Corporate Law

The Principle of Good Faith in the Course of Contract Performance ------ Starting from a Equity Transfer Dispute of a Foreign Invested Company

The Principle of Good Faith in the Course of Contract Performance

------ Starting from a Equity Transfer Dispute of a Foreign Invested Company

 

 

Min Chow, Attorney

 

Case Brief:

April 2, 2001, A Company (a USA company) and B Company (another USA company) concluded an equity transfer contract agreeing that: B Company purchased 21 million shares of equity of C Company (a foreign invested company registered in China) held by A Company at a total price of RMB 75.6 million Yuan. The first installment of equity transfer fee RMB 37.8 million shall be paid within 60 days after conclusion of the equity transfer contract; the remaining 50% equity transfer fee shall be paid within 15 months. B Company paid the first installment of equity transfer fee as agreed. In the course of applying for change of the register of shareholder with the Chinese Ministry of Commerce, the authorized agent on behalf of both A Company and B Company, in response to the requirement of the Ministry of Commerce, modified the contract term of “purchase at the total price of RMB 75.6 million Yuan” to “purchase at a price converted to RMB 75.6 million Yuan in total”, and changed the term “pay by RMB” to “pay by USD”. Subsequently, the Ministry of Commerce approved the new contract with the term of payment by USD. (Actually, the two parties did not resign and restamp this new contract. The authorized agent, without changing other content of the contract, only replaced the two pages bearing the old terms with another two pages bearing new terms). The AIC register of shareholder was also changed later. Now, A Company filed a lawsuit claiming the new equity transfer contract invalid with the reason of its being changed without authorization and company stamp.

 

Legal Analysis:

1. Is the new contract legal formed and valid?

In contrast to the old contract, the new contract merely changed the currency for payment of the equity transfer from RMB to USD and kept all other terms unchanged. Moreover, this modification was made by the authorized agent jointly appointed by A Company and B Company. Therefore, the legal consequence of the authorized agent’s activity shall be borne by the clients. Though both A Company and B Company did not sign and stamp on the new contract, however, considering the relative long period from submitting for the Ministry of Commerce’s approval to changing the register of shareholder with AIC, A Company who did not raise objection during this period in time shall be deemed to know and agree with the change. According to the principle of good faith, it is not suitable for A Company to claim the new contract invalid after the change of register of shareholders had been finished. Hence, the new contract was legally established and binding.

 

2. Even if the new contract was not established, following the principle of good faith, A Company is obliged to cooperate with B Company to change the register of shareholder according to the new contract. And the completed activity of transferring 21 million shares of equity is valid.

    There is not mandatory statute or administrative regulation on the kinds of currency that shall be used by a new foreign shareholder (assignee) to pay equity transfer fee to the original shareholder (assignor) when transfer the equity of a foreign invested company. So the old contract in this case is valid even though it included a term of payment by RMB. According to paragraph 2 of Article 60 of the Contract Law, A Company shall modify the old contract as required by the Ministry of Commerce by respecting the principle of good faith and on the basic of the nature, purpose and transaction customs of the contract. In consideration of the transfer of the 21 million shares of equity has been approved and the register of change of shareholder has been finished, for the purpose of saving judicial cost, the Court held that it is more effective to directly affirm the efficacy of the activity of transferring the 21 million shares of equity than declaring the new contract invalid and subsequently requiring A Company to cooperate to change the contract, sign and stamp on the new contract and refile the application with the Ministry of Commerce and AIC.