Perspective | Design and Practical Implementation of Third-Party Provision of Top-Up Guarantees

The shortfall guarantee is commonly used in structured financing and serves as a credit enhancement measure provided by a third party to the creditor. It refers to a commitment by the third party to cover any outstanding shortfall in the debtor’s obligations.

The core characteristics of the difference supplement are summarized as follows:

◆ In judicial practice, if the wording of a shortfall compensation clause is ambiguous (e.g., it fails to explicitly specify “guarantee” or “debt assumption”), such a clause will tend to be interpreted as a guarantee (with stronger subsidiary nature) based on this provision.

◆ If the promise states, “If the debtor fails to perform, I will make up the difference,” this meets the characteristics of a guarantee contract stipulated in this provision and should be recognized as a guarantee (which is subordinate and supplementary in nature).

◆ If a promise is made to “jointly and severally assume the debt with the debtor,” this may constitute debt assumption as stipulated in this provision (which is independent and joint and several).

◆ For state-owned wholly-owned enterprises and state-owned wholly-owned companies providing credit enhancement measures such as supplementary funding to cover any shortfall, the corresponding decision-making procedures must be followed.

The basic facts of the case are as follows: In February 2016, Guangda Jinhui Company (a wholly-owned subsidiary of Guangda Capital) jointly initiated the establishment of the Shanghai JinXin Fund together with other entities. The total committed capital contribution amounted to RMB 52.03 billion, of which China Merchants Wealth Co., Ltd. (a special asset management plan established with investment from China Merchants Bank) subscribed for a priority limited partnership interest of RMB 28 billion, while Guangda Capital subscribed for a junior limited partnership interest of RMB 60 million. Guangda Jinhui Company served as the general partner responsible for executing the fund’s affairs. The Partnership Agreement stipulated, among other things, the order of profit distribution, and the priority limited partners were expected to achieve an annualized rate of return of 8.2%. In April 2016, Guangda Capital issued a “Difference Supplement Letter” to China Merchants Bank, undertaking that within 36 months from the fund’s establishment, if the price at which a third party acquired equity in the target company fell below the target price (RMB 2.8 billion × [1 + 8.2% × number of days the asset management plan had been in effect / 365]), or if the equity of the target company remained partially unsold at the termination of the asset management plan, Guangda Capital would assume full responsibility for making up the difference. Guangda Securities Co., Ltd., as the sole shareholder of Guangda Capital, issued a “Reply Regarding the GD Cross-Border M&A Fund,” endorsing this supplemental arrangement. In February 2019, the Shanghai JinXin Fund entered the stage of asset disposal and liquidation. The target companies in which the fund had invested encountered severe operational difficulties and failed to exit as planned; their equity was not transferred at the target price. Specifically, by the maturity date of the 8th tranche of Asset Management Plan No. 5 on May 5, 2019, the target equity had still not been fully disposed of. Based on this, China Merchants Bank demanded that Guangda Capital fulfill its obligation to make up the difference, leading to a dispute between the two parties.

Court’s Ruling: The central issue in the second-instance proceedings of this case is: How should the legal nature, validity, and scope of the obligation to make up the difference under the “Letter of Supplementing the Difference” involved in the case be determined?

Regarding the legal nature of the “Supplemental Commitment Letter,” this Court holds that, first, the addressee of the Supplemental Commitment Letter is China Merchants Bank. In its “Reply Concerning the GD Cross-border M&A Fund” issued to Guangda Capital, Guangda Securities explicitly stated, “Our company has acknowledged and approved Guangda Capital’s supplemental arrangement toward China Merchants Bank.” Therefore, the party entitled to the rights under the Supplemental Commitment Letter is China Merchants Bank. Guangda Capital’s claim that Shanghai JinXin Fund is the rightful holder of the rights under the Supplemental Commitment Letter lacks sufficient basis and is thus not accepted by this Court. Second, the “Repurchase Agreement” was entered into between Guangda Jinhui Company and BF Group Corporation and others; China Merchants Bank is not a creditor under the Repurchase Agreement. The obligation to provide the supplemental payment promised by Guangda Capital in the Supplemental Commitment Letter is not identical to the repurchase debt obligation undertaken by BF Group Corporation under the Repurchase Agreement. Guangda Capital’s assertion that the Supplemental Commitment Letter constitutes an accessory contract to the Repurchase Agreement lacks corresponding factual support and is therefore not accepted by this Court. Third, Article 91 of the “Minutes of the National Conference on Civil and Commercial Trial Work of Courts” stipulates that if a party other than the trust contract provides third-party commitment documents—such as commitments to make up the difference, assume the obligation to repurchase upon maturity, or provide liquidity support—as credit enhancement measures, and the content of such documents conforms to the legal provisions governing guarantees, the people’s court shall recognize the establishment of a guarantee contractual relationship between the parties. If the content of such documents does not conform to the legal provisions governing guarantees, the corresponding rights and obligations shall be determined based on the specific terms of the commitment documents, and the corresponding civil liabilities shall be identified in light of the factual circumstances of the case. Accordingly, the nature of credit enhancement measures such as difference supplements cannot be generalized. If it is determined that such measures meet the requirements for guarantees, they should indeed be treated as guarantee arrangements. If, however, they fall under other legal categories, the legal relationship and associated legal responsibilities should be determined according to the actual nature of the difference supplement. The disputed “Difference Supplement Letter” contains neither an explicit expression of joint and several liability guarantee nor any specified object of guarantee; therefore, the second-instance court’s determination that it constitutes an independent contract was entirely appropriate.

Regarding the validity of the “Supplemental Commitment Letter,” this court holds that the letter genuinely reflects the true intentions of China Merchants Bank and Everbright Capital, and does not violate any mandatory provisions of laws or regulations; therefore, it should be deemed lawful and valid. Everbright Capital’s claim that China Merchants Bank’s investment activity was unlawful and thus the “Supplemental Commitment Letter” obtained on the basis of such investment is invalid lacks both factual and legal support, and this court declines to accept it. Furthermore, Everbright Capital contends that the “Supplemental Commitment Letter” was the result of malicious collusion between China Merchants Bank and employees of Everbright Capital, thereby harming Everbright Capital’s interests and rendering the letter itself unlawful and invalid. However, Everbright Capital has failed to provide sufficient evidence to substantiate this claim, and hence this court also declines to accept it. Everbright Capital further argues that Everbright Securities was unaware of and did not consent to Everbright Capital’s external guarantees, and that the “Supplemental Commitment Letter” therefore falls outside the scope of its authority. Exceeding authority to provide guarantee should be deemed invalid. In this regard, this Court holds that, as previously stated, the “Supplemental Difference Letter” does not constitute a guarantee; therefore, there is no issue of exceeding authority in providing such a guarantee. Furthermore, according to the contents of the “Reply Concerning the GD Cross-Border M&A Fund” issued by Everbright Securities to Everbright Capital, Everbright Capital’s appeal claim that Everbright Securities was unaware of and did not consent to the “Supplemental Difference Letter” is also inconsistent with the facts and is thus not accepted by this Court.

Judgment: First-instance judgment: The defendant, Everbright Capital, shall pay the plaintiff, China Merchants Bank, RMB 3,115,778,630.04 plus interest losses within ten days from the date this judgment becomes effective. Second-instance judgment: Dismiss the appeal and uphold the original judgment.

1. In practice, there is considerable controversy regarding the characterization of difference-supplement agreements or difference-supplement commitments. Currently, the main views can be broadly categorized into three: guarantee-based security, debt assumption, and an independent contract.

According to the "Minutes of the National Conference on Civil and Commercial Trial Work of Courts," if a make-up agreement expresses an intention to provide a guarantee, it should be recognized as a guarantee contract. If the content of the make-up agreement indicates an intention to provide a guarantee or to assume joint debt liability, it is recommended that the party obligated to make up the difference obtain a resolution from either the shareholders’ meeting or the board of directors in accordance with the relevant provisions of the Company Law, the Supreme People’s Court’s Interpretation on the Application of the Security System under the Civil Code of the People’s Republic of China, and the company’s articles of association. Otherwise, failure to follow the legally prescribed decision-making procedures could render the agreement invalid.

2. If you wish to hold a third party jointly and severally liable (i.e., to “join the debt”), the terms must explicitly state phrases such as “jointly perform the debt with the debtor” and “no requirement to first seek reimbursement from the debtor.”

3. If a guarantee is required, please take note. Warranty Period (Article 692 of the Civil Code: “The guarantee period is the period during which the guarantor assumes guarantee liability; it shall not be subject to suspension, interruption, or extension. The creditor and the guarantor may agree on a guarantee period. However, if the agreed guarantee period precedes the maturity date of the principal debt or expires simultaneously with the maturity date of the principal debt, such agreement shall be deemed non-existent. In the absence of an agreement or where the agreement is unclear, the guarantee period shall be six months from the date on which the maturity date of the principal debt expires. If the creditor and the debtor have not agreed on the maturity date of the principal debt or the agreement is unclear, the guarantee period shall commence from the expiration of the grace period granted by the creditor for the debtor to perform its obligation.”) If the period exceeds the stipulated term, the guarantor shall be exempt from liability.

4. As creditors, state-owned enterprises must verify whether the credit enhancement measures—such as difference supplements and buyback commitments—provided by third parties comply with Article 31 of the Law on State-Owned Assets, which stipulates that “the merger, division, increase or reduction of registered capital, issuance of bonds, distribution of profits, as well as dissolution or application for bankruptcy of wholly state-owned enterprises and wholly state-owned companies shall be decided by the institution performing the duties of investor.” Furthermore, Article 32 provides that “for wholly state-owned enterprises and wholly state-owned companies engaging in any of the matters listed in Article 30 of this Law, except those decisions made in accordance with Article 31 of this Law and relevant laws, administrative regulations, and the articles of association of the enterprise, the decisions regarding such matters by wholly state-owned enterprises shall be made collectively through deliberation by the enterprise’s management team, while those by wholly state-owned companies shall be made by the board of directors.” Therefore, when state-controlled companies and their subsidiaries include clauses related to debt assumption, guarantees, or buybacks in their agreements, they must obtain corresponding resolutions from the shareholders’ meeting or the board of directors and retain minutes of the meetings and the resolution documents as evidence. This is to avoid invalidating such clauses due to procedural defects and thereby mitigating the risk of loss of state-owned assets.