| The legal status of equity is different from that of debt.Corporation law and contract law offer different default rules for debt-holders and equity-holders accordingly.However,in the economic reality,debt and equity are often combined to acquire necessary investment.In its economic essence,the claim of a junior creditor is the equivalent of a call option against a senior creditor,and the right of the equity holder a call option against the junior creditor.Equity and debt arrangements are thus merely two typical contracts in corporate finance transactions.Between these two types of contracts,there are a large number of "untypical" contracts,i.e.contracts that have been not "nominated" by laws.Under the precondition of not violating capital maintenance and interest control rules,these "unnamed" contracts should be considered valid and enforceable.In qualitative terms,a key element to distinguish between equity and creditor rights lies in the parties' ability to participate in the distribution of all profits according to the proportion of their capital contribution.Correspondingly,having the right to vote,to appoint a director,to distribute part of the profits,or even to nominate directors alone should not be sufficient for characterizing the claims as equity.Chinese law and courts tend to make rigid distinction between debt and equity,thus misinterpreting the intent of the parties and sometimes misallocating the commercial risk between the transecting parties.The principle of respecting the parties' freedom in the arrangement of mixing debt and equity applies not only to corporate financing transactions,but also to various types of contractual arrangements under non-corporate law,such as secured transactions and borrowing-lending transactions with risk-sharing attributes. |
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