Is VAM still a safe option to protect investments?

The valuation adjustment mechanism (VAM), also known as the gambling agreement in China, is a commonly used tool for business investment, especially in growth enterprises. VAM is a set of contracts between investors and investees regulating their rights and obligations based on the uncertainty of the investees’ future performance. It is an option embodied in binding contracts, which can protect the investor’s interests. However, a recent case has quashed the possibility of realising the option previously agreed between the investor and investee, where the courts held that the contract carrying the option was void. This was the first time a Chinese court issued its opinion on the effectiveness of VAM and poses an unexpected question to private equity investors – is VAM still valid in China?

The case

Gansu Shiheng Nonferrous Resources Recycle is a wholly foreign-owned enterprise, fully owned by Hong Kong Diya. In 2007, by entering into an...