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Investment and financing are common in daily business operations. However, achieving perfect commercial objectives and ensuring smooth execution remain complex systemic challenges for investors, financiers, transferors and transferees. This article explores legal risk management in investment and financing through two illustrative case studies.

Case 1

Company A, a state-owned enterprise, entered into an equity transfer and capital increase agreement with company B, under which A acquired part of B¡¯s shares in company C and injected additional capital into C, ultimately securing A¡¯s controlling stake in C.

Following the completion of the equity transfer and investment, the process moved to phased payments. Company A requested an audit of company C in compliance with state-owned asset management regulations.

The audit uncovered a non-operational asset in C that should be divested. The asset, a property developed under C¡¯s name by B to secure a project, was later provided free of charge to local government authorities to address their office space shortage.

Actually, B had fully disclosed the above details during the legal and financial due diligence. As A was then aiming to expedite the investment process, it raised no objections and did not request the asset¡¯s exclusion or divestment. Subsequently, citing C¡¯s status as a state-controlled enterprise following the capital increase, A demanded compliance with state-owned-asset regulations and suspended further equity transfer payments, which significantly impacted B¡¯s financial planning. However, after careful consideration, B decided not to pursue legal action for A¡¯s breach of contract.

From the perspective of early-stage investment and acquisitions, the contract did not stipulate the divestment of non-operational assets, making A¡¯s payment refusal potentially a breach of contract. However, from the standpoint of state-owned-enterprise operations, auditing and divesting non-operational assets in compliance with regulations seems well justified. This situation presents a dilemma for both parties.

Case 2

M, a high-tech company specialised in cancer drug development, registered its domicile in D district of B city during its series A funding to leverage local policy incentives and support government investment initiatives. During its series B funding, a new investor required M to relocate its registration to B city¡¯s high-tech zone as a precondition for investment.

Throughout the series B process, M regularly updated its board and shareholders on the matter, with existing shareholders engaging in multiple discussions on the financing terms. However, no formal resolution was reached. To expedite the funding, M decided to proceed with relocating its registration to the high-tech zone.

Complications arose when the new investor, a state-owned enterprise, faced delays due to adjustments in its internal approval process for external investments, significantly slowing the series B review. With funds delayed, M faced severe operational challenges.

Meanwhile, some existing shareholders criticised the relocation, alleging it violated prior agreements, and demanded that M bear the resulting losses and address the negative impact. This left M and its controlling stakeholders in a predicament.

Uniqueness

Legal risks in investment and financing are dynamic and continually evolving, extending beyond the mere signing of contracts. Managing these risks requires an ongoing strategic approach, demanding vigilance and foresight from all parties involved. Stakeholders must closely monitor contract performance, particularly for agreements with execution periods spanning several months or longer.

Changes in the external environment often trigger unexpected disputes, posing challenges to risk management. The key to effective risk tracking lies in sensitivity and adaptability to external shifts.

At the outset, all parties may seem aligned in their interests. However, as the contract progresses, the priorities of the company, shareholders and other stakeholders tend to diverge, weakening the balance of interests.

Way out

Establish prompt communication. When disputes arise, avoiding the issue can escalate tensions and complicate matters further. Parties should engage proactively and seek resolution through negotiation.

Keep thorough records. In case 2, even if M fails to reach a meeting resolution, it is essential to maintain meticulous documentation. Every step should be carefully logged, from meeting notices and agenda planning to records of proceedings. The practice of documenting actions and reasons can provide crucial evidence for future internal clarifications or legal disputes.

Exercise caution in signing. Signing legal documents is not a mere formality but a critical process requiring thorough scrutiny and professional judgement. Every detail, from content to style, must be carefully reviewed, with a particular focus on commercial terms and key clauses.

A signature activates legal enforceability, and any oversight can result in significant risks. For parties in a weaker position, it is advisable to implement risk mitigation mechanisms and prepare dispute resolution strategies.

Wang Feng is a senior partner at DOCVIT Law Firm