Impact of new rules on PE VAM

By Harry Wu and Ashley Lei, Wintell & Co

With the issuance of the Guiding Opinions on Regulating the Asset Management Business of Financial Institutions (the New Rules) in April 2018, the asset management industry formally welcomed the era of “grand unified” regulation. The provisions of the New Rules on breaking “rigid payment” became the focus of attention from the end of 2017, when the central bank sought public comment. In response to a reporter’s question, a relevant senior official of the central bank stressed that when a financial institution “accepts an appointment to manage wealth on a client’s behalf”, it is additionally required to genuinely realize “seller is to duly fulfill its responsibilities and buyer is to himself bear the liability”, returning asset management business to its original principles. Though the New Rules do not directly address private equity investment funds, nevertheless, against the backdrop of “grand unified” regulation, private equity funds will necessarily feel the effects of the New Rules.


Generally speaking, valuation adjustment mechanisms (VAMs) are divided into three types: equity buyback, performance compensation and valuation adjustment, with equity buyback being the most common and the most core type.

吴迪  HARRY WU  瀛泰律师事务所合伙人  Partner  Wintell & Co
Wintell & Co

Buyback clause at the time of offering of a private equity fund. In one arbitration case in which the authors were involved, the private fund manager had committed to pay the principal and returns to the investors by way of a buyback. Additionally, the private fund had not registered the investors as limited partners and the investors did not bear the investment risks. The award of the arbitration tribunal found that the relationship between the investors and the private fund was a loan relationship.

In terms of the offering of private equity funds, the New Rules expressly restrict or prohibit financial institutions from making such arrangements as dividing product units into classes, nesting asset management products, “rigid payment”, etc. Though the New Rules do not directly address private equity investment funds, what private equity fund offering related buyback clauses embody is clearly a type of commitment to bear the risks on the behalf of the investors, which rubs up against the redline prohibiting “rigid payment”. Although, from the perspective of civil liability, private fund managers are not required to bear any punitive liability as a result, with the issuance of subsequent detailed rules or complementary rules specifically for private funds, they will necessarily be faced with more stringent regulation.

Buyback clauses in the private equity fund investment sphere. When a private fund makes an equity investment in a target company, there will usually be an equity value adjustment clause or valuation adjustment mechanism, the core of it being that if the investee company’s future performance does not achieve the specified targets, the investor has the right to exercise specified rights, e.g. demanding refund of part of the invested moneys or adjustment of the equity percentage; or if the investee company fails to achieve a listing within a certain delay, the investor may demand that the investee company or its shareholders buy back all or part of the investor’s shares at a certain return rate.

雷思铭 ASHLEY LEI  瀛泰律师事务所律师  Associate  Wintell & Co
Wintell & Co

In the Shanghai Ruifeng Equity Investment Partnership (Limited Partnership) et al. Equity Transfer Dispute Case, the court held that the valuation adjustment mechanism connoted a minimum guarantee, which could easily lead to confusion with circumstances specified in current laws that make a contract invalid, and there were no corresponding legal provisions that regulated such mechanisms. Accordingly, when carrying out its appropriate assessment, the court was required to abide by the principles of: (1) encouraging trade; (2) respecting party autonomy; (3) safeguarding the public interest; and (4) ensuring the justness of the commercial transaction process, in determining the legal validity of the valuation adjustment mechanism. The court found that the equity buyback clause in the case had formed and fell within the scope of party autonomy, so should be fully respected. The clause had also procured the lawful and smooth completion of the target company’s capital increase and had, to the maximum extent, safeguarded the basic interests of all of the parties. The parties had specified the completion of an approved listing by the target company within a certain delay as a condition for triggering the buyback, and although there were some defects, they did not materially run counter to the judgment criteria above and was thus valid.

In these types of cases, the shareholders or actual controller of the target company will often cite relevant rules of the Company Law to claim that the private fund, as a company shareholder, abused its rights, harming the interests of the company, its shareholders and its creditors, and argue that the buyback clause was invalid because it “violates the mandatory provisions of laws or administrative regulations”. The judicial authorities and arbitration institutions, in contrast, lean toward application of the principle of party autonomy and the principle of fairness in civil law and the Contract Law, the principle of capital maintenance in the Contract Law and other such basic principles as the legal basis in rendering their judgments or rulings, holding that the buyback clause between a private fund and the shareholders or actual controller of the target company is valid, whereas that with the target company is invalid. Accordingly, the issuance of the New Rules does not have an actual effect on the determination of the validity of VAMs in the private equity fund investment sphere.

From this it can be seen that, because private equity fund offering related buyback clauses rub up against the redline on “rigid payment”, they will be affected by the New Rules, while buyback clauses in the investment sphere are really a form of option, as they have a certain reasonableness based on party autonomy and will not be affected by the New Rules.

As for penalties for “rigid payment”, the targets for penalization specified by the New Rules are provisionally limited to deposit taking financial institutions and non-deposit taking licensed financial institutions. Whether private fund managers are a target has yet to be determined. We will pay increased attention to the issuance of the subsequent complementary rules for the New Rules, expecting that the penalty measures that private fund managers will face for “rigid payment” in the course of offerings will be specified.

Harry Wu is a partner at Wintell & Co. He can be contacted on +86 21 6854 4599 or by email at

Ashley Lei is an associate at Wintell & Co. She can be contacted on +86 21 6854 4599 or by email at