Perspective | Discussion on the Nature of Buyback Rights and Exercise Period in Betting Agreements

From the results of case searches, the main controversy in practice regarding the nature of the equity repurchase right and its exercise period in the "betting agreement" lies in whether it is recognized as a claim subject to the statute of limitations or as a right subject to a time limit.

On August 29, 2024, the Supreme Court provided answers to the question "How to determine the nature of the equity repurchase right and its exercise period in the 'betting agreement'?" in the "Selected Q&A from Legal Q&A Network (Ninth Batch)" published in the "People's Court Daily."

How to determine the nature of the equity repurchase right and its exercise period in the 'betting agreement'?

Answer:In the 'betting agreement', it is often stipulated that if the target company has not gone public by X year X month X day or the annual net profit has not reached XX million yuan, the investor has the right to request the shareholders or actual controllers to repurchase the equity held by the investor at the price of X. In judicial practice, there is considerable controversy regarding the nature of the above equity repurchase right and the exercise period. Some opinions believe that the investor's request for repurchase of equity is a creditor's claim, subject to the statute of limitations. Others believe that the investor's request for repurchase of equity is a right that is subject to a reasonable time limit.

We believe that the essence of this issue is how to understand the nature of the investor's right to request the major shareholder or actual controller to repurchase the equity. Regarding the agreement in the equity valuation adjustment agreement that allows the investor to request the major shareholder or actual controller to repurchase the equity, according to the contract interpretation rules established in Article 142, Paragraph 1 of the Civil Code, this agreement should be understood not only according to the wording used in the agreement but also in conjunction with relevant clauses, the nature and purpose of the actions, customs, and principles of good faith. From the perspective of the purpose agreed upon by both parties, it is essentially that when the conditions (not listed or profit not meeting the standard) are met, the investor can either request the other party to repurchase and thus "offload" the equity or choose not to request the other party to repurchase and continue to hold the equity. Since the investor has the autonomy to exercise this right, limiting it to a reasonable period aligns more closely with the commercial expectations of the parties. Specifically: 1. If both parties have agreed on a period for the investor to request the other party to repurchase, for example, if it is agreed that the investor can decide whether to repurchase within 3 months from the date it is determined that the company has not gone public, this agreement should be recognized from the perspective of respecting the parties' free will. If the investor requests the other party to repurchase after this 3-month period, it can be regarded as a waiver of the right to repurchase or a choice to continue holding the equity, and the people's court will not support its repurchase request. If the investor requests the other party to repurchase within this 3-month period, the statute of limitations should be calculated from the day after the request. 2. If the parties have not agreed on a period for the investor to request the other party to repurchase, then the right should be exercised within a reasonable period. To stabilize the commercial expectations of the company's operations, it is advisable that the determination of a reasonable period in judicial work does not exceed 6 months. The statute of limitations starts from the day after the request is made within this 6-month period.

According to this opinion, it can be summarized that regarding how to determine the nature of the equity repurchase right and its exercise period in the 'betting agreement', the Supreme Court mainly holds the following views:

1. The nature of the equity repurchase right is not clearly defined;

2. Respect the free will of the parties, and the exercise period should be primarily determined by the circumstances agreed upon in the agreement;

3. If no repurchase period is agreed upon, the right should be exercised within a reasonable period, and it is advisable that the determination of a reasonable period in judicial work does not exceed 6 months;

4. The statute of limitations starts from the day after the request is made within this 6-month period.

5. If the investor requests the other party to repurchase after the exercise period, it can be regarded as a waiver of the right to repurchase or a choice to continue holding the equity.

In response to the above Q&A opinions, the following discussion is made regarding the nature of the equity repurchase right (this article only addresses the repurchase by actual controllers or shareholders from investors) and its exercise period in the 'betting agreement':

Civil rights are classified according to their functions into rights of disposition, claims, rights of formation, and rights of defense. A claim is the right of the right holder to require another party to perform a specific act (either an action or inaction). The right holder needs to rely on the obligor to perform or refrain from a certain act to realize their rights. A right of formation is the right that can cause rights or legal relationships to arise, change, or extinguish by the unilateral expression of the will of the right holder.
 

1. Views of this article

This article attempts to clarify the nature of the repurchase right in the 'betting agreement' from two directions.

(1) Legal Relationship

From the perspective of the legal relationship, if the repurchase right is recognized as a claim, the repurchase right can be understood as the investor's right to require the obligor to pay the equity transfer price and perform the equity transfer procedures, which means that a repurchase relationship (equity transfer) has already been formed between the investor and the obligor before the investor issues the repurchase notice. However, in practice, the repurchase clauses usually stipulate that the investor can request the shareholders or actual controllers to repurchase, "can" rather than "must," which means that before the investor issues the repurchase notice, the investor has the right to choose, and the equity (repurchase) relationship depends on the investor's choice rather than being formed when the repurchase conditions are met.

In fact, the process of fulfilling the result of the repurchase can be divided into two parts: first, the exercise of the repurchase right, after the repurchase conditions are met, the investor issues a repurchase notice, and its unilateral expression of will forms the equity (repurchase) relationship between the investor and the obligor; second, the equity transfer, based on the aforementioned equity (repurchase) relationship, the investor enjoys the creditor's claim to require the obligor to pay the equity repurchase price and perform the equity transfer procedures.

(2) Realization of Rights

The view that the repurchase right is recognized as a debt claim usually holds that "the realization of the repurchase right depends on whether the other party agrees to fulfill the obligation to pay the repurchase price for the equity." However, from the general provisions of the betting agreement, it is usually the case that the obligor grants the investor the right to request the actual controller/shareholder to repurchase their equity when the repurchase conditions are met. This can be understood as a commitment or prior consent. Once the repurchase conditions are met, the investor's request for the actual controller/shareholder to repurchase does not require further consent or commitment from the actual controller/shareholder, who does not have the option to choose to contract. A unilateral, legal, and timely notice of the repurchase right issued by the investor will lead to a change in the legal relationship between the parties. This change in legal relationship can be understood as a right of contract termination, that is, the termination of the investment relationship based on the investment agreement forms a new legal relationship of equity transfer (repurchase). If the repurchase right is understood as a claim, this factually contradicts the initial commercial expectations that the investor aimed to achieve when signing the betting agreement. If the investor still needs to rely on the obligor's consent to achieve the purpose of terminating the investment relationship, there will be no difference between the exit of the investor who signed the betting agreement and the exit of shareholders who did not sign the relevant agreement, then the repurchase clause effectively loses its meaning.

2. Opinions on Q&A

In the Supreme Court's Q&A opinions, although the Supreme Court did not explicitly classify the repurchase right as a right of formation, from the relevant statements: "From the purpose agreed upon by both parties, it is actually the case that when the conditions (unlisted or profit not meeting standards) are met, the investor can either request the other party to repurchase and thus 'dispose' of the equity, or not request the other party to repurchase and continue to hold the equity. Since the investor has the autonomy to exercise this right, limited by a reasonable period, it is more in line with the commercial expectations of the parties." It can be understood that the Supreme Court believes that the investor has the right to choose, and the change in the legal relationship depends on the investor's choice, leaning towards the nature of the repurchase right as a right of formation.

As mentioned earlier, the repurchase right in the "betting agreement" is a right of formation arising from the agreements of the parties involved in the betting agreement, which can change the legal relationship through unilateral expression of intent and should apply the rules of exclusion period.
 

Article 199 of the Civil Code states: "The duration of the rights such as the right of revocation or the right of termination as stipulated by law or agreed by the parties, unless otherwise provided by law, shall be calculated from the date the right holder knows or should know the occurrence of the right, and the provisions regarding the suspension, interruption, and extension of the statute of limitations do not apply. Upon expiration of the duration, the right of revocation, the right of termination, and other rights shall cease to exist."

1. Exercise Period

This article believes that the exercise period of the repurchase right in the "betting agreement" should be comprehensively judged in conjunction with the relevant provisions of the betting agreement and the provisions of the Civil Code regarding the "exclusion period":

(1) Agreement from the Agreement

If the parties to the "betting agreement" have a specific and clear agreement on the exercise period of the investor's repurchase right, then the autonomy of the parties' intentions should be respected, and the exercise period of the investor's repurchase right should be determined according to the specific agreement in the "betting agreement."

For example, in the first-instance civil judgment (2024) Zhe 0108 Min Chu 1530, the court held that "According to the supplementary agreement signed on September 30, 2019, 2.3.2 'If the investor requests the repurchase of the equity held, a written notice should be sent to the company within six months from the date the investor is aware of the above repurchase reason.' If the investor does not exercise the aforementioned right within the agreed period, it is deemed that the investor has waived that right."

(2) No Exercise Period Specified in the Betting Agreement

As a legal term, the provisions of Chinese law regarding the exclusion period are mostly confirmed in specific clauses as "rights disappear" or "deemed to be waived" to confirm the exclusion period of a certain statutory right of formation. However, there are no clear provisions in Chinese law regarding the exclusion period of agreed rights of formation, which leads to difficulties in confirming the exclusion period when the repurchase right is recognized as a right of formation, especially when the betting agreement does not specify the exercise period for the repurchase right. The confirmation of the exclusion period, due to the difficulty in finding legal basis, relies on the judge's discretion, becoming another difficulty in resolving disputes in the betting agreement. This may also be the reason why more judgments in practice tend to recognize the repurchase right as a claim.

Article 564 of the Civil Code states: "If the law provides or the parties agree on the exercise period of the right of termination, if the period expires and the parties do not exercise it, that right shall be extinguished. If the law does not provide or the parties do not agree on the exercise period of the right of termination, it shall be extinguished if not exercised within one year from the date the right holder knows or should know the reason for termination, or if not exercised within a reasonable period after being urged by the other party."

In the above-mentioned nature determination, this article likens the repurchase right to a right of termination. If understood this way, the exclusion period of the right of termination of one year should apply, that is, if the investor claims the repurchase after one year of the repurchase conditions being met, the exclusion period has passed, and the repurchase right disappears. In fact, in the second-instance judgment (2023) Hu 01 Min Zhong 5708, the Shanghai First Intermediate People's Court applied the provisions of the second paragraph of Article 564 of the Civil Code regarding the exclusion period of the repurchase right in the "betting agreement."

In the retrial ruling (2020) Hu Min Shen 1297, the Shanghai High People's Court held that "The determination of a reasonable period should be based on good faith and fairness principles, comprehensively considering the characteristics of the company's management, changes in equity value, the purpose of the contract, and other factors. Based on the nature of the rights and the consequences of their exercise, the exercise period of the equity repurchase right should be shorter than the exercise period of the right of termination."

In the response to question 2 of the "Selected Q&A from the Supreme Court (Ninth Batch)," it states: "If the parties have not agreed on the period for the investor to request the other party to repurchase, then the right should be exercised within a reasonable period. To stabilize the commercial expectations of the company's operation, the determination of a reasonable period in judicial work should not exceed 6 months. The statute of limitations starts from the day after the request is made within 6 months." Thus, it is deemed reasonable for the period to not exceed 6 months.

In the second-instance ruling (2024) Hu 01 Min Zhong 12277 made by the Shanghai First Intermediate People's Court on September 29, 2024, it was held that "In the case where the parties have not clearly agreed on the exercise period, if no reasonable restrictions are placed on the exercise period, it may affect the company's equity structure and stability, which is not conducive to the long-term development of the company. The reasonable period for equity repurchase should be determined based on good faith and fairness principles, comprehensively considering the characteristics of the target company's management, changes in equity value, the purpose of the contract, and other factors, and should not exceed 6 months." This explains the 6-month reasonable period from the perspective of company stability.

2. Starting Point of the Period

For the starting point of the calculation, according to Article 199 of the Civil Code, "unless otherwise provided by law, the calculation starts from the date the right holder knows or should know the right has arisen." The difference from the statute of limitations, which starts from the date the right holder knows or should know that the right has been harmed and the obligor, is that one is about "rights" and the other is about "harm." Therefore, the starting point for the exercise period of the repurchase right in the "betting agreement" should be calculated from the date the investor knows or should know that the repurchase right has arisen (when the conditions for repurchase in the "betting agreement" are met).

It is worth noting that in the second part of the repurchase performance process mentioned above, "Second, the transfer of equity, based on the above equity (repurchase) relationship, the investor has the creditor's right to request the obligor to pay the repurchase price." The creditor's right here should be subject to the limitation of the statute of limitations.

The Legal Q&A Network is an information-sharing platform provided by the Supreme People's Court for judicial officers of the four-level courts nationwide, offering legal policy application, trial business consultation, and learning exchange services. Through the Legal Q&A Network, judicial officers can consult online about issues related to legal application, case handling procedures, and judicial policies involved in trial work, study, and research. The Q&A experts must strictly adhere to laws, judicial interpretations, etc., to provide answers within the specified time limit, and these must be reviewed and approved by the heads of relevant business departments to ensure the accuracy and authority of the answers to the greatest extent. Consultations are only for legal application issues and must not involve specific cases; the answers are for learning, research, and reference purposes only.

Although the "Selected Q&A from the Legal Q&A Network" of the Supreme Court is not a judicial interpretation and cannot be directly cited as a basis for judges to adjudicate cases, it is also clear in the Q&A that "Q&A experts must strictly adhere to laws, judicial interpretations, etc., to provide answers within the specified time limit, and these must be reviewed and approved by the heads of relevant business departments to ensure the accuracy and authority of the answers to the greatest extent." The ruling opinion of the Shanghai First Intermediate People's Court in case (2024) Hu 01 Min Zhong 12277 is highly similar to the Q&A opinions, indicating that as an official Q&A opinion from the Supreme Court, there is no doubt that the "Selected Q&A from the Legal Q&A Network" will inevitably influence the judicial rulings of courts at all levels in the future.

In response to the risks that may arise after the release of the Q&A opinions, the following suggestions are made for the relevant parties:

1. Betting Agreement Not Yet Signed

The setting of the exercise period for the repurchase right in the betting agreement should be as clear as possible. For investors, the exercise period should be extended as much as possible, and restrictive terms such as "should" should be avoided in the clauses that limit the exercise; for the obligor, the exercise period should be limited, and the investor's notification obligation and the legal consequences of the expiration of the repurchase right should be clearly defined.

2. Betting Agreement Signed

(1) Repurchase Conditions Not Met

Refer to "1. Betting Agreement Not Yet Signed" and sign a supplementary agreement to clarify any ambiguous matters in the repurchase terms of the betting agreement.

(2) Repurchase Conditions Met

1. Suggestions for Investors: If it is confirmed that they want to exit the investment, they should promptly send an exercise notice to the relevant obligor during the exercise period and retain necessary delivery evidence to avoid expiration leading to the loss of the repurchase right; they may also consider signing a supplementary agreement with the obligor to extend the exercise period. For repurchase rights that have already expired, they should quickly sign a supplementary agreement with the obligor to reach an agreement on extending the exercise period.

2. Suggestions for Obligors: After the repurchase conditions are met, they should pay attention to the investor's exercise notice, urging the investor to exercise as soon as possible, or not actively remind but monitor whether the investor has exceeded the period and still has not exercised the repurchase right.