The Enforceability of Anti-Dilution Provisions in Private Placement Transactions in China

AuthorLiang Tao
Pages46-63
LIANG (DO NOT DELETE) 2014-1-2912:36 PM
46 TSINGHUA CHINA LAW REVIEW [Vol. 6:45
THE ENFORCEABILITY OF ANTI-DILUTION PROVISIONS IN
PRIVATE PLACEMENT TRANSACTIONS IN CHINA
LIANG Tao
I. INTRODUCTION
Anti-dilution provisions are complex.1 In the Western legal
context, “anti-dilution provisions are designed to protect holders of
convertible securities 2against dilution from a large variety of
corporate events, including, among others, stock dividends and splits,
cheap issuance of additional common stock, and distribution of cash
or property.”3 The benefit of anti-dilution adjustments made under
these provisions is that one of the preferential rights may be carried
by preferred shares, which are “an integral part of the package of
privileges investors demand and founder shareholders offer.” 4
Therefore, the execution and enforcement of anti-dilution provisions
rely theoretically on a corporate legal regime that is capable of
accommodating the issuance of preferred shares.
To date, no Chinese5 legislative document, judicial interpretation
or court ruling6 has provided explicit guidance on how a company
could issue multiple classes of shares, including preferred shares, to
different groups of shareholders. 7 The concept of anti-dilution
1 See, e.g., Stanley A. Kaplan, Piercing the Corporate Boilerplate: Anti-Dilution Clauses in
Convertible Securities, 33 U. CHI. L. REV. 1, 3 (1965); Michael A. Woronoff & Jonathan A. Rosen,
Understanding Anti-dilution Provisions in Convertible Securities, 74 FORDHAM L. REV. 129, 12930
(2005).
2 Convertible Securities, US SECURITIES AND EXCHANGE COMMISSION, http://www.sec.gov
/answers/convertibles.htm (last visited Jan. 30, 2013) (defining a “convertible security” as a security,
usually a bond or a preferred stock, that can be converted into a different security, typically shares of
the company’s common stock).
3 Woronoff & Rosen, supra note 1, at 129.
4 Shen Wei, Face Off: Is China a Preferred Regime for International Private Equity Investments?
Decoding a “China Myth” from the Chinese Company Law Perspective, 26 CONN. J. INTL L. 89, 96
(2010–2011) (“Preferred shares carry preferential rights that are an integral part of the package of
privileges investors demand and founder shareholders offer.”).
5 For the purpose of this article, Chinese and China refer to the People’s Republic of China,
excluding Hong Kong, Macau and Taiwan.
6 Judicial precedents are not enforceable in China. The Supreme People’s Court, however, has the
authority to issue judicial interpretations as guidelines to trials, which are nationally enforceable. Legal
Research Guide: China, UNITED STATES LIBRARY OF CONGRESS, http://www.loc.gov/law/help
/china.php (last visited Jan. 30, 2013).
7 See, e.g., Shen, supra note 4, at 98 (“Although the basic legal interpretation doctrine does not
preclude the possibility of adopting a multiple-class share structure in a limited liability company, n o
Chinese legislation has actually provided explicit guidance over how a company may issue multiple
classes of shares to different groups of shareholders.”).
LIANG (DO NOT DELETE) 2014-1-2912:36 PM
2013] ANTI-DILUTION 47
provisions, common in the Western legal context, thus remains
unfamiliar and largely without a secure legal foundation in Chinese
law.8
However, anti-dilution provisions have been negotiated and
adopted by founder shareholders and investors in many private
placement9 transactions in China. This is especially frequent when
the investor is a foreigner who is familiar with anti-dilution
provisions.10 Yet the lack of a secure legal foundation for these
provisions casts considerable doubt on their enforceability.11
This article is divided into four parts. Part I describes typical
anti-dilution provisions in the Western private placement context.
Part II examines the most popular anti-dilution provisions used in
China and considers several high-profile deals. Part III analyzes the
validity and enforceability of anti-dilution provisions under PRC
law. Part IV concludes by proposing several courses of action to
minimize the uncertainty of enforcing anti-dilution provisions in
China.
II. TYPICAL ANTI-DILUTION PROVISIONS IN THE WESTERN CONTEXT
As Michael Woronoff and Jonathan Rosen note, “[t]o understand
different types of anti-dilution provisions, it is important to examine
the nature of the dilution against which each provision is designed to
protect.”12 There are two types of dilution. Percentage dilution refers
to a decrease in the percentage of the entity an investor owns.
Economic dilution refers to a decrease in the economic value of the
investor’s investment in the entity.13 Typically, a simple percentage
8 See Chunsheng (Tony) Lu & Gary P. Biehn, Private Equity in China: Enforceability of
Drag-Along Rights, WHITE AND WILLIAMS LLP (Jul. 17, 2009), http://www.whiteandwilliams.com/
resources-alerts-86.html (“Traditional concepts common in a Western private equity cont extsuch as
preferred shares, convertible shares, anti-dilution, drag-along and tag-along rightsare still unfamiliar
under current Chinese law.”).
9 For the purpose of th is article, private placement refers to non-public offerings or sales of shares
in a closed company incorporated in China. Anti-dilution provisions used in private placements of
companies outside China governed by foreign laws are not discussed in this article.
10 In many high-profile private placement transactions in China, anti-dilution provisions have been
adopted, such as the BOCOM-HSBC Deal and DGME-CBF Deal. For more detailed discussion of this
topic, see infra Part II.
11 See, e.g., Lu & Biehn, supra note 8 (“Under many private equity investment contracts, these
concepts have been widely negotiated and adopted, but whether such concepts will be enforced under
Chinese law remains uncertain.”).
12 Woronoff & Rosen, supra note 1, at 134.
13 Id.

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