Breaking through the ‘channel’ to protect investors

Authors: Ren Guobing / Li Xinqian

(This article was first published on China Business Law Journal column "Asset Management", authorised reprint)

Shanghai Financial Court released its Top 10 Typical Cases of 2020 on 16 March 2021. The first case in the country in which a trust company acting as a “channel” – where the entrusted party merely serves as a conduit for the funds flowing towards the assets designated by the client – was held liable for external investors was listed. The official media of the court stated this case “has important benchmark significance”. This comment responded to the previous view that the case was not universally applicable. This case is worth attention from relevant subjects in the channel business.

Previous cases

Article 93 of the Minutes of the National Work Conference on the Trial of Civil and Commercial Cases by Courts stipulates that “the rights and obligations between the principal and trustee shall be determined in accordance with the provisions of trust documents”. In relevant cases, the Supreme People’s Court (SPC) decided that trustees of the channel business should not bear the liability to principals after performing contractual obligations.

If rights and obligations between principals and trustees are not clearly agreed in trust documents, the courts might fill the gap, or explain the contracts, with default rules from the Trust Law to determine the obligation, fault and liability of trustees.

Recent cases

In the above-mentioned case, of Wu v Trust Company A (name withheld), no trust relation or contract relation was established between Wu and trust company A. Wu is the upper-tier investor of the trust product, and the court found trust company A liable for damages in tort to Wu according to the Tort Liability Law. The first trial of this case analysed the constituent elements of the tort, and the second trial recognised this analysis approach.

In recognition of the existence of infringement and subjective fault, the court reviewed the compliance of trust company A’s business. First, the administrative reconsideration decision from the China Banking and Insurance Regulatory Commission found that trust company A“failed to perform compliance review of the source of entrusted funds for the trust plan, violating the prudent operation rule”, and the court adopted this opinion.

Second, trust company A issued a false project risk screening report, at the client’s request, without performing due diligence investigation, violating the duty of reasonable care. This act violated the trustee’s duty of good faith under the Trust Law, which is also a pillar of civil law.

In terms of damages, as Wu’s investment money could not be retrieved, the court found that the damage was established. In terms of causality, the court’s stance was to protect the reliance of investors, and it found that, first, investors have reason to believe that the products are regulated and verified by the trust company, based on the project risk screening report, and that the issuance of the false screening report had objectively served to deceive investors.

Second, under the circumstances that trust company A knew, or should have known, that the funds were derived from unspecified persons in society, it “failed to take the necessary preventive and control measures against criminals borrowing their financial institutions’ backgrounds for fund raising, and failed to warn social investors accordingly, objectively contributing to criminals’ fund-raising frauds”.

Regarding the proportion and form of liability, the court found that the fund-raising fraud of the criminals was the root and main cause of the investors’ losses, and that Wu was at fault for the occurrence of the losses, and therefore found, at its discretion, that trust company A bore the supplementary liability for 20% of the incurred losses.

Fund of trust structure

In a separate case, the court of Chaoyang district in Beijing decided that trust company B was fully liable for the losses of upper-tier investors, and that the trust company, as a channelling party, had committed infringement to upper-tier investors. This decision is still to be tested by second trial. However, comparing with the trust company A case, some common features are shared. First, the investors are unspecified investors, and the fund-raising involved many people. Second, the issuer and manager of the trust product had conflicts of interest with the fund-raising party on the asset side.

Such a type of trust structure is called fund of trust (FOT), and this type of channel business has triggered tort liability for investors in courts in Shanghai and Beijing, which is related to the characteristics of this type of product.

On the one hand, these investors are not professional institutions, and they lack accurate understanding of investment risks and the nature and consequences of channel business. On the other hand, since the issuers and managers of the trust products have an interest in the fund-raising party, and the trust companies do not have the obligation of active management, the moral hazard of the issuers and managers of the financial products are easily triggered, resulting in losses to the investors.

In particular, it should be noted that in trust business regulation practice, although pooled fund trust plans and business management trusts are not in conflict, and business management pooled fund trust plan exist in practice, article 9 of the Measures for the Administration of Pooled Fund Trust Plans of Trust Companies stipulates: “Trust companies shall conduct due diligence investigations before establishing trust plans, and issue due diligence reports on matters such as feasibility analysis, legality, risk assessment, and the existence of related party transactions.” This article might lead the court to strengthen the responsibility of the trustee under the business management type of pooled fund trust plan.

Contractual privity

Based on the privity of contracts, investors can only claim liability to the institution with which they have established a direct contractual relationship, and if the institution lacks solvency, it is difficult for investors to recover their losses.

The trust company A case is an important benchmark case that breaks through the privity of contract, and uses the concept of tort to protect investors’ reliance when holding the capital management institution liable, which is an important model. This case may reshape the path of recovery for investors against asset management institutions, and its significance should not be underestimated.

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任国兵 

合伙人

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任国兵律师毕业于中国政法大学，获得法学学士学位。任律师专注于金融机构资产管理业务、家族信托与慈善信托业务及资产证券化业务。在加入竞天公诚之前，任律师曾分别在某知名律所金融信托部及某知名信托公司法律合规管理总部工作多年，担任过法规专业总监等职务，现担任某信托公司独立董事。

任律师服务的客户覆盖国内领先信托公司、商业银行及银行理财子公司、保险资产管理公司等几十家金融资产管理机构，任律师领导的律师团队已为超过1000支不同类型的资产管理产品提供过法律服务并擅长资产管理业务相关的风险处置与争议解决。任律师荣登2018年度LEGALBAND“中国律界俊杰30强”榜单，并于2019年及2020年连续两年荣获LEGALBAND中国顶级律师排行榜推荐律师。

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 李昕倩  

合伙人

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李昕倩律师主要从事金融、公司等领域的诉讼和仲裁。李律师主办了多起由最高人民法院和各级法院、中国国际经济贸易仲裁委员会、北京仲裁委员会等仲裁机构审理的重大案件，熟悉法院和仲裁机构的运作方式和裁判思维。李律师负责案件处理方案的筹划和实施，具有丰富的庭审经验。

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