In March this year, Jotai’s perennial legal advisory unit sent a special demand for legal services, requiring the liquidation and withdrawal of three limited partnership enterprises and two limited liability companies directly invested by the actual controller. During the due diligence period, it was found that the actual controller's companies invested not only spans multiple industries, but also some of the invested companies have as many as a hundred shareholders. However, those companies’ articles of association are all simple templates and there are no clear provisions regarding the actual controller's concerns such as equity structure, consortium offer, voting rights, capital reduction or withdrawl.

In March this year, Jotai’s perennial legal advisory unit sent a special demand for legal services, requiring the liquidation and withdrawal of three limited partnership enterprises and two limited liability companies directly invested by the actual controller. During the due diligence period, it was found that the actual controller's  companies invested not only spans multiple industries, but also some of the invested companies have as many as a hundred shareholders. However,  those companies’ articles of association are all simple templates and there are no clear provisions regarding the actual controller's concerns such as equity structure,  consortium offer, voting rights, capital reduction or withdrawl.

Starting from the legislative background and purpose of the Partnership Enterprise Law of the People's Republic of China, and combining with typical cases, this article aims to analyze how to effectively design and apply the "proviso" clauses in the Partnership Enterprise Law of the People's Republic of China to protect investors.

1、 Legislative background and purpose

The provisions of the "proviso" related to limited partnership enterprises are stipulated in the Partnership Enterprise Law of the People's Republic of China (2006 Revision) (hereinafter referred to as the "Partnership Enterprise Law"). To explore the legislative background and purpose of the proviso provisions can not be separated from the research on the legislative evolution, revision background and purpose of the Partnership Enterprise Law.

Legislative background

The limited partnership and the "proviso" clause are rooted in the fertile soil of the socialist market economy with Chinese characteristics, and are born in the legislation based on the continuous practice of economy.

Prior to the explicit provisions of the law, limited partnership enterprises had been included in the Partnership Regulations of Shenzhen Special Economic Zone in 1994 and were specified in the special chapter of "Chapter III limited partnership", without the provision of "proviso".

The Partnership Enterprise Law of the People's Republic of China (Draft) in 1996 contains information about limited partnership, but on February 19, 1997, at the 24th meeting of the Standing Committee of the Eighth National People's Congress, Li Yining, Vice Chairman of the Legal Committee of the National People's Congress, pointed out in the "Report of the Legal Committee of the National People's Congress on the Review Results of the Partnership Enterprise Law of the People's Republic of China (Draft)" that: "Some members of the Standing Committee, departments, local experts and legal experts have proposed that, in practice, it is a common form for partners to assume unlimited joint and several  liabilities, while the limited partnership formed by some unlimited partners and some limited partners is an exception and the problem is more complicated. Foreign countries generally legislate limited partnership separately. Considering that there is no limited partnership registration in China, there is still no experience in this regard. Therefore, limited partnership may not be stipulated in this law. After joint study with the Finance and Economics Committee of the National People's Congress, it is proposed to delete the provisions of the chapter on limited partners in the draft."

Therefore, the Partnership Law of the People's Republic of China, formulated in 1997, does not stipulate relevant provisions for limited partnership enterprises. Instead, it stipulates in Article 5 that "a partnership enterprise shall not use the words' limited 'or' limited liability 'in its name." Article 66 stipulates that in violation of the provisions of this Law, if the words' limited' or 'limited liability' are used in the name of a partnership enterprise, it shall be ordered to correct within a time limit, and a fine of no more than two thousand yuan can be imposed.

Later, with the economic development, and the increasing practices of relevant legislation , as the examples, the Regulations on Zhongguancun Science Park implemented by Beijing government in 2001 and the Regulations on High tech Industrial Park of Xiamen Special Economic Zone implemented by Xiamen government in 2002 both stipulate that "venture capital institutions can use the form of limited partnership"; At the same time, in order to meet the actual needs of China's socialist market economy system construction and economic and social development, the Standing Committee of the National People's Congress revised and passed the Partnership Enterprise Law in 2006, so far, limited partnership enterprise has been officially  confirmed by law, and the proviso clauses related to limited partnership enterprise have also been written into law.

Legislative purpose

The "proviso" clauses related to limited partnership enterprises serve the limited partnership enterprise system, which make the relevant systems of limited partnership enterprises more flexible in practice, and promote the development of the limited partnership enterprise system in China.

On April 25, 2006, at the 21st meeting of the Standing Committee of the Tenth National People's Congress, Yan Yixun, Vice Chairman of the Finance and Economic Committee of the National People's Congress, pointed out in the "Explanation on the Revised Draft of the Partnership Enterprise Law of the People's Republic of China" that: "... Secondly, the development of venture capital urgently needs to stipulate the limited partnership system in the law.... The common organizational form of venture capital is limited partnership, that is, on the basis that at least one partner assumes unlimited liability, other partners are allowed to assume limited liability, so as to effectively combine institutions or individuals with investment management experience or technology research and development capabilities with investment institutions with financial strength… Thirdly, The development of business service institutions urgently needs to stipulate the limited liability partnership system in the law …Since China's partnership enterprise law does not stipulate limited liability partnership, but only stipulates the form of general partnership in which all partners bear unlimited joint and several liability, therefore the development of professional service institutions such as accounting firms is greatly limited. The scale of each professional service institution is generally small, which makes it difficult to compete with foreign professional service institutions... "

Article 1 of the Partnership Enterprise Law stipulates: "In order to regulate the behavior of partnership enterprises, protect the legitimate rights and interests of partnership enterprises, their partners and creditors, maintain social and economic order, and promote the development of the socialist market economy, this law is formulated.

The "proviso" clause is conducive to the development of limited partnership enterprises in China, logically makes direct or indirect contribution to the development of venture capital and professional service institutions, and also conducive to "regulating the behavior of partnerships, protecting the legitimate rights and interests of partnerships and their partners and creditors, maintaining social and economic order, and promoting the development of socialist market economy".

2、 Main "proviso" clauses in the Partnership Enterprise Law and relevant cases

List of proviso clauses related to limited partnership

A proviso clause, also known as a proviso, is a specific sentence structure in a legal provision that serves as a turning point, exception, restriction, supplement, or additional condition to the previous provision. The proviso clause is generally expressed in the form of "... but...". But there are also exceptions, such as the form of "excluding...".

In the Partnership Law, the legal provisions of proviso clauses related to limited partnership are listed as follows:

Article 19, Paragraph 2 of the Partnership Enterprise Law stipulates: "Any amendment or supplement to the partnership agreement shall be unanimously agreed upon by all partners, except as otherwise agreed in the partnership agreement.”

Article 21 of the Partnership Enterprise Law stipulates: "Before the liquidation of the partnership enterprise, partners shall not request the division of the property of the partnership enterprise, except as otherwise provided in this Law

”

Article 23 of the Partnership Enterprise Law stipulates: "If a partner transfers their share of property in the partnership enterprise to a person other than the partners, the other partners have the right of first offer under the same conditions unless otherwise agreed in the partnership agreement

Article 61 of the Partnership Law stipulates that "a limited partnership shall be established by more than two and less than fifty partners, except as otherwise provided by law."

Article 69 of the Partnership Law stipulates: "A limited partnership may not distribute all its profits to  certain partners, unless otherwise agreed in the partnership agreement."

Article 70 of the Partnership Law stipulates: "A limited partner may conduct transactions with this limited partnership, unless otherwise agreed in the partnership agreement."

Article 71 of the Partnership Enterprise Law stipulates: "A limited partner may operate on his own or in cooperation with others a business that competes with this limited partnership, except as otherwise agreed in the partnership agreement."

Article 72 of the Partnership Law stipulates: "A limited partner may pledge his share of property in a limited partnership, unless otherwise agreed in the partnership agreement."

Article 82 of the Partnership Law stipulates: "Unless otherwise agreed in the partnership agreement, the transformation of a general partner into a limited partner or a limited partner into a General partner shall be subject to the unanimous consent of all partners."

Main "proviso" clauses and precedents

This section further introduces the proviso clauses in Article 19, Paragraph 2; Article 69; Article 71 and related cases.

(1) Article 19, Paragraph 2: Amendment or Supplement to the Partnership Agreement

Article 19 (2) of the Partnership Enterprise Law stipulates: "The modification or supplementation of the partnership agreement shall be subject to the unanimous consent of all partners unless otherwise agreed in the partnership agreement." This means that through the provisions of the partnership agreement, the number, proportion, or voting rights ratio of the partners required for "modifying or supplementing the partnership agreement" can be changed, but procedural issues should also be noted during the process.

Overall, the agreement should be clear and specific  both in the substantial and the procedural perspectives. It should also avoid conflicting terms between different documents and minimize the possibility of disputes.

In the (2020) Jing 03 Min Zhong No. 3355 case where Li and Yan filed to confirmed the invalidity of the contract. Article 10.1 of the firm's articles of associationstipulated, "modification of the partnership agreement of the firm must be approved by more than three-quarters of all partners before implementation." As a partner, Li has never received notice of the meeting to modify the partnership agreement, nor has he received any relevant proposals. Li believed that the Supplementary Agreement violates the provisions of the Firm's Articles of Association and was invalid.

The court found out that Li signed the Partnership Agreement with Yan and other 24 people, which was the true declaration of will of the parties, did not violate the mandatory provisions of laws and administrative regulations, and should be legal and effective. Article 7.11 stipulates that the interpretation and modification of this agreement shall be approved by more than three-quarters of all partners (including this number). The content above did not stipulate procedural matters such as convening a partner meeting or voting to modify the partnership agreement.

The court held that the Supplementary Agreement has been signed and approved by three-quarters of the partners, and complies with the provisions of Article 7.11 of the Partnership Agreement. The procedure was legal and therefore valid.

Due to the existence of relevant agreements, the appellant lost the lawsuit, which proves the necessity of the agreement. The case highlights the procedural deficiencies in the supplementary agreement for formulating the partnership agreement as well, which led to disputes. Although the court ultimately confirmed the effectiveness of the relevant supplementary agreement, from the perspective of reducing disputes, the enterprise ensures the uniformity of rules and regulations within the enterprise by setting reasonable procedures and measures, and ensures that there are no conflicts between the terms.

(2) Article 69: Distribute all profits to certain partners

Article 69 of the Partnership Law stipulates: "A limited partnership may not distribute all its profits to certain partners, except as otherwise agreed in the partnership agreement." That is, through the partnership agreement, a limited partnership may distribute all its profits to one or certain partners.

In the field of financial investment and asset management, the private equity funds, and trust products, etc. often adopt the structured arrangement of limited partnership, and carry out a structured classification design for limited partners (LPs), that is, the priority partners receive income distribution according to the priority of the partnership agreement, while the inferior partners obtain residual income or bear losses after the products have priority to distribute income to the priority partners. The structural arrangement of limited partnership needs to clearly stipulate in the limited partnership agreement that the principal of some limited partners will not suffer losses or guarantee their minimum interests. Profit distribution is one of the ways to realize the minimum guarantee clause. The provisions of Article 69 of the Partnership Law are more conducive to the implementation of the minimum guarantee clause, and there are many cases supporting it.

In the case of (2012) WFMCZ No. 01612 Chen sued Qiang for  for a partnership agreement, the court held that according to Article 69 of the Partnership Enterprise Law, "limited partnership shall not distribute all profits to certain partners unless otherwise agreed in the partnership agreement", the agreement agreed that the plaintiff would not bear risks but only collect fixed profits, which did not violate the law, so the defendant should pay 666600 yuan of profits to the plaintiff.

In the case of a dispute over the withdrawal of a certain enterprise management center and Liu in the (2020) Lu 14 Min Zhong No. 2320 case, the court held that Article 33 (2) of Chapter 2 of the Partnership Enterprise Law of the People's Republic of China  stipulated: "The partnership agreement shall not stipulate that all profits shall be distributed to certain partners or that certain partners shall bear all losses. However, Article 69 of the limited partnership part of Chapter III stipulates that "a limited partnership shall not distribute all its profits to some partners, unless otherwise agreed in the partnership agreement." In this case, the partnership is a limited partnership, and the provisions of Article 69 shall apply. In addition, Liu made an agreement with Li  personally, which does not violate the mandatory provisions of laws and administrative regulations, and shall be confirmed as valid. In the event that Li withdrew from the partnership after the two-year lockdown period, Liu shall be responsible for filling the gap between Li's principal loss and the annual earnings of less than 12%.

In a series of contract disputes between XXX( a real estate development group limited company)and Hu, from (2016) Wan 0102 Min Chu No. 1001 to No. 1019, the court held that, in accordance with Articles 33 and 69 of the Partnership Enterprise Law of the People's Republic of China, the profit distribution and loss bearing of the partnership enterprise shall be handled in accordance with the provisions of the partnership agreement. The limited partnership shall not distribute all profits to certain partners unless otherwise stipulated in the partnership agreement. It can be seen from this that limited partnership is different from general partnership in that it can be agreed that some partners can obtain income and cash the due principal according to the expected rate of return.

However, the profit distribution model of partnership private equity funds is different and will not be elaborated in this article.

(3) Article 71 Limited Partners Engage in Competitive Business

Article 71 of the Partnership Law stipulates that " limited partners may engage in business competing with this limited partnership on his own or in cooperation with others,  unless otherwise agreed in the partnership agreement." That is, a limited partner may lawfully engage in business competing with this limited partnership, whether on his own or in cooperation with others, unless prohibited by the partnership agreement.

If it is not prohibited in the partnership agreement, and the limited partner is only disposed of on the ground that the limited partner engages a competitive business, the court can support the limited partner's complaint to request the enterprise to revoke the decision. As shown in the following case:

In the (2017) Hu 01 Min Zhong No. 6517 partnership agreement dispute case between Qu and Zhu, Qu was expelled because he was engaged in business competing with the limited partnership enterprise, so he filed the lawsuit.

The court found out that Qu was a limited partner of a limited partnership at that time, and as a shareholder, he set up a company with others to engage in business that compete with the limited partnership enterprise. The partners of the limited partnership enterprise made the Resolution on Removal and Withdrawal of Limited Partner Qu: in view of your misconduct in the implementation of partnership affairs, the resolution on your removal and withdrawal of equity was unanimously agreed by the other four partners... The Partnership Agreement did not provide that limited partners to operate competitive businesses.

The court held that although the appellant had set up  other companies or enterprises with  similar business names to operate businesses competing with the partnership, China's laws allowed limited partners to operate businesses competing with the limited partnership on their own or in cooperation with others, and the Partnership Agreement involved in  this case did not prohibit limited partners from operating competitive businesses. Therefore, the appellant's behaviors does not constitute a situation where the partnership enterprise suffers losses due to the partner’s intentional or gross negligence.

Withdrawal of limited partnership - application of proviso clause in combination with other clauses

This part takes a case of  withdrawing from a limited partnership as a counter example to introduce how to draw up a partnership agreement beneficial to one's own side when the proviso clause is combined with other clauses.

▶ 1. Case Overview:

An investment management center (limited partnership) has invested in 5 limited partnership enterprises, and now needs to handle matters such as withdrawal of partnership and capital withdrawal, so as to finally realize the cancellation of enterprises smoothly. It was found that the partnership agreements of the five limited partnership enterprises invested did not specifically stipulate the relevant provisions on withdrawal.

▶ 2. Case analysis:

Before the cancellation of a partnership enterprise, it is necessary to clear the debt relationship, withdraw its investment in other entities, and properly resolve litigation matters. Otherwise, there may be legal risks such as breach of contract, breach of trust, and even suspected withdrawing the contributed capital. Therefore, it is necessary to comprehensively review the investment situations and safely complete the transfer of shares and withdrawal of capital.

The limited partnership is an enterprise with strong human cooperation, and the  transfer of shares is not as convenient as that of a company limited. The way of capital withdrawal needs to be confirmed according to the partnership agreement, the articles of association and relevant laws.

In addition, the law has strict regulations on withdrawal. The Partnership Enterprise Law stipulates as follows:

Article 45 stipulates: "If the partnership agreement stipulates the duration of the partnership, during the existence of the partnership enterprise, a partner may withdraw from the partnership if one of the following circumstances occurs: (1) the reason for withdrawal as stipulated in the partnership agreement occurs; (2) with the unanimous consent of all partners; (3) there is a reason why it is difficult for the partner to continue participating in the partnership; (4) other partners seriously violate their obligations as stipulated in the partnership agreement

Article 46 stipulates: "If the partnership agreement does not specify the partnership  duration, partners may withdraw from the partnership without causing adverse effects on the execution of the partnership's affairs, but other partners shall be notified 30 days in advance.

Article 47 stipulates: "If a partner withdraws from the partnership in violation of the provisions of Article 45 and Article 46 of this Law, they shall compensate for the losses caused to the partnership enterprise as a result

Article 48, Paragraph 1 stipulates: "A partner shall naturally withdraw from the partnership if: (1) a natural person who is a partner dies or is declared dead in accordance with the law; (2) an individual loses the ability to repay debts; (3) a legal person or other organization who is a partner is revoked of its business license, ordered to close down, revoke, or declared bankrupt in accordance with the law; (4) Legal provisions or partnership agreements stipulate that partners must have relevant qualifications and they lose such qualifications; （5） All property shares of partners in the partnership enterprise shall be enforced by the people's court

Article 78 stipulates: "If a limited partner falls under any of the circumstances listed in Items 1, 3 to 5 of Paragraph 1 of Article 48 of this Law, he shall  naturally withdraw from the partnership."

From the above legal provisions, it can be seen that a more reasonable way to withdraw from the partnership is for an investment management center to withdraw with the unanimous consent of all partners. The risk of this approach is that partners cannot withdraw from the partnership if they cannot obtain the consent of other partners.

Moreover, the exit mode of limited partnership is also the transfer of property shares.

Article 22 of the Partnership Enterprise Law stipulates: "Unless otherwise agreed in the partnership agreement, when a partner transfers all or part of  his(or her) property shares in the partnership enterprise to a person other than the partners, unanimous consent from the other partners is required. When a partner transfers all or part of his (or her) property shares in the partnership enterprise, the other partners shall be notified.

Article 73 of the Partnership Law stipulates that "a limited partner may transfer his(or her) shares of property in a limited partnership to a person other than the partners in accordance with the partnership agreement, but shall notify the other partners 30 days in advance."

The transfer of property shares can also be divided into internal transfer and external transfer. External transfer generally requires the consent of all partners, and the  right of first offer of other partners should be considered when transferring. Therefore, if we want to realize the withdrawal of capital as soon as possible, we can withdraw from limited partnership by means of internal transfer, that is, transfer of property shares between partners.

▶ 3. Case inspiration:

Since the partnership agreement of the investment management center (limited partnership) does not specifically stipulate the relevant provisions on withdrawal, it is inevitable that other partners will agree to achieve the purpose of withdrawal, and the conditions are more stringent. If the withdrawal clauses in the partnership agreement are agreed in advance according to the relevant provisions in the Partnership Law, and the threshold of withdrawal requirements is lowered, the  partners can withdraw from the limited partnership much easier; It is also possible to agree on modifications or supplementary terms that are beneficial to one's own party to the partnership agreement, in order to supplement the corresponding withdrawal terms that are beneficial to one's own party in the future.