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  • JAVY Insight | Things about equity pledge (II) -- risk analysis of equity pledge

    Release Time:2022-07-14

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    Reading guide

    The article "things about equity pledge (I) - overview of equity pledge" has introduced equity pledge in detail. This paper will focus on the risks of equity pledge and the matters needing attention in practice.

    I. risk of equity pledge


    01 for the pledgee

    For the pledgee, the risk of equity pledge is that the reduction of equity value makes it difficult to realize the pledge. The main reasons for the decrease in equity value are as follows


    ❐1.  Market reasons

    Equity pledge is like equity transfer. The pledgee's acceptance of equity pledge means that he has taken over the market risk of equity from the pledgor. The frequency and range of equity price fluctuations are generally much greater than the traditional physical assets used for security. Whether it is the operation risk of the enterprise whose equity is pledged or other external factors, the final result will be transferred to the price of equity.


    ❐2.  Litigation situation of the target company

    The target company is involved in a major lawsuit and may be ordered by the court to bear the liability for debt repayment, which will significantly reduce the value of the pledged equity.


    ❐3.  The behavior of the pledgor leads to the reduction of equity value

    After the establishment of the pledged equity, before the expiration of the debt repayment period, the pledgor, as the controlling shareholder, transfers the main assets of the target company at an obviously unreasonable low price, or hollows out the main assets of the target company through related party transactions.


    ❐4.  The behavior of the target company leads to the reduction of equity value

    Resolutions of the shareholders' meeting and the board of directors, and the distribution of profits and residual property of the target company; The management of the target company (management also includes strategic management, marketing, business management, etc.), and the disposal of major assets by the target company; Internal links related to the growth and management of the target company, such as the performance of business contracts and the face of major lawsuits.


    02 for the target company


    ❐1.  May damage the interests of the company

    As a shareholder, equity pledge itself is a choice between equity and cash. Once equity cannot be redeemed in equity pledge, it will damage the operating interests of the company, have a huge impact on the equity structure of the enterprise, increase the debt ratio, and the corresponding enterprise operation ability and solvency will be weakened.


    ❐2.  May cause the transfer of shareholders' control

    The high proportion of equity pledge of the actual controller led to economic difficulties in the later redemption of equity; Compared with traditional bank credit channels, equity pledge faces more uncertainty, so whether it has the ability to redeem after the expiration of the pledge period, and whether it can continue to pledge shares to provide additional security, these factors may lead to the change of control, which directly affects the stability of the company's production and operation and control.

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    (the picture is quoted from the network)


    II. Precautions in actual operation


    01 the scope of the guarantee is specified in the guarantee agreement, otherwise the guarantee may be invalid.

    In the case of Xinhua trust, the court finally held that the guarantee was invalid because it was not clearly defined that the guarantee was a creditor's right. As a result, after the court determined that the investment was an equity investment, the guarantee was invalid because the guaranteed main creditor's right did not exist.


    02 strengthen the examination of the pledge right.

    When establishing equity pledge, on the one hand, the articles of association and operating conditions of the target company should be strictly reviewed, such as whether there are restrictive provisions on equity pledge in the articles of association. Poor operating conditions lead to the reduction of equity value after the establishment of equity pledge. On the other hand, check whether the equity has defects, or whether the equity has been pledged. If the equity is flawed, it may face the risk of damage to the guarantee ability and the elimination of the pledge.


    03 equity pledge is best used in conjunction with other security measures.

    The guarantee of equity pledge is weak. Although the shareholders have pledged their equity, the assets and businesses of the target company can still be transferred. Once the core assets and businesses are transferred, the equity of the company will have little value, and it will be difficult to obtain the repayment of creditor's rights by disposing of the equity. If the target company has land and real estate, it is suggested that the land and real estate be mortgaged together. If there is no land and real estate, at least let the actual controller individuals or couples make joint and several guarantees. If the controlling shareholder is a legal person with good credit standing, the controlling legal person can be required to make joint and several guarantees. In addition, control measures such as seals, licenses and bank accounts of the co managed subject company can be added to try to control the risk of reducing the equity value of the subject company.


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