Abstract

The execution and enforcement of anti-dilution provisions rely theoretically on a corporate legal regime that is capable of accommodating the issuance of preferred shares. To date, no Chinese legislative document, judicial interpretation or court ruling has provided explicit guidance on how a company could issue multiple classes of shares, including preferred shares, to different groups of shareholders. The concept of anti-dilution provisions, common in the western legal context, thus remains unfamiliar and largely without a secure legal foundation in Chinese law. However, anti-dilution provisions have been negotiated and adopted by founder shareholders and investors in many private placement transactions in China. Yet the lack of a secure legal foundation for these provisions casts considerable doubt on their enforceability. This article examines the most popular anti-dilution provisions used in China and considers several high-profile deals. It also analyzes the validity and enforceability of anti-dilution provisions under PRC law and proposes several courses of action to minimize the uncertainty of enforcing anti-dilution provisions in China


I. Introduction

Anti-dilution provisions are complex. In the Western legal context, “anti-dilution provisions are designed to protect holders of convertible securities against dilution from a large variety of corporate events, including, among others, stock dividends and splits, cheap issuance of additional common stock, and distribution of cash or property.” The benefit of anti-dilution adjustments made under these provisions is that one of the preferential rights may be carried by preferred shares, which are “an integral part of the package of privileges investors demand and founder shareholders offer.” Therefore, the execution and enforcement of anti-dilution provisions rely theoretically on a corporate legal regime that is capable of accommodating the issuance of preferred shares.

To date, no Chinese legislative document, judicial interpretation or court ruling has provided explicit guidance on how a company could issue multiple classes of shares, including preferred shares, to different groups of shareholders. The concept of anti-dilution provisions, common in the Western legal context, thus remains unfamiliar and largely without a secure legal foundation in Chinese law.

However, anti-dilution provisions have been negotiated and adopted by founder shareholders and investors in many private placement transactions in China. This is especially frequent when the investor is a foreigner who is familiar with anti-dilution provisions. Yet the lack of a secure legal foundation for these provisions casts considerable doubt on their enforceability.

This article is divided into four parts. Part I describes typical anti-dilution provisions in the Western private placement context. Part II examines the most popular anti-dilution provisions used in China and considers several high-profile deals. Part III analyzes the validity and enforceability of anti-dilution provisions under PRC law. Part IV concludes by proposing several courses of action to minimize the uncertainty of enforcing anti-dilution provisions in China.