If a private equity fund is not incepted due to a fundraising failure, or for any other reason at the subscription stage, disputes over upfront costs or any other issues may arise between interested parties, of which there may be some concern about how the deposit is dealt with, and how the fundraising costs are shared, following the fundraising failure. This article will provide a brief analysis on these disputes by looking into two cases.
REFUND OF THE DEPOSIT
Case 1: A contract dispute between Lingshui Haifu Industrial (Haifu) and Nanjing Jianxin Industrial Investment Enterprise (Jianxin).
The facts: Haifu and Jianxin signed an investment co-operation agreement in connection with project financing, pursuant to which Jianxin would raise RMB150 million (US$23.8 million) as construction funding for a project of Haifu, and Haifu would have the right to terminate the co-operation if Jianxin failed to obtain the funding agreed for Haifu within 60 days.
All upfront costs, including costs incurred for gaining access to fundraising channels, were agreed to be paid by Jianxin as out-of-pocket costs on behalf of Haifu, provided that Haifu paid a deposit to Jianxin upon execution of the agreement. When it happened that Jianxin failed to obtain the funding within 60 days, disputes arose between the parties. Apart from liability for breach, the parties disagreed about whether Jianxin should refund the deposit, and if so, how much should be refunded.
The court’s opinion: The court found that both parties had breached their agreement. Haifu had committed a breach because not all approvals and procedures necessary for construction of the project were obtained or completed at the time of execution of the agreement, according to which Haifu should provide all data necessary for obtaining funding in a timely manner and ensure the availability of the above-mentioned approvals and procedures. As for Jianxin, the court argued that it should not have agreed on a fundraising period of 60 days with Haifu because it should have knowledge about the approvals and procedures necessary for the project.
Accordingly, the court held that both parties should be liable for breach. As for refunding of the deposit and the amount to be refunded, it said that, now the agreement between the parties was terminated, the deposit received by Jianxin from Haifu, which was RMB200,000 in total, should be refunded after being offset with Haifu’s liability for breach. Given the fact that Jianxin incurred costs in hiring lawyers and accountants for due diligence processes and reports, the court ordered Haifu to pay an indemnity of RMB65,000 to Jianxin. After the deduction of this sum and the offset of losses between the parties, the court ordered Jianxin to refund RMB135,000 to Haifu.
Lawyer’s opinion: The dispute concerned how responsibilities were shared between the project owner and fundraiser, and whether and how deposits received from the project owner should be refunded following fundraising failure. Given the agreement between the parties, the court found that the fundraising failure was attributable to both parties, pointing out that while Haifu failed to obtain qualifications necessary for the construction, Jianxin entered into the agreement with Haifu despite good reasons for being aware of Haifu’s failure with its capabilities as a professional fundraiser. Therefore, the percentage of deposit to be refunded, as determined by the court, was based on the liabilities for breach that the parties should each bear.
To avoid disputes over sharing of responsibilities in case of fundraising failure, it is advisable to specify all obligations of the parties during the subscription and inception process in the agreement. Examples include the obligation to pay capital contributions, the duty to co-ordinate in specific issues, and conditions for refund of deposit, if any. The authors also recommend further specific agreement on the schedule and order of performing these obligations.
REFUND OF INCEPTION COSTS
Case 2: Contract dispute between Beijing Hualei Alliance Capital Management Centre (Hualei) and Dongying Deda Property (Deda).
The facts: Deda and Hualei entered into a co-operation agreement and relevant supplemental clauses relating to an equity investment fund, pursuant to which they would work together over matters that include the inception of the Jinshi Huatong Equity Investment Fund. Deda would pay the inception costs to Hualei in advance. However, the inception costs must be fully refunded if Hualei failed to meet the fundraising target within the agreed period of time.
After fundraising failed, the parties failed to reach consensus on, among other things, why fund inception was unsuccessful, and whether Hualei should refund the inception costs of RMB1 million to Deda.
The court’s opinion: The court said that the fundraising failure should be attributable to Hualei’s failure to fulfil its fundraising obligation as explicitly specified under the agreement, unless there was verified evidence that the fundraising failure was due to any reason on the part of Deda. Therefore, it ordered Hualei to refund the inception costs of RMB1 million to Deda.
Lawyer’s opinion: There are no provisions under laws, regulations or industry self-regulatory rules that specify how costs should be borne in case of fundraising failure. A review of precedents finds that courts generally attribute the fundraising failure to the party who bears the fundraising obligation.
Therefore, fundraisers must take losses arising out of fundraising failure into account. They need to have thorough communication with project owners in advance, and ensure that relevant agreements provide solutions on how costs will be borne or shared.
Liu Hui is a partner and Wang Yubi is a paralegal at Boss & Young