Case Study: Reservation Contract Dispute Regarding Violation of Good Faith Negotiation

Judgment Reference: Shanghai No. 2 Intermediate People's Court (2023) Hu 02 Min Zhong No. 9584 Civil Judgment. 1. Cause of Action: Reservation Contract Dispute. 1. Parties:- Plaintiff (Appellant): Liu. - Defendant (Appellant): An Industrial Company. - Defendant (Appellee): Zhang. - Third Party: Ren.

[Basic Facts] On October 26, 2021, the Plaintiff signed an "Equity Acquisition Intent Agreement" (hereinafter referred to as the "Intent Agreement") with the two Defendants and a non-party Insurance Brokerage Company.

It was agreed that the Defendant Industrial Company and Defendant Zhang would transfer their 80% and 20% equity holdings in the Insurance Brokerage Company to the Plaintiff, respectively, for a transfer price of 25 million RMB.

The Plaintiff was required to pay a transaction deposit within 3 working days after signing the "Intent Agreement" and commence due diligence. Upon completion of due diligence, the parties were to sign the "Equity Transfer Agreement," and the Plaintiff would pay the remaining equity transfer price of 24.

5 million RMB according to the terms of the "Equity Transfer Agreement". If the Plaintiff refused to sign the "Equity Transfer Agreement" without justifiable reason after completing due diligence, the paid deposit would not be refunded. Third-party Ren, as the spouse of Defendant Zhang, signed the agreement on behalf of Defendant Zhang.

After the "Intent Agreement" was signed, the Plaintiff paid a deposit of 500,000 RMB to the Defendant Industrial Company and carried out due diligence. On December 15, 2021, the Plaintiff sent a drafted "Equity Transfer Agreement" template to the General Manager of the Defendant Industrial Company's group, requesting to sign the agreement as soon as possible,.

The Defendant Industrial Company replied requiring the Plaintiff to raise sufficient funds by the end of February 2022 before signing the equity transfer contract and paying the equity transfer funds together.

To raise funds, the Plaintiff agreed with a non-party Information Company that both sides would jointly raise 25 million RMB to acquire the Insurance Brokerage Company's equity. If the acquisition could not be completed on schedule, the Plaintiff would pay a penalty of 900,000 RMB to the Information Company.

In March 2022, the Plaintiff sent screenshots of the raised funds to the Defendant Industrial Company. The Defendant Industrial Company and the spouse of Defendant Zhang (the third party in this case) replied refusing to transfer the equity to the Plaintiff. In June 2022, the Plaintiff paid the penalty of 900,000 RMB to the Information Company.

Consequently, the Plaintiff sued in court, requesting that the two Defendants jointly return double the deposit (1 million RMB) and compensate the Plaintiff for losses. [Case Focus]

The contracting subjects and the nature of the "Intent Agreement";1. Whether the contracting subjects under the reservation contract engaged in behavior violating good faith negotiation;1. The liability for breach of contract to be borne by the party violating the reservation contract.

[Court Adjudication Synopsis] The Shanghai Hongkou District People's Court held after trial: Regarding Dispute Focus 1, the "Intent Agreement" is essentially two reservation contracts carried on the same written contract document.

Among them, both the Plaintiff and the Defendant Industrial Company had stamped or signed, so a reservation contract regarding the transfer of 80% equity of the Insurance Brokerage Company was established between these two parties.

As to whether a reservation contract was established between Defendant Zhang and the Plaintiff, since the third party Ren does not enjoy an automatic domestic agency right regarding the equity transaction matters involved in the reservation contract, and in the absence of authorization from Defendant Zhang, the third party Ren had no right to sign the "Intent Agreement" on behalf of Defendant Zhang,.

There was also no apparent agency appearance in this case. Therefore, no reservation contract relationship was established between the Plaintiff and Defendant Zhang regarding the 20% equity of the Insurance Brokerage Company.

According to the proportion of equity held by the two Defendants, the excess deposit of 100,000 RMB collected by the Defendant Industrial Company constituted unjust enrichment and should be returned. Regarding Dispute Focus 2, the "Intent Agreement" is a reservation contract between the Plaintiff and the Defendant Industrial Company agreeing to conclude an equity transfer agreement within a certain future period.

The main obligation of both parties under this reservation contract is to negotiate and conclude the equity transfer agreement with the counterparty, rather than to fulfill specific obligations under the equity transfer agreement.

The fundraising and payment of the equity transfer price belong to the scope of performance of the main contract (the Equity Transfer Agreement) after it is signed. In the absence of specific stipulations in the reservation contract, the Plaintiff was not obligated to raise or pay the equity transfer price prior to signing the main contract.

By setting extra conditions for the Plaintiff to sign the main contract outside of the reservation contract—specifically refusing to sign the main contract on the grounds that the Plaintiff had not raised transaction funds in advance—the Defendant Industrial Company violated its obligation to negotiate in good faith and conclude the main contract with the Plaintiff under the reservation contract, and should bear liability for breach of contract.

Regarding Dispute Focus 3, the breach of contract by the Defendant Industrial Company resulted in the parties being unable to conclude the main contract, and the purpose of the reservation contract could not be realized.

Therefore, it should bear liability for breach of the reservation contract based on the deposit penalty clause, returning double the deposit (800,000 RMB) to the Plaintiff,. Regarding the compensation for losses claimed by the Plaintiff, at the time the Defendant Industrial Company signed the reservation contract, it could not have foreseen the fact that the Plaintiff would unauthorizedly reach a joint acquisition agreement with a non-party and agree on liability for breach of contract.

The Plaintiff has no right to claim compensation for losses that the Defendant Industrial Company could not foresee. The Shanghai Hongkou District People's Court, in accordance with Articles 495, 509 Paragraph 1, 584, 586, 587, and 588 Paragraph 2 of the "Civil Code of the People's Republic of China," and Article 67 Paragraph 1 of the "Civil Procedure Law of the People's Republic of China," ruled as follows:

The Defendant Industrial Company shall double return the deposit of 800,000 RMB to the Plaintiff Liu within ten days from the effective date of this judgment;1. The Defendant Industrial Company shall return the money of 100,000 RMB to the Plaintiff Liu within ten days from the effective date of this judgment;1.

The Defendant Industrial Company shall compensate the Plaintiff Liu for lawyer agency fee losses of 60,000 RMB within ten days from the effective date of this judgment;1. Dismiss the remaining litigation requests of the Plaintiff Liu against the Defendant Industrial Company;1.

Dismiss all litigation requests of the Plaintiff Liu against the Defendant Zhang. The Plaintiff Liu and the Defendant Industrial Company refused to accept the first-instance judgment and filed an appeal. The Shanghai No. 2 Intermediate People's Court held after trial: It agreed with the judgment opinion of the first-instance court.

In accordance with Article 177, Paragraph 1, Item 1 of the "Civil Procedure Law of the People's Republic of China," it ruled as follows: Dismiss the appeal and sustain the original judgment.