Researches On Legal Validity Of Valuation Adjustment Mechanism

In the context of the rapid development of the capital markets, valuation adjustment mechanism( VAM) as a regulator for the interests of both the investors and financing parties emerged and has been widely used in practice field. Chinese legislation does not expressly prohibit valuation adjustment mechanism. Judicial institutions have differences on the effect of VAM. VAM also were excluded by securities regulators because of a violation of clarity and stability of equity capital. Therefore, if the court still have no generalized standard for identifying the effect of VAM, or deny it without any estimate, VAM will result in underground operation. At the same time, financing parties will be exposed to a greater legal risk as a result of inaccurate disclosure, hence the interests of ordinary investors will also suffer damage.In the beginning, this paper researches the legislative, judiciary and other institutions’ attitudes towards the effect of VAM. Firstly, because the legislature did not expressly provided, VAM, as a kind of nameless contract with commercial character, not only to comply with the provisions of contract law, but also to comply with the mandatory provisions in commercial law. Secondly, studying the first case in China and the cases of other two districts, this paper concluded the reasons for the court’s determination of valid and invalid VAM. Negative reasons are :VAM does not comply with the provisions of Article 8 of The Law of People’s Republic of China on Chinese-Foreign Equity Joint Ventures ";or does not meet the subparagraph 1 of Article 20, of Company Law of the People’s Republic of China ";or constitutes loan relationship in fact. Positive reasons are: VAM between the shareholders does not violate the law; VAM is valid because the shareholders’ or the Board’s confirm; or because VAM is in according with the legal principles, such as encourage trade, respect autonomy, protect public interest, and protect trade fair. Thirdly, the attitude of other institutions mainly refers to attitudes of capital market supervisions. SFC prohibits VAM in companies to be listed, but permits VAM in share reform, private placement and reorganization, and also allows incentive arrangements, which is not involved in IPO. Yet NEEQ has begun to allow VAM in listed companies.Value adjustment is necessary for finding generalized standard for identifying the effect of VAM. This work should be based on the principle of fair value, taking into account the commercial character of VAM, and paying attention to the compatibility criteria identified with the relevant provisions of contract law.VAM is divided into equity VAM(which is split into 3 types: equity-transfer, stock dilution and preferred stock), monetary compensation VAM, management incentive VAM. Whether equity-transfer VAM is valid depends on: equity in terms of locking, the provisions of Article 8 of The Law of People’s Republic of China on Chinese-Foreign Equity Joint Ventures ", the compatibility with the special law and share price. Whether stock dilution VAM is valid or invalid lies on: the program for increasing capital, the legitimacy of stock price, the legitimacy of related transaction and compatibility with the special law. The legal effect of preferred stock VAM rely on: is the VAM contrary to the principle of “the same stock with the right”; whether priority in the allocation of dividends legal compliance; compliance with the relevant provisions of bankruptcy laws and the voting rules of shareholders’ meeting and the board. Monetary compensation VAM is usually effective, unless unfair compensation, or the compensation violates the company’s internal decision-making process of major investment matters. The legal effect of management incentive VAM is rests with: the relevant provisions of the equity-transfer-VAM, and the conflicts between incentive and corporate governance rules.Based on the microscopic conclusions above, this paper re-reviews SFC’s attitudes towards the standard for identifying the effect of VAM. The paper points out unless its different treatment for different type of VAM, SFC’s standard is illogical. It also held that the decision of the Supreme Judicial Court is simple but blur, which caused a misunderstanding of legal workers.In conclusion, Courts should not only base their adjustment on the Article 52, Article 54 of "Contract Law" while identifying the legal effect of VAM, but also consider 4 factors: type of company; the articles of association of company and other internal procedural rules; the price of VAM; and finally, third party interests.A central argument of this paper is VAM should not be denied without exclusion by the judicial practice and securities markets. The starting point of the paper is legal basis of VAM. Based on typed research, analysis of practice in the judiciary and stock disclosure cases, combining corporate law, securities law, contract law, the paper abstracted the basic standards for recognizing legal validity of VAM and guided legislation and practice. The innovation of this paper is: on the one hand, domestic researches on VAM are superficial, mostly are introductory and practical. Therefore, the empirical study through jurisprudence case and disclosure of securities is one of this innovation. On the other hand, there is no domestic standards for the unity of the problem identified in judiciary, the executive and other institutions. The paper finds that an agreement on a unified standard of VAM.