Storage Case | If the company repurchases shares without following the capital reduction procedure, can the founders' joint guarantee liability be exempted?

Case Name

No.1

Inclusion Case 2024-08-2-269-007: Tu Mou v. Chen Mou, Shanghai Smart Technology Co., Ltd. and Other Contract Dispute Case

Key Points of the Judgment

No.2

The investment agreement stipulates that the target company shall bear the obligation to repurchase shares, and provides that a third party shall offer joint guarantee for the repurchase obligation. When the investor sues to hold the third party liable for the joint guarantee, the court needs to distinguish between the effectiveness evaluation and realization standards of the repurchase obligation and the guarantee liability: (1) If the share repurchase clause of the target company is lawful and valid, based on the validity of the main contract, then the subordinate contract in which the third party provides joint guarantee is also valid. When the target company refuses to repurchase or does not meet the conditions for repurchase, making the performance of the repurchase obligation temporarily impossible, the guarantor should bear the guarantee liability. (2) After the guarantor repurchases the shares, they cannot automatically seek reimbursement from the target company; they must still comply with prerequisite procedures such as the target company’s capital reduction, to prevent circumvention of restrictions such as fund withdrawal or evasion of capital contributions.

Basic Case Facts

No.3

Plaintiff Tu Mou claims: He and defendant Chen Mou and Shanghai Smart Technology Co., Ltd. (hereinafter referred to as “the Technology Company”) jointly signed an “Investment Framework Agreement” with an investment amount of 3.6 million RMB (same below). Subsequently, Tu Mou paid the investment of 3.6 million RMB as agreed. Article 8 of the “Investment Framework Agreement” stipulates that the Technology Company has an obligation to repurchase shares, and Chen Mou provides joint guarantee for this repurchase obligation; the Technology Company only paid 300k RMB for the repurchase. Therefore, Tu Mou filed a lawsuit requesting the court to order: the defendants Chen Mou and the Technology Company jointly fulfill the repurchase obligation, and pay Tu Mou 3.3 million RMB for the share repurchase, plus interest calculated at 6% annually.

Defendants Chen Mou and the Technology Company jointly argue: 1. The Technology Company is not a party to the “Investment Framework Agreement” and has not reached an agreement with Tu Mou on the share repurchase. The provisions regarding the repurchase obligor in the agreement are unclear; when the main debtor cannot be identified, the main debt does not exist, and the subordinate debt of Chen Mou as guarantor also does not exist. 2. When Tu Mou requested to add the repurchase clause in Article 8 of the agreement, he did not delete Article 3.4, which conflicts with it; thus, the interpretation should be unfavorable to Tu Mou, meaning Article 8 is invalid and does not bind Chen Mou and the Technology Company. 3. The repurchase clause violates the principle of capital maintenance, has statutory grounds for invalidity, and is an invalid clause, essentially allowing shareholders to withdraw capital at will, damaging the interests of the company, shareholders, and creditors.

The court, after review, found: On July 28, 2017, the Technology Company formed a “Meeting Minutes,” attended by Tu Mou, Chen Mou, and other investors. The minutes stated that they agreed to continue using the Technology Company as the target company for all future business expansion and financing, welcoming Tu Mou as a new investor. On September 21 of the same year, Tu Mou and Chen Mou signed the “Investment Framework Agreement,” with the company’s official seal affixed. The agreement states: “… Article 3.4, strategic partners explicitly agree not to claim performance commitments, valuation adjustments, or share repurchase from the target company and founders… Article 8, Tu Mou can request repurchase at any time, and the other party must agree; within 30 working days after the request, the Technology Company shall repurchase at an annualized return rate of 6% (excluding compound interest), completing the payment. Founder Chen Mou shall bear joint guarantee liability for this agreement, including joint guarantee for the repurchase…” On the same day, a shareholders’ meeting passed a resolution to increase Tu Mou’s capital contribution, which was recorded in the shareholder register. From November to December 2017, Tu Mou transferred a total of 3.6 million RMB to the Technology Company account, fulfilling his investment payment obligation under the “Investment Framework Agreement,” which was recorded as company capital reserve.

On December 21, 2019, Tu Mou met with Chen Mou, explicitly stating that he demanded the repurchase of all shares according to Article 8 of the agreement. Chen Mou stated that he would bear responsibility for the increased repurchase clause.

Further findings: 1. All three parties confirmed that Tu Mou is a shareholder of the Technology Company, holding the shares recorded in the shareholder register. 2. Chen Mou confirmed that he is a founding shareholder and the actual controller of the Technology Company. 3. Both the Technology Company and Chen Mou confirmed that the capital reduction procedures have not yet been completed. 4. Tu Mou clarified that after receiving the share repurchase payment, he would no longer hold the disputed shares, and he is not a shareholder recorded in the public information, so there is no involvement in the share transfer registration procedures.

The People’s Court of Jing’an District, Shanghai, rendered a civil judgment (2022) Hu 0106 Minchu 16142 on August 2, 2021: dismissing all of Tu Mou’s claims. After the judgment, Tu Mou appealed. The Shanghai Second Intermediate People’s Court issued a civil judgment (2023) Hu 02 Minzhong 12817 on June 12, 2024: one, revoke the first-instance judgment; two, Chen Mou shall pay Tu Mou 3.3 million RMB for the repurchase, plus returns calculated at 6% annualized interest (based on 3.3 million RMB principal, from January 21, 2020, until actual payment); three, dismiss Tu Mou’s other claims.

Reasons for the Judgment

No.4

The key issues in this case are: (1) the identification of the contractual subject of the disputed “Investment Framework Agreement”; (2) the validity of the share repurchase clause; (3) the determination of contractual liabilities.

I. Regarding the Contractual Subject of the “Investment Framework Agreement”

Based on the content of the “Investment Framework Agreement” and the process of its formation, the “Meeting Minutes” on July 27, 2017, clearly indicated that the target company for business expansion and financing was the Technology Company; the main content of the agreement involved investing in the Technology Company and related rights and obligations. Before signing, Chen Mou, as the actual controller of the Technology Company, fully negotiated the contract terms with Tu Mou, and after reaching consensus, the Technology Company affixed its official seal. It is evident that the Technology Company participated in the negotiation and signing of the “Investment Framework Agreement,” was aware of the content, confirmed it, and continued to perform the contract as the target company, thus the agreement should be recognized as a mutual consensus reached by Tu Mou, Chen Mou, and the Technology Company, representing their true intentions, and establishing contractual rights and obligations among the three parties, which are binding unless they violate mandatory laws and regulations.

II. Regarding the Effectiveness of the Repurchase and Guarantee Clauses

Although the provisions of Articles 3.4 and 8 of the “Investment Framework Agreement” conflict, the Article 8 repurchase clause is a special agreement made later by the parties, based on the latest expression of intent, and does not violate the purpose of the contract; thus, it should be given priority. Specifically, reviewing the performance of the contract, Tu Mou, Chen Mou, and the Technology Company all confirmed that Tu Mou had become a shareholder of the Technology Company based on his investment, and resolutions of the shareholders’ meeting and the shareholder register also recorded Tu Mou’s shareholder status and shareholding ratio. Although Tu Mou’s investment funds have not been registered as changes in the company’s registered capital, they have been recorded in the company’s capital reserve, and Tu Mou is indeed a shareholder of the Technology Company. As an investor, based on the “Investment Framework Agreement,” Tu Mou requested the Technology Company to repurchase his shares, which could objectively harm the company’s capital maintenance and external solvency. However, the circumstances constrained by the “Company Law of the People’s Republic of China” (2013 amended) do not necessarily constitute a negative evaluation of the contract’s validity, and the request for repurchase must still comply with mandatory provisions such as the prohibition on shareholders withdrawing capital and share repurchase. In this context, the claim that the repurchase clause violates the principle of capital maintenance and is invalid is unfounded and unsupported by law. Since the Technology Company and Chen Mou cannot prove that the contract is invalid under Article 52 of the “Contract Law of the People’s Republic of China,” the Technology Company’s promise to repurchase should be deemed valid. Meanwhile, Chen Mou, as a fully capable natural person, fully understood the risks and responsibilities as a joint guarantor when signing, and his guarantee commitment in the clause is also valid.

III. Regarding the Specific Responsibilities of the Parties

Regarding the repurchase obligation, the disputed repurchase clause is valid, and Tu Mou can request the Technology Company to repurchase, but this request must be examined in accordance with the mandatory provisions of the Company Law, such as Article 35 (prohibition on shareholders withdrawing capital) and Article 142 (share repurchase), to determine whether the Technology Company can fulfill the repurchase obligation. According to the burden of proof, Tu Mou currently cannot provide sufficient evidence that the Technology Company’s performance of the share repurchase complies with legal mandatory provisions, and the Technology Company does not recognize that it has met the conditions for the repurchase. Without the company completing legal procedures such as capital reduction, the court does not support Tu Mou’s claim for the Technology Company to repurchase the shares. Regarding guarantee liability, the main debt and subordinate debt are both valid; the temporary inability to perform the repurchase obligation does not affect the joint guarantee liability. Furthermore, Chen Mou, as a founding shareholder and actual controller of the Technology Company, provided guarantee to Tu Mou. If the target company fails or refuses to repurchase, it would be improper for the guarantor to evade responsibility, which is detrimental to investment safety. Therefore, Chen Mou’s claim that he should not bear joint guarantee liability due to the temporary inability to fulfill the repurchase obligation is invalid. Tu Mou’s request that Chen Mou assume guarantee liability within his guarantee scope is supported by law.

Additionally, Tu Mou explicitly stated that after receiving the share repurchase payment, he would no longer hold the shares obtained under the “Investment Framework Agreement.” Moreover, Tu Mou is not recorded as a shareholder in the public information of the Technology Company, so there is no involvement in the share transfer registration procedures. Meanwhile, the Technology Company and Chen Mou did not request to handle the ownership of the shares involved in the repurchase at the same time. Therefore, after Chen Mou pays the repurchase payment based on guarantee liability, the issue of recourse between him and the Technology Company can be addressed separately.