In recent years, continual development of the market economy has led to a surge in shareholder disputes, significantly impacting company growth. Consequently, it is crucial for legal counsel to effectively manage these disputes. Key considerations and strategies for legal counsel include clarifying the basis of claims and maximising protection of your company’s legal rights by means of counterclaims and separate litigation.
Senior Partner,
Director of Bankruptcy
Management Business Centre
Joint-Win Partners
Tel: +86 185 2151 9053
E-mail:
wangyongjie@joint-win.com
The author once handled an equity dispute arising from a former shareholder’s claim for equity transfer payments. In addition to defending against the original claim, the author, representing the current shareholder, filed a counterclaim for a breach of the non-compete clause to seek liquidated damages.
Eventually the court ruled that the current shareholder should pay more than RMB4 million (USD560,000) for the equity transfer, while the former shareholder was ordered to pay liquidated damages of more than RMB4 million. At the same time, the author initiated a separate lawsuit to take preservative measures against the former shareholder’s claim for the equity transfer payment, so that the former shareholder ended up owing the current shareholder more than RMB2 million.
This article analyses the case in detail.
The background
On 11 March 2022, company X and Z, a natural person, signed an equity transfer agreement. Under this agreement, company X agreed to acquire Z’s equity in a target company, with the transfer payment to be made in instalments.
It was agreed that the business registration alteration was to be completed by company X after the first instalment was paid. However, prior to the payment of the second instalment, a dispute arose between the two parties. Z filed a lawsuit, demanding company X pay the second instalment of more than RMB4 million and compensate Z for associated economic losses.
The strategies
In response to Z’s claim, the author proposed dual solutions based on the equity transfer agreement: on the one hand, defend against the original claim by arguing that the transaction prerequisites were not met; on the other hand, file a counterclaim for breach of contract to challenge the original claim.
Raising a defence
It was not until taking over the target company’s operations that company X discovered the former shareholder was liable for certain compensations during their tenure. As both parties had agreed on preconditions for the transaction, this new information could be used to argue that company X should not be required to pay the due share transfer instalment.
Filing a counterclaim
Based on the non-compete clause and liability for breach of contract set out in the agreement, in addition to claiming Z had violated the non-compete clause, the author filed a counterclaim against Z for breach of contract and sought liquidated damages.
In equity transactions, a non-compete clause is commonly exerted against the transferor to protect the interests of the transferee and the target company. Appropriate application of this clause could strengthen the current shareholder’s legal position in litigation and safeguard its rights and interests.
In this case, the key issue was how to prove the former shareholder’s breach of the non-compete obligation. This involved dissecting the details of the non-compete clause and similar cases, analysing key elements and outlining relevant evidence to demonstrate Z’s violation to the court.
The agreement stipulated that neither the equity transferor nor any of its affiliates should ever – in its own name, independently or jointly – establish any new entity that either operated the same or similar business as the target company or had business relations with the target company. In default, the violating party would be held liable for corresponding liquidated damages.
This clause consisted of three elements, namely: the subject (the equity transferor and its affiliates); the action (independently or jointly establishing under their own or another’s name); and the object (entities operating the same or similar business as the target company or having business relations with it).
Once these elements were clearly defined, gathering and presenting evidence became crucial. In this case, Z’s kinship, titles, business scope and other revealed corporate information were examined.
With the focus on Z, its relatives and business partners, the author identified companies where these individuals served as shareholders or senior executives. We specified each company’s business scope and their overlaps. A mind map was produced and presented to the court to demonstrate that Z had violated the non-compete clause.
Eventually, the court ruled the current shareholder should pay more than RMB4 million for the current equity transfer, and ordered the former shareholder to pay more than RMB4 million in liquidated damages for breaching the non-compete clause.
Consolidating
Considering Z’s debt payable under another contract, the author filed a separate claim to recover the debt from Z based on the original claim’s progress. Through this separate claim, a litigation preservation order was obtained to freeze the equity transfer payment owed to Z by X, which prevented the transferor from receiving the equity transfer payment and urged Z to pay the liquidated damages to X at its own expense. Ultimately, Z ended up owing the current shareholder more than RMB2 million.
Conclusion
Equity is a fundamental element of a company. A common challenge confronting lawyers and in-house counsel in equity disputes is to adopt diverse legal tools to protect shareholders’ legitimate rights.
Reflecting on this case, the author recommends that lawyers and in-house counsel acquire a broad understanding of business management and commercial logic. This will enable them to identify an opponent’s weaknesses and hit the mark during litigation.
It also helps achieve positive interaction between individual cases by analysing issues from a holistic perspective, effectively managing legal risks and contributing to the advancement of corporate systems. Ultimately, this creates value for the company.
Wang Yongjie is a senior partner and the director of bankruptcy management business centre at Joint-Win Partners. He can be contacted by phone at +86 185 2151 9053 and by email at wangyongjie@joint-win.com
