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Preface
In the context of the slowdown in global economic growth, the inherent contradiction between the capital needs of the target company and the exit expectations of investors is intensifying, and how to properly resolve the post-investment exit dispute has become one of the hot topics in the market.
In the first article of our post-investment exit series, we have given an overall introduction to how investors can set up risk defense lines, lay out exit strategies in advance, and implement exit plans. Under this premise, in view of the complex and changeable equity structure of the target company, it is necessary to explore in detail how to customize a differentiated post-investment exit mechanism for different equity structures. Based on our practical experience, this article focuses on the post-investment exit issues under the Cayman structure (including the direct shareholding structure and the VIE structure, hereinafter collectively referred to as the "Cayman structure"), which is a common investment structure, and focuses on the practical difficulties and relevant countermeasures for investors to claim rights against domestic assets through a question-and-answer format.
Q1
In practice, what are the difficulties in exercising rights against domestic assets under the Cayman structure?
When the target company adopts the Cayman structure, the preset path of the parties to the transaction is that the target company will exit the market after the target company has carried out capital operations such as qualified listing or mergers and acquisitions abroad. However, due to factors such as the decline in the prosperity of the overseas IPO market and the lower-than-expected issuance price, the relevant preset path often fails, and disputes caused by the "difficulty in exiting" are not uncommon.
In addition, investors choose to resort to dispute resolution in some cases, and withdraw through judicial enforcement procedures. However, in the cases we have participated in, the common concern of investors is that even after a lengthy litigation process, they may not have the right to claim compensation from a solvent domestic entity, or may encounter many obstacles in the enforcement stage, resulting in the unrecoverable investment costs.
These concerns accurately address the key features of the Cayman structure and reflect the difficulty of investors in exercising their rights over onshore assets under the Cayman structure. In other words, for companies with a Cayman structure, investors often only hold shares at the Cayman level, even though their physical operations and core assets are located in China. At the level of domestic entities, investors may neither directly hold shares nor occupy the seats of directors or supervisors, and even the constraints on domestic entities in transaction documents are relatively limited. Under this pattern of rights allocation, the challenges faced by investors in exercising their rights are: first, investors may not have the right to require a truly solvent domestic entity to bear legal liability, second, it is difficult for investors to fully grasp the relevant situation of domestic entities, and in addition, cross-border enforcement issues of extraterritorial adjudication are often involved under the Cayman structure, so investors may struggle in the enforcement stage and have difficulty accessing the truly valuable domestic assets of the target company.
In order to effectively deal with the above-mentioned problems in exercising rights, investors should focus on multiple issues such as the design of transaction terms, the identification and tracking of domestic assets, and the recognition and enforcement of foreign judgments in China, so as to do a good job in overall planning and layout, and effectively manage investment risks.
Q2
What risk prevention and control measures can investors plan in advance to deal with potential disputes?
In order to take the initiative in potential disputes, investors should adopt a series of forward-looking risk prevention and control measures during the post-investment management stage. Investors may consider the following measures to prepare for possible disputes and enforcement needs in the future:
Timely adjustment of transaction documents: For existing transaction documents, investors should reorganize the transaction documents according to the company's development stage and the feasibility of the exit path, sign supplementary agreements in a timely manner, or embed or adjust rights and obligations clauses in subsequent rounds of transaction documents, so as to ensure that they are in a favorable position in potential disputes. Specifically, investors should strive for the following rights in the transaction documents:
（1）
Expansion of Signatories: Strive to include all or key onshore entities as signatories to the transaction documents, and clarify the obligations and responsibilities of each party in the transaction documents, especially the specific commitments and guarantees for onshore entities. This provides a legal basis for directly pursuing the liability of domestic entities for breach of contract in contracts, and is conducive to reducing the "intermediate links" to domestic assets through Cayman companies or founders.
（2）
Enhance information transparency: Clarify the right to know information about domestic entities and the obligation of domestic entities and founders to cooperate in disclosure, including but not limited to requiring domestic entities to provide detailed financial information on a regular basis, disclose management decisions, strategic planning and implementation, and timely report information on changes in asset purchases, sales or mortgages, so that investors can timely grasp the business dynamics and asset trends of domestic entities.
（3）
Set up a diversified exit mechanism: Broaden the exit path as much as possible and set the trigger conditions reasonably. For example, investors can explicitly set specific risk events (such as major legal proceedings) as triggers for the mandatory repurchase clause. For another example, in order to make it easier to enforce the trigger criteria for the sale of assets to be equivalent to a liquidation event, investors can set clear financial indicators or other trigger conditions that are easy to prove in the agreement.
Strive for the right to participate in the governance of domestic entities: Investors can actively strive to appoint directors or supervisors in domestic entities, which can be used as a "fulcrum" to grasp the operation dynamics of domestic entities in real time, and effectively protect the right to participate in the operation of domestic entities and the right to know. At the same time, investors can also stop the misconduct and take rights protection measures in a timely manner based on the status of directors and supervisors when there is a change in the company.
Continuous tracking of daily business information: Investors should make reasonable use of their right to know and require the target company to provide information on the business and operations of the domestic company in addition to the consolidated financial data of the group. Investors can set these requirements as customary disclosure requirements to ensure the continuity and completeness of information disclosure. As a result, investors can continuously monitor and analyze the company's operating dynamics and asset changes, maintain a high degree of vigilance against any major changes in the target company, and then take preventive measures quickly when risks emerge.
Q3
Under the VIE structure, what are the special points of concern for investors to exit?
In a VIE structure, the offshore entity exerts control over the onshore entity that holds assets and business through a series of contractual arrangements. Under such a structure, given that the core assets and business of the target company are usually concentrated in domestic VIE entities, it may be relatively difficult for investors to provide property clues in the process of preservation and enforcement.
However, in this case, although the investor can require the domestic entity to bear the contractual liabilities in accordance with the agreement, due to the lack of an "equity bond", the structure substantially increases the complexity of the investor's influence or recourse against the domestic entity and its assets. From the perspective of exercising shareholders' rights, in the absence of special provisions in the agreement, it is more difficult for investors to directly claim rights against domestic entities as "shareholders of foreign entities". The more obvious obstacles are: first, the VIE structure is usually different from the nominee shareholding, so it is more difficult for investors to assert relevant shareholder rights against domestic entities as actual investors; Second, if an investor intends to assert claims against a domestic entity through a "shareholder representative lawsuit" or similar means, it needs to first review the shareholder rights enjoyed by the investor under the framework of foreign law, and at the same time analyze whether these rights are sufficient to penetrate the multi-layered structure to reach the domestic entity.
Considering the above-mentioned structural features, investors can plan relevant rights protection measures in advance:
（1）
Investors may strive to directly hold shares in domestic VIE companies through domestic related entities. Even if the shareholding ratio is relatively limited, investors can still easily correct misconduct and protect the legitimate rights and interests of the company and themselves through shareholder representative lawsuits, disputes over liability for damage to shareholders' interests, etc. At the same time, investors can use their influence and legal means in the company as bargaining chips to negotiate with the founder or other shareholders of the target company to obtain favorable exit conditions.
（2）
Regardless of whether the shareholding structure or the VIE structure is structured, investors can consider "mirroring" their corresponding rights in the Cayman corporate governance structure in the domestic entity, including seeking the appointment of directors or supervisors in the domestic entity, and clarifying the right to know about the domestic entity. As mentioned above, this move aims to establish a direct connection between investors and domestic entities and domestic assets, so that investors can keep abreast of the company's business dynamics before disputes arise and take multiple rights protection measures after disputes occur.
Q4
How can onshore assets be executed across borders when a domestic entity under the Cayman structure is liable?
On the premise that the effective judgment confirms that the domestic entity should be held liable, ensuring that the award is enforced is a key step in the successful closed-loop exit strategy of investors, and its importance is self-evident. For investors under the Cayman structure, if they have the right to directly sue in Chinese mainland courts in accordance with Article 276 (foreign-related jurisdiction clause) of the Civil Procedure Law (2023 Amendment) and win the judgment, there is no substantial obstacle to applying to the Chinese mainland courts for enforcement. In this case, it is important to note that, in our experience, the dispute resolution clause in the transaction document usually stipulates Hong Kong[1] arbitration, so investors need to understand the legal basis and basic requirements for the enforcement of Hong Kong arbitral awards in China.
If an investor obtains a favorable award in Hong Kong, it can apply for enforcement of the arbitral award in both the Mainland and Hong Kong at the same time in accordance with the Arrangement of the Supreme People's Court on Mutual Enforcement of Arbitral Awards between the Mainland and the Hong Kong Special Administrative Region and its supplementary arrangements, so as to anchor valuable assets in China in a timely manner.
The basic procedures for applying for recognition and enforcement of Hong Kong arbitral awards in the Mainland can be summarised as follows:
Application method: The investor directly applies to the people's court with jurisdiction in the Mainland based on the effective award.
Competent court: the Intermediate People's Court where the respondent is domiciled or where the property is located.
Enforcement review: After reviewing that there are no statutory non-enforcement circumstances (i.e. the incapacity of the parties, the invalidity of the arbitration agreement under the applicable law, defects in the arbitration procedure, over-award, etc.)[2], the enforcing court will issue a Civil Award recognizing and enforcing the Hong Kong arbitral award, and initiate enforcement proceedings upon the application of the parties.
Time limit for applying for enforcement of arbitration: The relevant time limit provisions of the law of the place of enforcement shall be followed. In the Mainland, the application period is two years. [3]
Avoid duplicate compensation: In response to the court's request, the courts of the two places should provide each other with the information on the enforcement of their own awards according to the requirements of the other court, so as to ensure that the total amount of property enforced by the courts of the two places does not exceed the amount determined by the award.
At this stage, considering that it takes a certain period of time for the people's court to make a recognition and enforcement ruling, and that the enforcement may involve a series of procedures such as service by domestic/foreign entities and jurisdictional objections, the time period for the enforcement of the award is highly uncertain. In this regard, investors need to connect all links to shorten the process as much as possible, and at the same time take preservation measures in advance in the arbitration proceedings.
It is also worth mentioning that if an investor obtains an effective judgment from another foreign arbitration institution or court, the legal basis for applying for enforcement in China and the difficulty of landing it will be different. For example: (1) when an investor obtains a judgment from a Hong Kong court, it may apply to the courts of the two places for enforcement at the same time in accordance with the Arrangement of the Supreme People's Court on the Reciprocal Recognition and Enforcement of Judgments in Civil and Commercial Cases by the Courts of the Mainland and the Hong Kong Special Administrative Region, which came into effect on 29 January 2024. The above-mentioned judicial interpretations are detailed and comprehensive, and are expected to provide great convenience for investors to anchor assets in the Mainland and enforce Hong Kong judgments. (2) When an investor obtains an effective award from a foreign arbitration institution, it is required to apply for recognition and enforcement in China in accordance with the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the "New York Convention"). In view of the good adherence of Chinese courts to the New York Convention, the path for arbitral awards made in the contracting parties to the Convention to be enforced in China is relatively smooth. (3) As for the judgment rendered by a foreign court, it is necessary to apply for recognition and enforcement in China in accordance with the bilateral judicial assistance treaty and the principle of reciprocity. From a practical point of view, there is no clear adjudication guideline on whether a judgment rendered by an offshore court in Cayman and other offshore places can be recognized and enforced in China in accordance with the principle of reciprocity, which poses a challenge to the smooth exercise of investors' rights.
Q5
Can investors sue for disputes under the Cayman structure in China at the same time?
In the context of the emergence of contradictions, investors may have a number of disputes with multiple domestic and foreign entities. At this time, the investor can "multi-pronged" and start the procedure in multiple jurisdictions simultaneously according to different reasons and different grounds. For example, if an investor claims the counterparty to perform its contractual obligations in an extraterritorial proceeding, it will not affect its claim to exercise its shareholder rights in the Mainland courts. A number of legal actions are carried out in parallel and mutually reinforcing, which can help investors gain a more favorable position in the negotiations.
Even for the same dispute, investors can also consider the "parallel litigation" model to seek to continuously expand their dominant position. In this case: (1) if the parties have agreed on an arbitration clause, it is more difficult for the investor to file a separate lawsuit with the mainland court while seeking relief through the arbitration procedure for the dispute within the scope of the arbitration clause. (2) If the parties have not agreed on a jurisdiction clause or a non-exclusive jurisdiction clause, they may take a "dual-track" legal action in a timely manner according to the specific circumstances of the case. Article 280 of the newly amended Civil Procedure Law (amended in 2023) provides that for the same dispute between parties, if one party files a lawsuit in a foreign court and the other party files a lawsuit in a court in Chinese mainland, or if one party files a lawsuit in both a foreign court and a Chinese court, the Chinese court may accept it. [4] In view of this, even if the investor determines that the main battlefield is a foreign court, it may consider filing a parallel lawsuit in China in a timely manner to seek the preservation of domestic assets. Even if the proceedings are suspended in accordance with the law after the acceptance of a lawsuit in Chinese mainland, in principle, the preservation measures that have been taken will not be affected.
Q6
What other auxiliary measures can investors take to ensure the enforcement of arbitral awards in Hong Kong?
1. Before or during the arbitration, apply for preservation measures in China in a timely manner to lock in core assets in advance
If the parties to the dispute agree to arbitrate in Hong Kong, the investor may apply to the Mainland court for interim measures in accordance with the Arrangement of the Supreme People's Court on Mutual Assistance in Interim Measures in Aid of Arbitral Proceedings by the Courts of the Mainland and of the Hong Kong Special Administrative Region. Accordingly, the investor may apply to the Intermediate People's Court of the Mainland where the respondent is domiciled or where the property is located ("pre-arbitration preservation") before the arbitration application is accepted, or the arbitration institution may forward the application for interim measures to the Mainland court after the arbitration is accepted ("interim preservation") to prevent and control the misconduct of the other party.
The above-mentioned judicial documents provide detailed provisions on the scope of preservation, preservation procedures, preservation courts, preservation fees, etc., and provide practical rules for the parties to follow, which investors can directly follow. It can be appropriately emphasized that, first, the scope of the investor's application for "preservation" includes property preservation, evidence preservation, and conduct preservation. In the context of the outbreak of conflicts, if there is a dispute between the investor and the founder team at multiple levels of contract and corporate governance, the investor can plan to take multiple preservation measures in conjunction with the arbitration request.
Second, when choosing the time point for preservation, the situation of preservation in arbitration is more common in practice, that is, the investor usually applies for preservation and requests the issuance of a letter of transfer at the same time as the application for arbitration. In this case, in order to save the "time difference" between the procedures, the applicant may try to communicate with the preservation court and submit the application for preservation together with the transmission letter from the arbitration institution to the court on its own, and the court will directly verify the situation with the arbitration institution or office. However, it should be noted that the above-mentioned practice of "self-submission" has only been recognized by some courts in practice[5], and has not formed a judicial consensus.
If the investor intends to apply for interim measures before arbitration, it may face considerable obstacles. In short, the people's courts have always been cautious about pre-arbitration or pre-litigation preservation requirements, given that "the situation is urgent, and failure to apply for preservation immediately will cause irreparable damage to their legitimate rights and interests". Taking into account the increased difficulty of review due to the "cross-border" factor, the people's courts will be more cautious and strictly control the adjudication scale of consent to preservation. In this case, the investor should be prepared for both, i.e., prepare a full set of arbitration documents and an application for interim measures during arbitration at the same time as applying for an application for pre-arbitration preservation; If the pre-arbitration preservation application is not smoothly advanced, the investor should quickly transition to the interim preservation application to ensure that the entire preservation process is seamless and the asset control can be achieved as soon as possible.
2. At the stage of applying for recognition of effective awards, an application for interim measures can also be made at the same time
Similarly, for Hong Kong arbitrations, the time period for arbitration hearings and the issuance of recognition and enforcement awards by Mainland courts is uncertain. During this period, the preservation measures before the award is rendered may expire due to the expiration of the time limit at the stage of applying for recognition, or the right holder may only discover new property clues at the stage of applying for recognition, and there is an urgent need to seal or freeze assets. Therefore, at this stage, investors can also apply for interim measures under the Supplemental Arrangement Concerning Mutual Enforcement of Arbitral Awards between the Mainland and the Hong Kong Special Administrative Region.
The above-mentioned measures are conducive to the full coverage of the preservation measures in the arbitration hearing, the application for recognition stage, and the award enforcement stage, so as to avoid the gap period for the protection of the preserved assets.
3. Formulate a thorough strategy for the prevention and control of the other party's legal actions, and strive for the smooth progress of arbitration and enforcement procedures
As mentioned above, investors may adopt a "parallel litigation" strategy under certain circumstances to protect their legitimate rights and interests. At the same time, however, the opposing party may also use the "parallel litigation" rule to open up a new battlefield and thus obtain a favorable situation for it.
In the event of a Hong Kong arbitration clause, the other party to the dispute may directly claim the invalidity of the arbitration agreement and file a lawsuit with the Mainland court, which will lead to the investor being in a passive position. For example, in the (2013) Min Si Zhong Zi No. 3 case, HG filed an arbitration with a Hong Kong arbitration institution while filing a lawsuit with a mainland court. In view of the fact that HG did not raise an objection and respond to the litigation in the Mainland, the Mainland court exercised jurisdiction in accordance with the "Respondent Jurisdiction Rules", and the Mainland litigation and Hong Kong arbitration were carried out in parallel. If the aforesaid or similar circumstances occur, it is likely that there will be a conflict between the adjudication of the Mainland and Hong Kong, which will lead to the failure of the investor's legal action. In order to avoid the occurrence of such adverse situations, it is necessary for investors to fully study and judge the possible legal actions taken by the counterparty before initiating legal procedures, strive to take precautions before the counterparty takes action, pay attention to the conflicts and connections of different legal procedures when the counterparty actually acts, and respond prudently.
epilogue
Under the Cayman structure, how to use judicial means to enforce onshore assets is often one of the most concerned issues for investors in the common situation where they encounter exit difficulties. This article attempts to explore this issue to some extent. On the whole, in the early stage of the transaction, investors should take precautions and build a solid line of defense for their rights based on the negotiating position of both parties and their own core demands. After a dispute arises, investors should make overall plans and overall considerations, actively seize the initiative in the negotiation and litigation procedures, and consolidate and expand their dominant position. Through a series of smooth and complementary legal actions, investors can effectively protect their legitimate rights and interests.
In the current volatility and uncertainty of the global economy, the challenges faced by companies and their shareholders are becoming increasingly complex, and in the following series of articles, we will continue to explore and analyze the deep-seated issues in the field of post-investment exits.
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Footnote:
[1] Any reference to "Hong Kong" or "Hong Kong Special Administrative Region" shall be construed as "Hong Kong Special Administrative Region of the People's Republic of China".
[2] According to Article 7 of the Arrangement of the Supreme People's Court on Mutual Enforcement of Arbitral Awards between the Mainland and the Hong Kong Special Administrative Region, the circumstances under which a Hong Kong arbitral award may not be enforced include: (1) the parties to the arbitration agreement are incapacitated under the law applicable to them; or the arbitration agreement is invalid in accordance with the applicable law agreed; or if the law prevails without specifying, the arbitration award shall be invalid under the law of the place where the arbitral award is made; (2) the respondent has not received proper notice of the appointment of an arbitrator, or is unable to present its views for any reason; (3) the dispute dealt with by the award is not the subject of the arbitration or is not covered by the terms of the arbitration agreement, or the award contains a decision on matters outside the scope of the arbitration; However, if the decision on the transfer of the matter for arbitration can be divided from the matter not submitted for arbitration, the part of the decision on the matter transferred for arbitration in the award shall be enforced; (4) the constitution of the arbitral tribunal or the proceedings of the arbitral tribunal are inconsistent with the agreement between the parties or, in the absence of such agreement, with the law of the place of arbitration; (5) the award is not binding on the parties, or has been revoked or suspended by the court of the place of arbitration or in accordance with the law of the place of arbitration; (6) The relevant court determines that the dispute cannot be resolved by arbitration according to the law of the place of enforcement; (7) The Mainland court finds that the enforcement of the arbitral award in the Mainland is contrary to the public interest of the Mainland, or the decision of the HKSAR court to enforce the arbitral award in the HKSAR is contrary to the public policy of the HKSAR.
[3] Article 250 of the Civil Procedure Law (2023 Amendment) stipulates that "the period for applying for enforcement shall be two years. Where an application is made for the suspension or interruption of the statute of limitations, the provisions on the suspension or interruption of the statute of limitations shall be applied in accordance with the law. The period provided for in the preceding paragraph is calculated from the last day of the period for performance provided for in the legal document; Where legal documents provide for performance in installments, it is calculated from the date on which the last period for performance expires; Where the legal document does not provide for a period of performance, it is calculated from the date on which the legal document takes effect. ”
[4] <中华人民共和国民事诉讼法>Article 549 of the Interpretation of the Supreme People's Court on Application (2022 Amendment) stipulates that: "The people's courts may refer to the special provisions on foreign-related civil procedures when hearing civil litigation cases involving Hong Kong, the Macao Special Administrative Regions and the Taiwan Region." ”
[5] See Shanghai Financial Court, "Review of Property Preservation by Parties in Hong Kong Arbitration Proceedings to Mainland Courts - Application for Property Preservation in Mainland China in Hong Kong Arbitration Proceedings between UBS Group Singapore Branch and Shanghai Guochu Energy Group Co., Ltd."
Author of this article
Hu Jing
copartner
Finance & Securities Department
Practice areas: overseas listing, red-chip restructuring, private equity financing, mergers and acquisitions
Ms. Hu Jing has 15 years of experience in the field of overseas listing, private equity financing, mergers and acquisitions, and has handled a large number of cross-border service projects that combine domestic and foreign laws in China, and has provided comprehensive and integrated legal services for many well-known domestic and foreign investment institutions, listed companies and unicorn enterprises for a long time. In the field of red-chip restructuring and overseas listing, Ms. Hu has assisted a number of domestic enterprises in the construction and restructuring of domestic and foreign red-chip structures, and has assisted in dozens of overseas listing or additional issuance projects as an issuer lawyer or securities firm lawyer.
Yang Ting
copartner
Dispute Resolution Department
Practice Areas: Corporate Litigation, Securities Litigation and Other Civil and Commercial Dispute Resolution
In the field of corporate disputes, Ms. Yang Ting has handled hundreds of complex and difficult cases, such as control disputes, mergers and acquisitions disputes, and performance VAM disputes. In the field of securities disputes, Mr. Yang has successfully handled a large number of securities compliance and securities litigation cases on behalf of listed companies and securities companies, and can provide clients with a full range of legal services such as securities compliance crisis management, administrative penalty hearings or administrative reconsideration procedures, and securities litigation response.
Liu Ying
Dispute Resolution Department
Chen Yichen
Finance & Securities Department
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