May 2026
On the Legal Nature of Equity Repurchase Rights in Valuation Adjustment Mechanisms (VAM Agreements) (Mainland China)
As a core clause in valuation adjustment mechanisms (VAM agreements), the legal characterization of the equity repurchase right directly determines the applicable standard for the exercise period. For a long time, judicial practice has been divided between the “claim right theory” and the “formative right theory,” resulting in inconsistent judgments in similar cases. In August 2024, the Supreme People’s Court issued the Selected Q&A of the FaDa Network (Ninth Batch), providing a tendency-oriented response regarding the nature of equity repurchase rights and the applicable exercise period. Taking this response as a point of departure, this article examines the legal nature of equity repurchase rights and the applicable time limits.
I. The Nature of Equity Repurchase Rights
As a core instrument in private equity investment, VAM agreements aim to resolve valuation discrepancies arising from information asymmetry between investors and financing parties. Among these, the equity repurchase clause is the most common form: where the target company fails to achieve an initial public offering within the agreed period or fails to meet specified performance targets, the investor is entitled to require the founding shareholders or the target company to repurchase the equity held by the investor at an agreed price.
However, the precise legal nature of the equity repurchase right has long troubled both academia and practice. This issue carries significant practical implications: if the repurchase right is characterized as a creditor’s claim right, it is subject to a three-year statute of limitations, which may be suspended or interrupted; if it is characterized as a formative right, it is subject to a peremptory period, upon the expiration of which the right is extinguished and is not subject to rules on suspension or interruption. This distinction directly determines the time frame within which investors may exercise their rights and affects the stability of the commercial expectations of the target company and its shareholders.
II. Theoretical Debates on the Nature of Equity Repurchase Rights
A. The Claim Right Theory : The claim right theory holds that an investor cannot, by unilateral declaration of intent, directly establish a share transfer relationship; rather, realization of the right depends on the performance of the repurchase obligor. Once the repurchase conditions are satisfied, the investor merely acquires the right to request that the obligor perform the repurchase obligation. If the obligor refuses to perform, the investor must assert their rights through litigation.
The principal arguments supporting this view include: First, the repurchase clause is essentially a contractual arrangement subject to a condition precedent; upon fulfillment of the condition, the investor acquires a creditor’s claim. Second, the transfer of equity requires the cooperation of both parties in completing the registration of the change, and a unilateral declaration cannot effectuate the transfer of property rights. Third, characterizing the repurchase right as a claim right is consistent with the fundamental principles governing obligations under the Civil Code.
B. The Formative Right Theory : The formative right theory posits that the repurchase clause grants the investor the unilateral power to form a legal relationship of equity transfer. Once the repurchase conditions are triggered, the investor may establish a share transfer contractual relationship by issuing a repurchase notice, leaving the repurchase obligor with no discretion as to whether to contract.
The supporting arguments are as follows: First, repurchase clauses are typically phrased as “the investor has the right to require repurchase,” rather than “repurchase is automatically triggered,” reflecting the investor’s unilateral decisional power. Second, characterizing the right as formative encourages timely exercise and prevents prolonged uncertainty in legal relationships. Third, the repurchase right is functionally analogous to the right of contract rescission, which is widely recognized as a formative right. The Shanghai First Intermediate People’s Court, in case (2023) Hu 01 Min Zhong No. 5708, adopted this view, holding that the repurchase right “is capable of unilaterally altering legal relationships and should be subject to the rules governing peremptory periods.”
C. The Composite Right Theory : The composite right theory attempts to reconcile the above two positions by dividing the repurchase right into two stages. The first stage is the “repurchase option,” namely a unilateral formative right allowing the investor to decide whether to exit, which must be exercised within a reasonable period. The second stage is the “claim for payment of the repurchase price,” a creditor’s claim arising after the option is exercised and subject to the statute of limitations.
The theoretical advantage of this approach lies in its dual accommodation: it respects the investor’s freedom of choice upon the occurrence of repurchase conditions while avoiding indefinite non-exercise that could undermine corporate stability. As noted in scholarly commentary, the repurchase right constitutes “a composite right combining an option to request repurchase and a claim for payment arising from the execution of the repurchase transaction.”
III. Evolution in Judicial Practice
A. The 2024 FaDa Network Response
In August 2024, the Supreme People’s Court responded via the FaDa Network on issues concerning equity repurchase rights in VAM agreements. The key points may be summarized as follows: First, the repurchase right is a composite right conferring an option upon the investor. Second, where the parties have agreed on the exercise period, such agreement shall prevail; in the absence of such agreement, the right shall be exercised within a reasonable period, which “in adjudicative practice should generally not exceed six months.”
The innovation of this response lies in its explicit adoption of the composite right theory at the level of the Supreme People’s Court and in providing concrete guidance on the exercise period. However, its limitations are equally evident: responses from the FaDa Network do not constitute judicial interpretations and therefore lack binding force; moreover, the suggested six-month period lacks empirical grounding and its reasonableness remains open to question.
B. Standards for Determining a “Reasonable Period”
The FaDa Network suggests that a “reasonable period” should not exceed six months, yet the legitimacy of this standard warrants scrutiny. Article 564 of the Civil Code provides for a one-year peremptory period for the right of contract rescission. Given the functional similarity between rescission rights and repurchase rights, the rationale for recommending six months instead of one year is not adequately explained.
More importantly, whether a six-month period can accommodate complex commercial scenarios is debatable. Investors often require time to assess the company’s prospects and explore alternative exit strategies; a six-month period may be unduly restrictive. Practitioners have suggested that the determination of a reasonable exercise period should take into account multiple factors, including the visibility of the triggering event, the objective feasibility of exercising the right, and fluctuations in equity value, rather than applying a uniform temporal standard.
IV. Conclusion
The legal characterization of equity repurchase rights, while ostensibly a matter of applying civil law concepts in the commercial context, is, in essence, a question of balancing two competing values: the investor’s freedom to exit and the stability of corporate operations. The composite right theory, with its dual structure of “option plus claim,” provides a coherent theoretical framework for achieving this balance. The FaDa Network response aligns with this theoretical trend and offers important guidance for judicial practice. Nevertheless, its recommended six-month standard requires further empirical validation and institutional refinement and may serve as a reference for investors contemplating the adoption of equity repurchase mechanisms.
I. The Nature of Equity Repurchase Rights
As a core instrument in private equity investment, VAM agreements aim to resolve valuation discrepancies arising from information asymmetry between investors and financing parties. Among these, the equity repurchase clause is the most common form: where the target company fails to achieve an initial public offering within the agreed period or fails to meet specified performance targets, the investor is entitled to require the founding shareholders or the target company to repurchase the equity held by the investor at an agreed price.
However, the precise legal nature of the equity repurchase right has long troubled both academia and practice. This issue carries significant practical implications: if the repurchase right is characterized as a creditor’s claim right, it is subject to a three-year statute of limitations, which may be suspended or interrupted; if it is characterized as a formative right, it is subject to a peremptory period, upon the expiration of which the right is extinguished and is not subject to rules on suspension or interruption. This distinction directly determines the time frame within which investors may exercise their rights and affects the stability of the commercial expectations of the target company and its shareholders.
II. Theoretical Debates on the Nature of Equity Repurchase Rights
A. The Claim Right Theory : The claim right theory holds that an investor cannot, by unilateral declaration of intent, directly establish a share transfer relationship; rather, realization of the right depends on the performance of the repurchase obligor. Once the repurchase conditions are satisfied, the investor merely acquires the right to request that the obligor perform the repurchase obligation. If the obligor refuses to perform, the investor must assert their rights through litigation.
The principal arguments supporting this view include: First, the repurchase clause is essentially a contractual arrangement subject to a condition precedent; upon fulfillment of the condition, the investor acquires a creditor’s claim. Second, the transfer of equity requires the cooperation of both parties in completing the registration of the change, and a unilateral declaration cannot effectuate the transfer of property rights. Third, characterizing the repurchase right as a claim right is consistent with the fundamental principles governing obligations under the Civil Code.
B. The Formative Right Theory : The formative right theory posits that the repurchase clause grants the investor the unilateral power to form a legal relationship of equity transfer. Once the repurchase conditions are triggered, the investor may establish a share transfer contractual relationship by issuing a repurchase notice, leaving the repurchase obligor with no discretion as to whether to contract.
The supporting arguments are as follows: First, repurchase clauses are typically phrased as “the investor has the right to require repurchase,” rather than “repurchase is automatically triggered,” reflecting the investor’s unilateral decisional power. Second, characterizing the right as formative encourages timely exercise and prevents prolonged uncertainty in legal relationships. Third, the repurchase right is functionally analogous to the right of contract rescission, which is widely recognized as a formative right. The Shanghai First Intermediate People’s Court, in case (2023) Hu 01 Min Zhong No. 5708, adopted this view, holding that the repurchase right “is capable of unilaterally altering legal relationships and should be subject to the rules governing peremptory periods.”
C. The Composite Right Theory : The composite right theory attempts to reconcile the above two positions by dividing the repurchase right into two stages. The first stage is the “repurchase option,” namely a unilateral formative right allowing the investor to decide whether to exit, which must be exercised within a reasonable period. The second stage is the “claim for payment of the repurchase price,” a creditor’s claim arising after the option is exercised and subject to the statute of limitations.
The theoretical advantage of this approach lies in its dual accommodation: it respects the investor’s freedom of choice upon the occurrence of repurchase conditions while avoiding indefinite non-exercise that could undermine corporate stability. As noted in scholarly commentary, the repurchase right constitutes “a composite right combining an option to request repurchase and a claim for payment arising from the execution of the repurchase transaction.”
III. Evolution in Judicial Practice
A. The 2024 FaDa Network Response
In August 2024, the Supreme People’s Court responded via the FaDa Network on issues concerning equity repurchase rights in VAM agreements. The key points may be summarized as follows: First, the repurchase right is a composite right conferring an option upon the investor. Second, where the parties have agreed on the exercise period, such agreement shall prevail; in the absence of such agreement, the right shall be exercised within a reasonable period, which “in adjudicative practice should generally not exceed six months.”
The innovation of this response lies in its explicit adoption of the composite right theory at the level of the Supreme People’s Court and in providing concrete guidance on the exercise period. However, its limitations are equally evident: responses from the FaDa Network do not constitute judicial interpretations and therefore lack binding force; moreover, the suggested six-month period lacks empirical grounding and its reasonableness remains open to question.
B. Standards for Determining a “Reasonable Period”
The FaDa Network suggests that a “reasonable period” should not exceed six months, yet the legitimacy of this standard warrants scrutiny. Article 564 of the Civil Code provides for a one-year peremptory period for the right of contract rescission. Given the functional similarity between rescission rights and repurchase rights, the rationale for recommending six months instead of one year is not adequately explained.
More importantly, whether a six-month period can accommodate complex commercial scenarios is debatable. Investors often require time to assess the company’s prospects and explore alternative exit strategies; a six-month period may be unduly restrictive. Practitioners have suggested that the determination of a reasonable exercise period should take into account multiple factors, including the visibility of the triggering event, the objective feasibility of exercising the right, and fluctuations in equity value, rather than applying a uniform temporal standard.
IV. Conclusion
The legal characterization of equity repurchase rights, while ostensibly a matter of applying civil law concepts in the commercial context, is, in essence, a question of balancing two competing values: the investor’s freedom to exit and the stability of corporate operations. The composite right theory, with its dual structure of “option plus claim,” provides a coherent theoretical framework for achieving this balance. The FaDa Network response aligns with this theoretical trend and offers important guidance for judicial practice. Nevertheless, its recommended six-month standard requires further empirical validation and institutional refinement and may serve as a reference for investors contemplating the adoption of equity repurchase mechanisms.
The contents of all newsletters of Shanghai Lee, Tsai & Partners (Content) available on the webpage belong to and remain with Shanghai Lee, Tsai & Partners. All rights are reserved by Shanghai Lee, Tsai & Partners, and the Content may not be reproduced, downloaded, disseminated, published, or transferred in any form or by any means, except with the prior permission of Shanghai Lee, Tsai & Partners.
The Content is for informational purposes only and is not offered as legal or professional advice on any particular issue or case. The Content may not reflect the most current legal and regulatory developments. Shanghai Lee, Tsai & Partners and the editors do not guarantee the accuracy of the Content and expressly disclaim any and all liability to any person in respect of the consequences of anything done or permitted to be done or omitted to be done wholly or partly in reliance upon the whole or any part of the Content. The contributing authors' opinions do not represent the position of Shanghai Lee, Tsai & Partners. If the reader has any suggestions or questions, please do not hesitate to contact Shanghai Lee, Tsai & Partners.
