Dispute over Equity Transfer

Tang Changlong v. Zhou Shihai for Dispute over Equity Transfer
(Issued on September 19, 2016, as deliberated and adopted by the Judicial Committee of the Supreme People's Court)
Keywords civil; equity transfer; payment in installments; rescission of contract

Key Points of Judgment
Where the transferee delays or refuses the payment of the transfer price in installments for equities in a limited liability company or otherwise defaults, and the transferor requires rescission of the equity transfer contract between them, the provision of Article 167 of the Contract Law of the People's Republic of China that the seller under a sales contract with payment in installments may rescind the sales contract if the amount of installments past due reaches one fifth of the total price should not apply.

Legal Provisions
Articles 94 and 167 of the Contract Law of the People's Republic of China

Basic Facts
On April 3, 2013, plaintiff Tang Changlong and defendant Zhou Shihai concluded an Agreement on Equity Transfer and an Agreement on Payment in Installments of Equity Transfer Price, under which they agreed that: Zhou Shihai should transfer 6.35% of the equities of Chengdu Shuangxing Electronic Appliance Co., Ltd. of Qingdao Transformer Group held by him to Tang Changlong, for a total price of 7.1 million yuan to be paid in four installments: paying 1.5 million yuan on April 3, 2013, 1.5 million yuan on August 2, 2013, 2 million yuan on December 2, 2013, and 2.1 million yuan on April 2, 2014. The agreements should take effect upon signatures of both parties, and they would never regret. After the conclusion of the agreements, Tang Changlong paid Zhou Shihai the first installment of 1.5 million yuan on April 3, 2013, as agreed on. Since Tang Changlong failed to pay the second installment within the prescribed time limit as agreed on, on October 11 of the same year, Zhou Shihai served a Notice of Rescinding Agreement upon Tang Changlong by notarization to rescind the Agreement on Payment in Installments of Equity Transfer Price on the ground that Tang Changlong committed a fundamental breach of contract. On the following day, Tang Changlong paid Zhou Shihai the second installment of 1.5 million yuan by wire transfer, and performed his obligations of paying the third and fourth installments as scheduled in the agreed amounts. Zhou Shihai refunded the four equity transfer payments made by Tang Changlong on the ground that the Agreement had been rescinded. Tang Changlong filed a lawsuit with the people's court, requesting the court to confirm that the Notice of Rescinding Agreement issued by Zhou Shihai was invalid and order Zhou Shihai to continue performance of the Agreement.
It was also found that on November 7, 2013, in the modification registration (or recordation) of Chengdu Shuangxing Electric Appliance Co., Ltd. of Qingdao Transformer Group, the 6.35% equities formerly held by Zhou Shihai were registered under the name of Tang Changlong.
Judgment
On April 15, 2014, the Intermediate People's Court of Chengdu City, Sichuan Province entered a civil judgment (No. 1815 [2013], First, Civil Division, IPC, Chengdu) to dismiss the claims of Tang Changlong. Tang Changlong appealed. On December 19, 2014, the Higher People's Court of Sichuan Province entered a civil judgment (No. 432 [2014], Final, Civil Division, HPC, Sichuan) that: (1) the original judgment should be revoked; (2) Zhou Shihai's unilateral rescission of the Agreement on Payment in Installments of Equity Transfer Price between both parties should be held invalid; and (3) Tang Changlong should, within ten days after this judgment took effect, pay Zhou Shihai the equity transfer price of 7.1 million yuan. Against the judgment of the Higher People's Court of Sichuan Province, Zhou Shihai filed a petition for retrial with the Supreme People's Court on the ground that the application of law by the court of second instance was erroneous. On October 26, 2015, the Supreme People's Court entered a civil ruling (No. 2532 [2015], Civil Retrial Petition, SPC) to dismiss Zhou Shihai's retrial petition.
Judgment's Reasoning
In the effective judgment, the court considered that the dispute in this case focused on whether Zhou Shihai was entitled to rescind a contract under Article 167 of the Contract Law of the People's Republic of China (hereinafter referred to as the “Contract Law”).
1. Paragraph 1 of Article 167 of the Contract Law provided that: “Where, under a sales contract with payment in installments, the buyer fails to make payments due, if the delinquent amount has reached one fifth of the total price, the seller may require the buyer to pay the total price or rescind the contract.” Paragraph 2 thereof provided that: “If the seller rescinds the contract, it may require the buyer to pay a fee for use of the subject matter.” Article 38 of the Interpretation of the Supreme People's Court on Issues concerning the Application of Law in the Trial of Sales Contract Dispute Cases provided that: “The term ‘payment in installments' as mentioned in paragraph 1 of Article 167 of the Contract Law means that the buyer pays the total price to the seller in at least three installments within a certain period. Where any provision of a sales contract with payment in installments violates paragraph 1 of Article 167 of the Contract Law, causing damage to the interests of the buyer, if the buyer claims that the provision of the contract is void, the people's court shall support such a claim.” In accordance with the provisions of the aforesaid law and judicial interpretation, a sale in the manner of payment in installments had the following major characteristics: (1) The buyer paid the total price to the seller in at least three installments, and after the delivery of the subject matter by the seller, the buyer paid the price to the seller in at least two installments. (2) Payment in installments often occurred between merchants and consumers, generally in transactions where the buyers were consumers to meet demands in life consumption. (3) The seller granted a certain credit to the buyer, and thus assumed a certain risk in recovering the price. To guarantee the recovery of the remaining payments, under certain conditions, the seller may exercise a right to rescind the contract.
In this case, a shareholder of a limited liability company transferred the equities held by him to another person who was not a shareholder of the company. Although the transfer was also in the form of payment in installments, since the subject matter of purchase and sale was equities, it differed from ordinary purchase and sale for consumption purposes: (1) Tang Changlong as the transferee acquired the equities for the purposes of participating in the company's business management and seeking economic benefits, rather than satisfying his needs in life consumption. (2) Since the equities held by Zhou Shihai continued to exist in the target company, the risk of recovering the equity transfer price paid in installments assumed by Zhou Shihai as the transferor of equities of a limited liability company was not equal to that assumed by a seller in a sale with payment in installments for general consumption purposes. (3) The rescission of the Agreement on Equity Transfer between both parties would not lead to the circumstance that the transferee was required to pay fees for using the subject matter. Based on the above characteristics, an agreement on equity transfer with payment in installments was substantially different from a sales contract with payment in installments for general consumption purposes. It was inappropriate to apply Article 167 of the Contract Law to the Agreement on Payment in Installments of Equity Transfer Price to allow a right to rescind a contract.
2. In this case, the purpose of the Agreement on Payment in Installments of Equity Transfer Price concluded by both parties could be fulfilled. Tang Changlong and Zhou Shihai concluded it for the purpose of transferring 6.35% of the equities of Chengdu Shuangxing Electric Appliance Co., Ltd. of Qingdao Transformer Group held by Zhou Shihai to Tang Changlong. According to Tang Changlong's performance of payment of the equity transfer price, except that Tang Changlong paid the second installment of 1.5 million two months past due, he paid the other three installments as agreed on. Considering that Tang Changlong's late payment constituted a breach of contract, Zhou Shihai required rescission of the Agreement, and returned the payment of 7.1 million yuan made by Tang Changlong, which, however, did not affect the fact that Tang Changlong paid three instalments as agreed on. In addition, in both the original and the appellate trials, Tang Changlong clearly stated that he was willing to perform the obligation of payment. Therefore, the purpose of the Agreement on Payment in Installments of Equity Transfer Price signed by Zhou Shihai could be fulfilled. It was also found that on November 7, 2013, in the modification (or recordation) registration of Chengdu Shuangxing Electric Appliance Co., Ltd. of Qingdao Transformer Group, the 6.35% equities formerly held by Zhou Shihai were registered under the name of Tang Changlong.
3. From the standpoint of good faith, Article 60 of the Contract Law provided that: “Each party shall fully perform its obligations as agreed upon. The parties shall, under the principle of good faith, perform the obligations of notification, assistance, and confidentiality, among others, in accordance with the contract's nature and purpose and transaction practices.” It was specified in the equity transfer agreement between both parties that: “This Agreement is made in duplicate, and takes effect upon signatures of both parties, who shall never regret.” Therefore, even though Zhou Shihai invoked Article 167 of the Contract Law, he should first require Tang Changlong to pay the total price rather than rescind the contract.
4. From the standpoint of maintaining transaction safety, a transaction of equities of a limited liability company required various considerations, for example, the acceptance of and confidence in Tang Changlong from other shareholders (more than 50% of all shareholders consented to the equity transfer), the recording of Tang Changlong in the register of shareholders, and the equity registration with the administrative department for industry and commerce. Social costs and influences had occurred. In this case, after acquiring the equities, Tang Changlong had actually participated in the business management of the company, and the equities had undergone transfer registration to his name. In the absence of any fundamental breach of contract by Tang Changlong, the unilateral rescission of the contract may adversely impact the stable operation and management of the company.
In conclusion, Tang Changlong's argument that Zhou Shihai's unilateral rescission of the contract under Article 167 of the Contract Law lacked basis was well-founded in law and should be upheld.
(Judges rendering the effective judgment: Liang Hongya, Wang Yue, and Li Li)