Series Discussions on Trial Practice of Equity Incentive Mechanism Disputes (2) ─ Determination of Equity Exit Price (Mainland China)

March 2023

Jolene Chen and Teresa Huang

Following the Series Discussions on Trial Practice of Equity Incentive Mechanism Disputes (1) ─ Employees’ Passive Lay-off (Mainland China), this article will discuss the determination of equity exit price.  In equity incentive disputes, the exit price is also the main point of contention.  In practice, the equity incentive systems of enterprises are very different, and the agreements on the exit price are also different markedly.  In a judicial judgment, the court will often make a decision according to the actual situation of the case, combined with the agreement of both parties on the exit price and other factors.  This article will make an analysis based on actual cases, hoping that it can be a reference for companies to set equity incentive mechanism, so as to protect the incentive receipts’ peaceful exit of incentive mechanism and avoid disputes.

1. If both parties agree on an unclear equity exit price, the court will make a discretionary decision based on the specific circumstances of the case.

In judicial practice, the design of equity incentive mechanism varies in detail, and there is a situation that the enterprise does not make a clear agreement on the pricing of the exit price, in which case it is easy to cause disputes when an incentive receipt exits.  Moreover, there is no uniform standard for how to determine the exit price of the equity incentive in judicial practice, and the court will make discretionary decisions according to the circumstances of the case.  For example, in Case 3, the court took into consideration both parties’ restrictions on the buy-back price of equity, the reasons for the incentive recipient’s exit and the estimation of the value of the equity when both parties signed the equity incentive agreement, and then determined the exit price of the equity incentive, but the amounts decided by the two courts differ widely. 

Case 3: The Civil Judgment of the Second Instance Regarding Gift Contract Dispute of Xu v. Zhou

Zhou and Xu agreed in the agreement involving the equity incentive that Zhou, as the controlling majority shareholder of Tingmei Health-care Science & Technology Co., Ltd. (hereinafter referred to as “Tingmei”), agreed to transfer shares of RMB700,000 from those held by him, accounting for 1% of Tingmei’s total shares, to Xu without compensation.  Xu had enjoyed the ownership and dividend rights of the 1% shares since 2008.  Xu was not entitled to the right to transfer the 1% shares received by him without compensation.  If Xu left Tingmei after two years from the date of the agreement, the shares may only be bought back by Zhou at a price of not more than RMB 500,000.  If Xu left Tingmei in 2008, the shares must be returned to Zhou without compensation, and Xu was not entitled to the dividends of the shares.

In the lawsuit, Xu requested Zhou to buy back the disputed 1% shares of Tingmei at a price of RMB500,000.

Key Points of the First-instance Judgment: Regarding Xu’s claim to request Zhou to buy back the shares, both parties agreed in the agreement that the buy-back price shall be no more than RMB500,000, but it does not mean the buy-back price is RMB500,000.  In the case of unclear agreement between both parties, the court made a discretionary decision on the buy-back price to require Zhou to buy back the 1% shares held by Xu at a price of RMB100,000 within ten days from the effective date of the judgment.

Key Points of the Second-instance Judgment: As both parties had agreed on the upper limit of the buy-back price of the shares in the agreement involved in the case, Zhou expected and clearly knew the price.  Moreover, in the case Xu’s departure was not attributable to his personal reasons.  Therefore, the determination of the buy-back price based on Xu’s understanding of the agreement involved in the case is more in line with the contractual intent, but also makes the rights and obligations of both parties more reciprocal and balanced.  As a result, the court adopted the relevant claims, and accordingly upheld Xu’s appeal to request Zhou to buy back the 1% shares of Tingmei at a price of RMB500,000.

2. If both parties clearly agree on the pricing method of the exit price, both parties’ expectations on the value of the incentive equity can be fixed, incentive recipients’ exit efficiency can be improved, and the relevant company’s lawsuits can be reduced.

As each enterprise’s equity incentive plan is formulated based on its own characteristics, there are significant differences in the exit prices of different enterprises’ equity incentives.  For a non-listed company, the exit price may be determined based on its registered capital, net assets and the market valuation of similar companies in the same industry.  However, it is important to clarify the pricing method of the exit price in advance, so as to avoid the failure of incentive, which may affect the company’s implementation of equity incentive and normal operation in the future. 

Case 4: The Civil Judgment of the Second Instance Regarding Equity Transfer Dispute of Beijing Shougang International Engineering Technology Co., Ltd. (hereinafter referred to as “BSIET”) v. Xie

The Equity Management Measures of BSIET stipulates that an employee’s equity shall be settled at the internal equity price (internal equity price = net assets in the company’s audited financial statements at the end of the previous year / the company’s total shares) when the equity exits, and its risk liability and asset income shall be calculated to the month in which the equity exits.  In the case, the employee Xie needed to return the shares held by him because of his job transfer, so he appealed to the court to order BSIET to buy back the original issue shares held by Xie at the audited internal equity price of the company at the end of 2020.

Key Points of the First-instance Judgment: Regarding the buy-back price, according to the above-mentioned Equity Management Measures, both parties recognized that the value of the company’s equity in 2020 is RMB4.4593 per share, then BSIET shall pay Xie RMB1,**7,790.  As part of Xie’s claim for the buy-back of shares had a factual basis, the court upheld it.

Key Points of the Second-instance Judgment: According to the provisions of the Equity Management Measures on “shareholder position name” “hierarchical ratio” and “personal shareholding”, the shareholding ratio of Xie should be adjusted from RMB500,000 to RMB200,000.  BSIET should pay the equity buy-back price to Xie to recover the adjusted portion of the shares.  Upon examination, the court of second instance held that the amount of the equity buy-back price determined by the court of first instance was not improper and confirmed it.


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