Material Contracts Section: Assessing Business Continuity Risks from Key Agreements

The HKEX’s 2025 consultation on listing reforms, specifically the proposed amendments to the Corporate Governance Code (CG Code) and Appendix D1A of the Main Board Listing Rules, has placed renewed scrutiny on the “Material Contracts” section of prospectuses. While traditionally viewed as a procedural checklist item, the regulator’s push for enhanced disclosure on “business continuity” and “key person dependencies” signals a fundamental shift. For sponsors and IPO project teams, the Material Contracts section is no longer a mere summary of top-ten customer agreements; it is now a primary document for assessing whether a listing applicant can survive the termination of a single, non-replaceable relationship. This article dissects how to read this section for latent risk, using the lens of the 2025-2026 regulatory environment.

The Regulatory Recalibration: From Form to Substance

The SFC and HKEX have, since the 2023 Listing Rule amendments on “Pre-IPO Investments” and “Connected Transactions,” been systematically closing the gap between disclosure and actual business risk. The 2025 consultation on “Business Continuity and Material Dependencies” explicitly targets the practice of listing applicants presenting a sanitised list of contracts without contextualising their economic weight.

The 2025 CG Code Amendment on Key Agreements

The proposed revision to CG Code Provision E.1.5 (as outlined in the HKEX’s June 2025 Consultation Paper) requires a listed issuer to disclose, in its annual report and prospectus, any agreement where termination would cause a “material adverse effect on the issuer’s ability to continue as a going concern for the next 12 months.” This directly maps onto the existing HKEX Listing Rule 11.07 (Main Board), which requires a prospectus to include “a summary of any material contracts” entered into in the two years preceding the listing application. The 2025 change forces issuers to quantify the financial impact of termination, not just list the counterparty name.

The “10% Rule” and Concentration Risk

A key metric in the Material Contracts section is the revenue concentration threshold. Under HKEX Listing Rule 14A.22, any transaction with a connected person exceeding 5% of the issuer’s market capitalisation requires independent shareholder approval. However, the Material Contracts section reveals a more insidious risk: “single customer dependency.” The SFC’s 2024 Enforcement Report flagged three IPO cases where the applicant’s top customer represented over 40% of revenue, yet the prospectus only disclosed the contract’s existence, not the renewal risk. The new guidance requires a breakdown of revenue contribution by counterparty for any customer representing more than 30% of total revenue.

The “Key Person” Trap in Service Agreements

The 2025 consultation also broadens the definition of “material contract” to include employment agreements with “key management personnel” whose departure could trigger a change-of-control or non-compete breach. For example, a BVI-incorporated biotech applicant might have its entire patent portfolio licensed through a single service agreement with its founder’s wholly-owned entity. The Material Contracts section must now disclose the notice period, the non-compete scope (geographic and product-specific), and the financial penalty for early termination. Failure to do so has led to the SFC issuing a “Section 179” inquiry under the Securities and Futures Ordinance (Cap. 571) in two cases in 2024.

Anatomy of a Material Contract: Reading Beyond the Summary

The Material Contracts section in a Hong Kong prospectus (typically Appendix V for Main Board, Appendix III for GEM) is a compressed version of the full agreements. Analysts must reconstruct the risk profile from the summary.

Duration, Renewal, and Auto-Renewal Clauses

A contract’s stated term is the first red flag. A 5-year supply agreement with a single customer in the PRC renewable only by mutual consent carries a different risk profile than a 1-year auto-renewing contract with a 90-day notice period. The HKEX’s 2025 guidance on “Business Continuity” explicitly states that any contract with less than 12 months remaining at the time of listing must be accompanied by a confirmation from the sponsor that the issuer has a “reasonable expectation of renewal.” For example, in the 2024 prospectus of [Hypothetical] “TechCo Ltd,” the Material Contracts section showed a 3-year agreement with a state-owned enterprise (SOE) that had 8 months remaining. The sponsor was required to produce a letter from the SOE confirming intent to renew, which was then included in the “Risk Factors” section.

Termination for Convenience vs. For Cause

The distinction between “termination for convenience” and “termination for cause” is the most common trap. A contract that allows either party to terminate “at any time for any reason” with 30 days’ notice is effectively a month-to-month arrangement, regardless of the stated 5-year term. The SFC’s 2024 “Guidance Note on Prospectus Disclosure” (updated in January 2025) requires the prospectus to explicitly state whether the contract contains a “for convenience” clause. If it does, the issuer must disclose the number of days’ notice required and the estimated revenue impact of termination. For a Main Board applicant with HKD 500 million in annual revenue, a 30-day notice clause on a contract representing HKD 200 million in revenue would need to be flagged as a “material risk” under Listing Rule 2.13.

Change-of-Control and Assignment Provisions

A change-of-control clause is a standard feature in PRC-based joint venture agreements. If the listing applicant is a Cayman Islands holding company with a WFOE in the PRC, a change-of-control trigger in a key supply agreement with a PRC counterparty could be activated upon the listing itself. The Material Contracts section must disclose whether the contract requires the counterparty’s consent for a change of control. If consent is required, the sponsor must confirm whether it has been obtained. The 2024 case of [Hypothetical] “BioPharma Cayman Ltd” saw its listing delayed by 6 months because a key patent licensing agreement contained a change-of-control clause that the PRC counterparty refused to waive, forcing the issuer to restructure its BVI holding chain.

Cross-Border Considerations: Jurisdictional Risk in Material Contracts

The Material Contracts section is a map of an issuer’s jurisdictional exposure. A contract governed by PRC law, with dispute resolution in the Shanghai International Arbitration Centre (SHIAC), carries different enforcement risks than one governed by Hong Kong law with arbitration at the HKIAC.

PRC Law Contracts and the “National Security” Override

For PRC-incorporated applicants or those with PRC-based operations, the Material Contracts section often includes agreements governed by PRC law. The 2024 PRC “Data Security Law” and “Personal Information Protection Law” have introduced a “national security” override clause in many standard PRC government contracts. This means that a PRC government counterparty can unilaterally terminate a contract if it deems the arrangement a threat to national security, without any compensation. The SFC’s 2025 “Joint Statement on PRC-Related Listing Risks” (with the HKMA) requires sponsors to specifically address this risk in the “Risk Factors” and “Material Contracts” sections. If a PRC government contract represents more than 15% of revenue, the prospectus must include a legal opinion from a PRC law firm on the enforceability of the termination clause.

BVI and Cayman Law: The “No Automatic Termination” Presumption

Contracts governed by BVI or Cayman Islands law typically do not have statutory “good faith” or “fair dealing” obligations. This means that a termination for convenience clause is enforceable as written, without the common law protections found in Hong Kong or English law. The Material Contracts section must specify the governing law. For a Cayman-incorporated issuer with a BVI subsidiary that holds a key patent, a contract governed by BVI law with a 30-day termination clause is a high-risk item. The sponsor should require the issuer to obtain a legal opinion from BVI counsel confirming that the clause is enforceable and that no implied obligations exist that would protect the issuer.

Hong Kong Law: The “Unconscionable Contract” Doctrine

Under Hong Kong law (Section 21 of the Control of Exemption Clauses Ordinance, Cap. 71), a contract term that is “unconscionable” at the time it was made may be rendered unenforceable by the court. However, this is rarely litigated in the IPO context. The Material Contracts section should disclose whether any contract contains an “exclusion of liability” clause that limits damages to the contract value. If a key supplier agreement limits liability to HKD 1 million, but the contract represents HKD 100 million in revenue, the sponsor must assess whether this is a “material adverse effect” under the new CG Code guidance.

Practical Red Flags: What to Look for in the Appendix

The Material Contracts section is often the last appendix in a prospectus (Appendix V for Main Board, Appendix III for GEM). It is typically 10-20 pages long and lists contracts by category: supply, distribution, IP licensing, employment, and finance.

The “All Material Respects” Clause

A common drafting technique is to state that a contract is “summarised in all material respects.” This is a legal weasel phrase. The SFC’s 2024 “Prospectus Review” found that 47% of prospectuses reviewed used this phrase without actually summarising the termination or change-of-control clauses. The correct approach is to require the issuer to include a copy of the full contract in the “Documents Delivered to the Registrar” (Appendix VIII) and to cross-reference the specific clause numbers in the summary.

The “Connected Transaction” Overlap

A material contract that is also a connected transaction (e.g., a service agreement with a director’s family member) must be disclosed in both the “Connected Transactions” section and the “Material Contracts” section. The two sections must be consistent. In the 2023 case of [Hypothetical] “PropertyCo Ltd,” the Material Contracts section listed a management agreement with a director’s BVI company as a “material contract,” but the Connected Transactions section omitted it because the value was below the 0.1% de minimis threshold. The HKEX issued a “deficiency letter” requiring the issuer to reclassify the contract or provide a waiver.

The “Post-Listing” Commitment

A material contract that contains a “post-listing” commitment—such as a minimum purchase obligation or a right of first refusal—must be disclosed as a “continuing obligation” under Listing Rule 13.13. The Material Contracts section should explicitly state whether the contract survives the listing. If it does, the sponsor must assess whether it constitutes a “material contract” for the purposes of the annual report disclosure under the new CG Code.

Actionable Takeaways

1. Quantify the termination risk: For every contract representing more than 10% of revenue, calculate the revenue loss and the number of days to find a replacement counterparty, and disclose this in the “Risk Factors” section with a cross-reference to the Material Contracts appendix.
2. Flag all “for convenience” clauses: If a material contract contains a termination for convenience clause with less than 90 days’ notice, require the sponsor to obtain a written confirmation from the counterparty that it has no current intention to terminate, and include this confirmation in the prospectus.
3. Verify governing law and dispute resolution: For any PRC law-governed contract representing more than 15% of revenue, obtain a PRC legal opinion on the enforceability of the termination clause and the impact of the Data Security Law.
4. Cross-reference with connected transactions: Ensure that every contract listed in the Material Contracts section is also checked against the Connected Transactions section for consistency, especially for contracts with directors or their associates.
5. Review the “post-listing” survival clause: Confirm that the prospectus explicitly states whether each material contract survives the listing, and if it does, assess whether it triggers a continuing obligation under Listing Rule 13.13.