Time Limit for Share Repurchase Rights in China: Does the Game Rules Change in Private Equity？

[Michael's Chinese Law Series-Compliance & Dispute Resolution]

In the private equity (PE) and venture capital (VC) landscape in China, the legal nature of share repurchase rights has been a contentious issue. The debate surrounding whether repurchase rights are considered "rights of action" or "rights of formation" under Chinese law.

On August 29, 2024, the "Legal Answer Network Selected Q&A" (the ninth batch) published in the People's Court Daily of China included responses from judges of the First Civil Division of the PRC Supreme Court regarding the nature of the share repurchase right in "bet-the-company agreements" and how to determine the exercise period of such rights. The core viewpoint is that if the parties have a clear agreement on the exercise period of the repurchase right, it shall be followed. In the absence of a clear agreement, the right holder should exercise the right within a "reasonable period." To stabilize the business expectations of company operations, it is considered appropriate in judicial practice to determine the reasonable period as no more than six(6) months. The statute of limitations begins the day after a request is made within the six-month period.

The "Q&A" has sparked widespread discussion and concern within the industry.Here's a summary of the key points:

1. The Debate Over Repurchase Rights: Repurchase rights are a common feature in investment contracts, allowing investors to sell their shares back to the company or founders under certain conditions. The legal nature of these rights—whether they are rights of action (requesting the other party to perform a legal act) or rights of formation (the power to unilaterally alter legal relations)—is crucial as it determines the time limits for exercising these rights.

2. Implications of the Debate: If repurchase rights are classified as rights of formation, it could lead to a significant shift in the PE/VC industry. The authors argue that such a classification could result in a rush to exercise these rights, potentially destabilizing the market and leading to numerous legal disputes.

3. Recent Court Opinions: The the PRC Supreme Court's "Q&A" further clarifies that if both parties have agreed upon a period within which the investor may request a repurchase from the other party, this agreement should be recognized. If the investor requests a repurchase beyond this period, it may be considered a waiver of the right to repurchase or a decision to continue holding the equity. Should the parties fail to stipulate such a period, the right should be exercised within a "reasonable period," the determination of which, in the interest of stabilizing the business expectations of company operations, is deemed appropriate not to exceed six(6) months in judicial practice. According to this content, the "Q&A" appears to have established a new statute of limitations for the right of formation, as the "Civil Code" generally sets the statute of limitations for the right of rescission and revocation at one year.

4. The 'Two-Stage' Approach: The authors propose a nuanced approach, distinguishing between the establishment and the performance of the legal relationship. They argue that the activation of the repurchase right (establishment) is a right of formation, while the subsequent claim for payment (performance) is a right of action.

5. Practical Implications and Recommendations: For future contracts, it is recommended to clearly define the exercise period of repurchase rights to avoid ambiguity. For existing contracts, a thorough review is necessary to determine the status of repurchase rights and take appropriate action, such as timely notification of exercise or renegotiation with the counterparty.

6. The Impact on the Industry: There is opinion suggests that the Supreme Court's guidance, while well-intentioned, may have unintended consequences. It could lead to a rush of repurchase claims or a reluctance to negotiate, potentially harming the industry's stability and legal predictability.

(Michael Chen, JunHe LLP Shanghai)