China’s private equity (PE) fund industry has experienced rapid growth in recent years, playing an active role in improving financing structures and encouraging innovation and entrepreneurship. However, due to changes in the market environment — with difficulties in listing and mergers and acquisitions (M&A) along with weakened investor confidence — many PE funds face challenges in exiting projects on schedule.

Against a backdrop of sub-optimal investment returns and increased market volatility, disputes have become increasingly frequent between investors and fund managers, custodians, advisory institutions and sales agencies over issues such as suitability obligations, fiduciary duties and rigid payment guarantees.

Analysis of litigation and arbitration cases involving PE funds reveals a clear upward trend in such disputes, with arbitration cases significantly outnumbering litigation cases.

Disputes are concentrated in the management and exit stages of the “fundraising, investment, management, and exit” cycle. During the management stage, key issues often include whether managers have acted diligently, whether investment decisions comply with regulations, and information disclosure.

In the exit stage, disputes frequently centre on diverse performance-based agreements and listing-related clauses, with conflicts between investors and founders becoming particularly intense. Additionally, a common practical challenge is the low enforcement rate of favourable judgments due to the poor creditworthiness of judgment debtors.

Debt evasion

In cases where portfolio companies underperform, the financing environment deteriorates and performance-based agreements reach their deadlines, some founders face significant moral risks of “debt evasion” under the pressure of such agreements.

For instance, in a case handled on behalf of a PE fund against a founder, the portfolio company failed to meet performance targets and did not complete an IPO within the stipulated timeframe, triggering the founder’s obligations for performance compensation and equity buyback.

The fund sued the founder for payment of performance compensation and equity buyback amounts. During the litigation, the founder presented a shareholder resolution — previously unseen by the fund — claiming their obligations for performance compensation and equity buyback had been waived.

As the resolution bore the fund’s official seal, the first-instance court accepted it and dismissed the fund’s claims. Upon taking over the case at the appeal stage, evidence was uncovered showing the founder had forged the shareholder resolution using a blank stamped page provided by the fund during a capital increase registration process.

By reconstructing the facts through business registration records, interviews with personnel and communication records — and arguing that authenticity of a seal does not necessarily validate the content of a document — the court was successfully persuaded to overturn the initial judgment and fully support the fund’s claims.

Another common dispute in judicial practice involves the risk of debt evasion arising from “contract signing by proxy”. During the negotiation stage, parties such as investors, portfolio companies, founders and guarantors are often geographically dispersed, and contracts undergo multiple revisions.

Due to the inconvenience of in-person signing, parties frequently sign investment and guarantee contracts through proxies, creating risks of unauthorised signatures. When performance-based clauses are triggered, relationships deteriorate or litigation ensues, founders may argue that the contracts were not personally signed and are therefore not legally binding.

In another case handled for a PE fund against a guarantor, the guarantor argued that the guarantee contract was signed by another person on their behalf, and that they did not agree to assume guarantee responsibilities, requesting handwriting verification.

Verification confirmed that the signature on the guarantee contract was not the guarantor’s, and the first-instance court ruled that the guarantor was not liable. At the appellate stage, new evidence was gathered, including chat records showing: the guarantor’s awareness and approval of the guarantee contract; their active facilitation of the fund’s investment; proof of their long-term involvement in the portfolio company’s management; and recordings of their negotiations with the fund.

The evidence demonstrated the guarantor’s knowledge and consent to the guarantee obligations. Although the signature was not theirs, the fund had reasonable grounds to believe the guarantor authorised the proxy under the principle of apparent authority. The appellate court ultimately ruled that the guarantor was jointly liable, safeguarding the fund’s rights and mitigating potential risks of investor claims against the fund manager for negligence.

Evolving perspectives

Another particularly noteworthy trend is the impact of evolving judicial perspectives on the PE fund sector. For instance, the Supreme People’s Court recently stated that the reasonable period for exercising equity buyback rights should be six months. If investors exercise buyback rights beyond this period, courts will not support their claims.

This perspective has rapidly spread within the judicial community, sparking heated debate and potentially triggering a wave of equity buyback disputes.

From the perspective of fund managers, they could previously make commercial decisions based on market conditions, the company’s status, future prospects and communication with founders. However, the new risk of forfeiture due to delayed action means that fund managers must exercise buyback rights within six months, once conditions are triggered.

This could immediately place founders under buyback obligations, leaving no room for negotiation and potentially destabilising portfolio companies. Banks may cut off loans due to perceived risks, external financing channels may be blocked, and companies may face cash flow crises. Founders burdened with heavy debt may struggle to manage their companies, leading to internal instability and operational chaos, or even bankruptcy.

On the other hand, if fund managers choose not to exercise buyback rights within six months, they risk being held accountable by investors. In a buyback case being currently handled, the fund manager faces this dilemma: whether to promptly pursue legal action against the founder for equity buyback, or delay action in an attempt to rescue the struggling portfolio company.

This decision affects not only the interests of fund managers, investors and founders, but also the future of the portfolio company and the investment industry.

New challenges

Such dynamic changes in judicial policies and perspectives present new challenges for PE funds. In addition to focusing on investment performance, PE funds must pay close attention and adapt to evolving regulatory requirements and government policies, with the impact of geopolitical factors becoming increasingly significant.

On the legal and regulatory front, the introduction and revision of the Regulations on the Supervision and Administration of Private Investment Funds, the Minutes of the Ninth Civil Trial Conference and the newly revised Company Law have improved the legal framework for PE funds and had a profound impact on dispute resolution within the industry.

On the government influence front, institutional limited partners (LPs) such as government platforms and industrial platforms are playing an increasingly important role in China’s PE sector. State-owned capital is rapidly expanding and the state-owned nature of fund managers is becoming more prominent.

In January 2025, the General Office of the State Council issued its “No. 1 Document”, namely the Guiding Opinions on Promoting the High-Quality Development of Government Investment Funds. This proposes 25 measures across seven areas to promote the scientific, efficient and high-quality development of government investment funds, which have become a significant force in the capital market.

Due to the policy-driven needs of local governments, government investment funds often aim to leverage state-owned capital to attract more private capital and channel funds into local industries. As a result, the market-oriented operations of PE funds are inevitably influenced by policy objectives such as local employment, tax revenue and industrial support.

In some cases, PE funds may even be compelled to provide “guaranteed returns” to government investment funds. When investors exit, they may face challenges such as subordinated returns compared to government investment funds, local protectionism or policy restrictions.

The above-mentioned guiding opinions also encourage the development of secondary market funds (S funds) and M&A funds, which may lead to new hotspots in dispute resolution such as disputes over share transfers, the validity of partnership resolutions, and withdrawal issues.

Key takeaway

PE funds in China face diverse, complex, professional and high-risk disputes in the field of dispute resolution. With improved laws and stricter regulations, the PE fund industry must strengthen compliance operations, risk management, information disclosure and investor education, while effectively addressing disputes, seeking professional support and safeguarding their rights through legal means.