to appeal before the Shanghai High Court. In the meantime, there are some steps investors can take to mitigate risk.
For example, if the controlling equity-holder wishes to maintain control in all situations and avoid a stalemate, it should take a stake higher than 50% in the first place.
Also, investors should be extremely cautious when acquiring equity in the holding company whose only asset is equity in an operational company (or another holding company of an operational company) in China, which has other equity-holders.
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