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Case 5: Determination of disputes related to performance compensation clauses (VAM)
—A contract dispute between a partnership enterprise and a US company and the target company

Updated: December 23, 2022

This case involves a series of legal issues such as performance compensation clauses (Valuation Adjustment Mechanism, VAM), changes in circumstances, and company's guarantee liability for shareholders' debts.

The target company was originally a wholly foreign-owned enterprise registered in China, mainly engaged in the gas supply business, and its founding shareholder was a company (the Company). Fan is the actual controller of the target company. In December 2016, a partnership entered into an equity transfer and capital increase agreement and a supplementary agreement with the Company, the target company and Fan, stipulating that the partnership would receive part of the equity of the target company held by the Company and increase capital to the target company. The agreement also stipulated the terms of performance compensation within three years. The partnership filed a lawsuit on the grounds that the target company failed to fulfill its performance commitment and requesting that the Company, Fan, and the target company jointly pay the performance compensation for 2018, penalty interest, and attorney fees. During the litigation period, the Company, Fan, and the target company filed a counterclaim request to terminate the above-mentioned contract on the grounds of changes in circumstances. The court prudently reviewed the defense of the changes in circumstances, and finally determined that there were no pertinent changes of circumstances, and ordered the Company and Fan to bear corresponding compensation responsibilities. Considering the basic business ethics, according to the liquidated damages adjustment rules stipulated in Article 114 of the Contract Law, the court determined the amount of payment that the Company and Fan should bear. The court also conducted a prudent review as to whether the target company should bear the guarantee liability. On the basis of determination of the legality of the guarantee provided by the Company to shareholders, and the operating profit of the target company is sufficient to cover the amount of the guarantee responsibility and will not lead to a disguised withdrawal of the Company's capital, the court ruled that the Company and Fan should pay the partnership 2.8 million yuan of performance compensation and 50,000 yuan of legal fees within a time limit. The target company assumed joint and several guarantee liabilities within the scope of the debt determined in the first item of the judgment, and has the right to recover from the Company and Fan after assuming the guarantee liability.


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