Where a subscriber’s default prevents a listed company / NEEQ-listed company from obtaining regulatory approval for a non-public offering, can the issuer claim breach of contract under a Conditional Share Subscription Agreement that has not yet taken effect? — A case study of a private placement dispute of an A-share listed company
I. Introduction
Article 158 of the Civil Code of the PRC provides that civil juristic acts may be subject to conditions. A civil juristic act subject to a condition precedent takes effect when the condition is satisfied.
Article 46 of the Measures for the Administration of Securities Issuance by Listed Companies provides that a listed company shall obtain the approval of the CSRC before issuing securities.
Article 11 of the Implementing Rules for Non-Public Issuance of Shares by Listed Companies provides that, where the issuance targets of a non-public offering have been determined, the listed company shall enter into a share subscription contract subject to conditions precedent with the targets, and it shall be agreed therein that the contract takes effect upon the approval of the issuance by the board of directors and the shareholders’ meeting of the listed company and the approval of the CSRC.
Article 27 of the Rules of the National Equities Exchange and Quotations (NEEQ) for Directional Issuance of Shares provides that, where the issuance targets are determined at the time of the board resolution, it shall be agreed in the subscription contract that the contract takes effect after the directional issuance is approved by the issuer’s board of directors and shareholders’ meeting and relevant approval procedures are completed.
Article 3 of the NEEQ Rules for Directional Issuance of Shares provides that, where the number of shareholders of the issuer after the directional issuance does not exceed 200 in aggregate, the issuance shall be subject to self-regulatory review by the NEEQ Company; where the aggregate exceeds 200, the issuer shall report to the CSRC for approval after the NEEQ Company issues its self-regulatory review opinion.
Under the above series of regulations, both a listed company conducting a non-public offering and a NEEQ-listed company conducting a directional issuance (which is also a form of non-public offering) are required to enter into a Conditional Share Subscription Agreement (the “Conditional Subscription Agreement”) with the issuance targets. Apart from completing internal decision-making procedures, with respect to external approval procedures, a listed company’s non-public offering must obtain CSRC approval, and a NEEQ-listed company’s directional issuance must pass the NEEQ’s self-regulatory review, or in special circumstances obtain CSRC approval (additional approval requirements may apply in other special situations, such as those involving state-owned capital or foreign investment). If CSRC approval is not obtained or the NEEQ’s self-regulatory review is not passed, the Conditional Subscription Agreement does not take effect.
The question then arises: where the failure to obtain CSRC approval or pass the NEEQ’s self-regulatory review is caused by the subscriber’s default, so that the Conditional Subscription Agreement never takes effect, can the issuer still hold the subscriber liable for breach of contract based on the “not-yet-effective” Conditional Subscription Agreement?
This exact scenario arose in a private placement dispute of a domestic A-share listed company that the author recently handled. In the end, a Beijing arbitration commission upheld the author’s position and ruled that the subscriber bore liability for breach of contract by compensating the issuer for its actual losses.
II. Case Overview
To raise funds, a listed company planned a non-public offering and entered into a Conditional Subscription Agreement with the subscriber (who was also the company’s largest shareholder).
After signing the Conditional Subscription Agreement, the issuer engaged securities firms, accounting firms, law firms and other intermediaries, prepared the Offering Proposal and other application materials, and submitted them to the CSRC for review. The offering subsequently passed the review of the CSRC’s Issuance Examination Committee (IEC). However, before CSRC approval was obtained, the subscriber’s financial condition deteriorated severely: it was sued by a large number of creditors in high-value lawsuits, and all of its shares in the listed company were frozen and sequentially re-frozen. The subscriber then expressly declared default to the listed company, clearly refusing to pay the share subscription consideration of RMB X hundred million.
The subscriber was the principal issuance target of this offering (accounting for more than 50% of the subscription amount). Moreover, as the largest shareholder, it faced numerous lawsuits and the complete freeze of its shareholding. After overall consideration, the issuer applied to the CSRC to withdraw the non-public offering application materials, and the offering ultimately failed.
Thereafter, the issuer claimed interest, intermediary fees and other losses from the subscriber. After being refused, the issuer initiated arbitration before a Beijing arbitration commission pursuant to the arbitration clause in the Conditional Subscription Agreement. In the end, the commission ruled that the issuer held a claim for breach-of-contract damages of RMB X ten million against the subscriber.
III. Disputed Issues, the Subscriber’s Defenses and the Issuer’s Rebuttals
The disputed issues in this case — and the difficulties in asserting the issuer’s rights — were: (1) Where the condition precedent of “obtaining CSRC approval” under the Conditional Subscription Agreement had not been satisfied, was the issuer entitled to claim breach of contract against the subscriber under the Agreement? (2) What was the form, composition and amount of liability for breach of contract? (3) Had the subscriber’s liability for breach of contract been waived?
Around these three disputed issues, the subscriber raised its defenses, and the author, on behalf of the issuer, put forward targeted rebuttals. The parties’ positions are summarized as follows:
(1) Where the condition precedent of “obtaining CSRC approval” had not been satisfied, was the issuer entitled to claim breach of contract against the subscriber under the Conditional Subscription Agreement?
1. The subscriber’s defense
The Conditional Subscription Agreement only took effect upon obtaining CSRC approval. Since CSRC approval was not obtained in this offering, the Agreement did not take effect due to the unsatisfied condition precedent. The subscriber therefore bore no subscription obligation and, naturally, no liability for breach of contract.
At the time of signing the Conditional Subscription Agreement, the subscriber made no false representations, warranties or undertakings. The freeze of shares occurred more than one year after the signing of the Agreement, and the Agreement did not provide that the subscriber should bear responsibility for changes in its future business condition. In addition, the subscriber had timely informed the issuer after the lawsuits arose, with no concealment whatsoever.
2. The issuer’s rebuttal
In response to the above defenses, the issuer raised the following rebuttals:
(1) The provisions on liability for breach of contract in the Conditional Subscription Agreement had already taken effect
The Conditional Subscription Agreement provided that “except for Chapter III, this Agreement takes effect upon the satisfaction of all of the following conditions…”. Accordingly, the provisions of Chapter III “Representations, Warranties and Undertakings” took effect upon the execution of the Agreement. The Agreement also stipulated the liability for breach of contract where either party breaches the Chapter III “Representations, Warranties and Undertakings” provisions; such clauses naturally took effect simultaneously and were binding on both parties.
(2) The subscriber had breached the Chapter III “Representations, Warranties and Undertakings” of the Conditional Subscription Agreement
The subscriber was embroiled in lawsuits with enormous claimed amounts and had completely lost its capacity to perform. The subscriber therefore breached the Chapter III representation in the Conditional Subscription Agreement regarding having sufficient financial capacity to pay the subscription consideration, and should bear liability for breach of contract in accordance with the Agreement.
Moreover, all of the subscriber’s shares in the listed company were frozen and sequentially re-frozen. Under the provisions of the Memorandum No. 5 on Standards for Share Issuance Review (Newly Revised) — Operating Procedures for Post-Meeting Supervision and Case Sealing of Companies Having Passed the IEC Review and Planning Securities Issuance, the occurrence of the subscriber’s circumstances during the post-meeting case-sealing procedures necessitated re-submission to the IEC for review. Re-submission to the IEC for review meant that the original Offering Proposal had to be correspondingly revised, and a revision plan was tantamount to the failure of this offering.
(2) The form, composition and amount of liability for breach of contract?
1. The subscriber’s defense
First, the issuer voluntarily withdrew its application for the non-public offering rather than being rejected. There was no causal link between the subscriber’s conduct and the failure of the offering.
Second, the issuer had publicly announced that it would continue to advance the non-public offering and had not abandoned it because of the subscriber’s withdrawal. Hence, no causal link was established between the subscriber’s withdrawal and the withdrawal of the offering.
Third, the issuer had not exhausted its remedies, such as seeking a substitute subscriber. It could not be established that the issuer’s withdrawal was causally linked to the failure of the offering.
Finally, the subscriber’s subscription obligation had been waived, and the issuer was not entitled to claim liability for breach of contract.
2. The issuer’s rebuttal
In response to the above defenses, the issuer raised the following rebuttals:
(1) The issuer sustained interest losses
The issuer argued that the Offering Proposal expressly stated that the entire proceeds of the offering would be used to repay bank loans. The subscriber’s failure to perform its payment obligation meant the issuer could not repay its bank borrowings in accordance with the intended use of proceeds set out in the Offering Proposal. Bank loan interest continued to accrue, and the issuer sustained losses.
The issuer’s offering had already passed the CSRC’s IEC review. According to big-data statistics of other private placement projects in the same period, it generally takes about four months from IEC approval to the receipt of raised funds. Had this offering proceeded smoothly, all bank borrowings would have been repaid around December of that year. Since all bank borrowings actually matured before December, the interest commencement date was provisionally set as December of that year, and the termination date was the actual repayment date.
(2) The issuer sustained intermediary fee losses
The issuer argued that the subscriber’s failure to perform its payment obligation prevented the Offering Proposal from passing CSRC approval, and the offering could not proceed. All intermediary fees paid by the issuer for this offering constituted losses, including legal fees, sponsorship fees, audit fees and document preparation costs.
(3) There was a causal link between the subscriber’s default and the issuer’s losses
The issuer argued that, based on the following reasons, there was a causal link between the subscriber’s default and the issuer’s losses:
First, after the subscriber’s lawsuits and share freeze arose, the non-public offering had to be re-submitted to the CSRC’s IEC for review.
Second, even if the issuer continued to advance the offering, the original Offering Proposal would have to be withdrawn and revised; whether other investors would be willing to continue participating in the subscription when the largest shareholder and principal subscription target no longer participated was subject to material uncertainty.
Third, even if the offering could ultimately obtain CSRC approval, given that the subscriber had clearly lost its subscription capacity, it would be impossible for the subscriber to pay the subscription consideration, and the issuer’s losses were bound to occur.
Fourth, if a new offering were to be planned, all issuance procedures would have to be repeated, and the proceeds would be received much later; losses were unavoidable.
Fifth, apart from the subscriber’s loss of performance capacity, no other circumstance caused the issuer to abandon the non-public offering. The subscriber’s default was the sole cause of the failure of the offering and of the issuer’s losses.
Sixth, the subscriber was fully aware of the intended use of proceeds and could foresee the consequences of default at the time of signing.
Finally, what the issuer waived was only the subscriber’s subscription obligation, not its liability for breach of contract.
(3) Had the subscriber’s liability for breach of contract been waived?
1. The subscriber’s defense
Both the issuer’s announcement “Regarding Waiver of ******” and its announcement in response to the CSRC’s inquiry “Regarding the Concern Letter ******” expressly waived the subscriber’s obligation to subscribe for shares in the non-public offering under the Conditional Subscription Agreement. Obligation is the premise and foundation of liability; without an obligation, there is naturally no liability.
The subscriber’s subscription obligation was the primary and only obligation under the Conditional Subscription Agreement. The representations, warranties and undertakings in the Agreement were all established for the purpose of performing the subscription obligation. Where the subscription obligation had not taken effect and had been released, the issuer’s basis for asserting rights was insufficient.
2. The issuer’s rebuttal
First, the so-called “waiver” was a waiver by the issuer of the subscriber’s obligation to continue performing the contract, but not a waiver of liability for breach of contract.
Second, the so-called “waiver” was not an expression of the issuer’s “forgiveness” of the subscriber, but merely the performance of the statutory information disclosure obligation under Article 5, Paragraph 2 of the then-effective Guidelines No. 4 for the Supervision of Listed Companies (CSRC Announcement [2013] No. 55).
Third, after the “waiver”, the issuer had never returned the subscriber’s security deposit and had continuously asserted that the subscriber should bear liability for breach of contract. It is thus evident that the issuer’s true intention was only to waive the obligation of continued performance, not the liability for breach of contract.
IV. The Tribunal’s Findings
(1) Where the condition precedent of “obtaining CSRC approval” had not been satisfied, was the issuer entitled to claim breach of contract under the Conditional Subscription Agreement?
The parties did not agree on any special condition precedent for the effectiveness of Chapter III “Representations, Warranties and Undertakings” of the Conditional Subscription Agreement. Accordingly, Chapter III was lawfully formed and took effect on the date the parties signed and sealed the Agreement.
Given that Chapter III had been formed and had taken effect, the clauses on liability for breach of contract applicable to breaches of Chapter III also took effect from the date of signing and sealing by both parties.
Prior to the CSRC’s approval of this non-public offering, the subscriber’s deteriorating financial condition, high-value lawsuits, share freeze and other circumstances clearly breached the representations and warranties in Chapter III of the Conditional Subscription Agreement.
(2) The form, composition and amount of liability for breach of contract?
1. The causal link between the issuer’s damages and the subscriber’s breach
First, after the IEC review was passed and before CSRC approval, apart from the event of the subscriber’s material deterioration in assets and inability to perform its subscription obligation, there was no evidence of any other adverse event that could have affected this non-public offering.
Second, after the subscriber’s material deterioration in assets and inability to perform its subscription obligation arose, there was no longer any possibility of continuing to advance this non-public offering: 1) the offering would have to be re-submitted for review, but a comprehensive revision of the Offering Proposal created material uncertainty as to whether the remaining investors would continue to participate, and the original Offering Proposal had in effect failed; 2) the offering would not only have brought raised funds to the issuer but would also have triggered a change of the issuer’s de facto controller. Under these circumstances, the capital plan and the corporate organizational structure and decision-making procedures set out in the original Offering Proposal had undergone fundamental changes. The issuer’s choice to withdraw its application at that point in time was reasonable.
In summary, the subscriber breached the representations and warranties in Chapter III of the Conditional Subscription Agreement, and there was a causal link between such breach and the failure of this non-public offering.
2. The scope of damages payable by the subscriber
First, the intermediary fees paid by the issuer for this non-public offering were actual expenditures of the issuer — a decrease in its existing interests — and should be understood as “direct economic losses” sustained by the issuer.
As for the bank loan interest losses: the subscriber’s high-value lawsuits and severe deterioration in assets made it unable to perform its subscription obligation, causing the non-public offering to fail and the issuer to be unable to repay its maturing bank borrowings. The bank loan interest paid by the issuer due to deferred repayment was an actual expenditure — a decrease in its existing interests — and should also be understood as “direct economic losses” sustained by the issuer.
Second, pursuant to Article 119 of the Contract Law, which provides that “where one party to a contract breaches the contract, the other party shall take appropriate measures to prevent the aggravation of losses; if the other party fails to take appropriate measures and thereby aggravates the losses, it may not claim compensation for the aggravated portion”, the tribunal limited the interest period for which the issuer could claim.
Given that a court accepted the reorganization application against the subscriber in month Y of 20**, the interest losses claimable by the issuer could at most accrue until month Y of 20**. The tribunal accordingly exercised its discretion to uphold the bank interest losses.
In summary, the failure of the non-public offering caused the issuer to sustain bank loan interest losses and intermediary fee losses. Therefore, a causal link existed between the subscriber’s breach of representations and warranties and the bank loan interest losses and intermediary fee losses sustained by the issuer, and the subscriber should bear corresponding compensation liability.
(3) Had the subscriber’s liability for breach of contract been waived?
First, in terms of the content of the waiver, the issuer had never mentioned waiving the subscriber’s liability for breach of contract.
Second, under Articles 107 and 110 of the Contract Law, although the subscriber was no longer required to continue performing its subscription obligation, this did not mean that it was also released from liability for damages for breach of contract.
Third, the waiver of the subscriber’s subscription obligation was the issuer’s performance of statutory procedures at the request of the regulatory authority, rather than a release of the subscriber’s liability for breach of contract.
In summary, the issuer waived only the subscriber’s obligation of continued performance, not the subscriber’s liability for damages for breach of contract.
V. Commentary
In the author’s view, the tribunal’s findings are consistent with the principle of good faith in civil law, conducive to stabilizing market expectations and safeguarding transaction security, and in compliance with laws and regulations. The subscriber’s defense that it bore no obligation whatsoever under the Conditional Subscription Agreement before the Agreement took effect was a distortion of the validity of conditional civil juristic acts — it confused “void contracts” with “contracts that have not taken effect” and violated the principle of good faith in civil law, and should not be upheld. This is analyzed from the following two perspectives:
Perspective 1: Analysis from the literal meaning of legal provisions.
Article 8 of the former Contract Law provided: “A lawfully formed contract is legally binding on the parties. The parties shall perform their respective obligations in accordance with the contract and may not unilaterally modify or rescind the contract.” Article 119 of the Civil Code provides: “A lawfully formed contract is legally binding on the parties.”
Therefore, before a contract that has been formed but has “not taken effect” — i.e., before the satisfaction of the condition precedent — it is not entirely without binding force on the parties; some of its clauses may still be valid.
In this regard, the Minutes of the National Courts’ Civil and Commercial Trial Work Conference (the “Jiumin Minutes”) also expressly states that a void contract is, in essence, one that lacks the essential requirements for validity or contains statutory grounds for nullity, and is void from the outset. A contract that has not taken effect, by contrast, already possesses the essential requirements for validity and has a certain binding force on both parties: neither party may unilaterally withdraw, rescind or modify it. However, because it lacks the special conditions precedent required by laws, administrative regulations or the parties’ agreement, it cannot, before those conditions are satisfied, produce the legal effect of requiring the other party to perform the principal rights and obligations of the contract.
Perspective 2: Analysis from the legislative intent of securities regulatory regulations.
Where approval serves as the condition precedent for the effectiveness of an agreement, this reflects the state administrative authority’s regulation of the contents of the agreement. One should therefore explore which rights and obligations under the contract the approval condition is intended to regulate. In the present case, in the author’s view, by making CSRC approval a special condition precedent for the effectiveness of the Conditional Subscription Agreement, the laws and regulations were intended to regulate the parties’ acts of “non-public issuance of shares” and “subscription of shares”, but not the other clauses designed to ensure the smooth progress of the transaction, such as the representations, warranties and undertakings clause, the security deposit clause, and the clause on cooperating in the performance of filing/approval obligations.
This understanding of the Conditional Subscription Agreement may also find reference and support in Article 1 of the Provisions of the Supreme People’s Court on Several Issues Concerning the Trial of Disputes over Foreign-Invested Enterprise Contracts (I) (2020 Revision).
VI. Conclusion
According to the tribunal’s final award in this case, even where the condition precedent attached to a Conditional Subscription Agreement entered into by a listed company or NEEQ-listed company is not satisfied, this does not mean that all clauses of the Agreement are without effect. If the subscriber’s default prevents the securities issuance from obtaining regulatory approval, the issuer may still rely on the Conditional Subscription Agreement to hold the subscriber liable for breach of contract and protect its lawful rights and interests.
References cited in this article:
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Guidelines No. 4 for the Supervision of Listed Companies — Commitments and Performance of Actual Controllers, Shareholders, Related Parties and Acquirers of Listed Companies (CSRC Announcement [2013] No. 55), Article 5, Paragraph 2
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Provisions of the Supreme People’s Court on Several Issues Concerning the Trial of Disputes over Foreign-Invested Enterprise Contracts (I) (2020 Revision), Article 1: Where a contract concluded by the parties in the course of the establishment or alteration of a foreign-invested enterprise is, under laws or administrative regulations, required to take effect upon approval by the examination and approval authority for foreign investment, the contract takes effect from the date of approval; where approval has not been obtained, the people’s court shall find that the contract has not taken effect. If a party requests confirmation that such contract is void, the people’s court shall not uphold the request. Where a contract referred to in the preceding paragraph is found not to have taken effect due to lack of approval, the validity of the clauses on the parties’ obligation to perform the filing/approval procedures and the clauses established in connection with such obligation shall not be affected.