Abstract
When hearing a case concerning an atypical actively-managed trust, the court should determine whether the trustee has fulfilled its fiduciary duties based on trust documents and following the spirit of trust law. In case of violation of fiduciary duties, the court should examine whether a causation exists between the trustee’s misconduct and the settlor’s losses and determine the share of the trustee’s liability in light of its causative potency.
Basic Facts
The defendant, a trust company, created a Pooled Funds Trust Plan for Equity Income Rights Investment (the “trust plan”) in 2016. The trust plan would raise, in tranches, trust funds to acquire the equity income rights of a gold trading company, a subsidiary of an industrial company, and upon expiry of the trust plan, the industrial company would repurchase these equity income rights at an agreed price. According to the Due Diligence Report of a Pooled Funds Trust Plan for Equity Income Rights Investment (the “Due Diligence Report”) prepared by the trust company for the trust plan, both the industrial company and the gold trading company were in a healthy condition and highly solvent. The plaintiff, a rural commercial bank (the “bank”), subscribed to the trust plan’s tranche 2 units worth RMB 220 million. The tranche 2, worth RMB 220 million, was duly created on February 28, 2017 and in favor of the sole beneficiary, namely the bank, offering a 6.8% expected annualized return.
After the creation and operation of the trust plan, the trust company sent to the bank a Post-Loan Inspection Report and then periodically, from April 11, 2017 to April 13, 2018, a Quarterly Trust Affairs Management Report. None of these reports indicate any default risk on the side of the industrial company. Thereafter, in the quarterly report dated July 12, 2018, the trust company declared the industrial company in default for failing to pay the required interest on June 21, 2018. Consequently, the trust company sued the industrial company, who was ordered by the effective judgment to pay the trust company RMB 922,427,340 in total covering the principal, repurchase premiums, and liquidated damages, plus the interest thereon. But the industrial company was unable to fulfill the effective judgement. During the enforcement procedure, the ruling of termination of the present enforcement proceedings decided an outstanding amount of RMB 1,157,595,990 on the part of the industrial company. Additionally, public records indicate that the industrial company was involved in hundreds of cases, where the claimed enforcement value totaled more than RMB 2.4 billion. The bank alleged that the trust company frequently misstated or omitted several key matters or facts in its disclosures in the Due Diligence Report and other supporting documents, failed to base its conclusions therein on facts and professional judgement, and failed to take timely stop-loss measures for the severe deficiency in its risk management and compliance processes during its operation and management of the trust funds. Therefore, the bank filed this lawsuit, demanding compensation from the trust company for: (1) its subscription funds loss of RMB 220,000,000; and (2) its expected income loss of RMB 14,002,396.72. The defendant trust company argued that as the disputed trust project was essentially a passageway deal, the trustee was not required to perform active management duties, and further, the trustee had diligently and prudently fulfilled its obligations as a trustee during the project management.
Holding
On March 23, 2023, the Shanghai Financial Court (the “Court”) issued a civil judgment ((2022) Hu 74 Min Chu No. 204): (1) ordering the defendant trust company compensate the plaintiff bank RMB 22,000,000 for subscription funds loss; (2) dismissing the remaining claims of the plaintiff bank. Both the bank and the trust company appealed the first instance judgement. On September 8, 2023, the Shanghai High People’s Court issued a civil judgment ((2023) Hu Min Zhong No. 523), dismissing the appeal and affirming the original judgment.
Reasoning
The Court opined that regarding the determination of the type of the disputed trust: First, neither the Trust Contract nor the Due Diligence Report specifies that the trust company would only provide passageway services to the bank without bearing any active management duties; and according to the Due Diligence Report, it can be determined that the trust plan was designed by the trust company according to the capital needs and purposes of the industrial company rather than to the independent decision of the bank. Second, the Trust Contract stipulates, among others, that “during the term the Equity Income Rights Transfer and Repurchase Contract, if the Trustee considers that its exercise of rights thereunder (including, but not limited to, requiring the industrial company to perform repurchase obligation in advance) might substantially affect the beneficiaries’ interests, the Trustee shall consult all beneficiaries in advance and exercise these rights according to their unanimous opinion or the resolution of the beneficiaries’ meeting”. It follows that in case of a major matter, the trustee is not allowed to deal with at its own discretion but required to seek an opinion from beneficiaries, which is clearly at odds with the duties of a trustee in an actively-managed trust. Therefore, the disputed trust constitutes neither a passageway deal claimed by the trust company, nor a typical actively-managed trust in the practice.
Regarding the performance standards and determination of liability for a trustee in an atypical actively-managed trust: First, when reviewing whether a trustee, as a professional financial institution, has fulfilled its legal and contractual duty of due diligence, regardless of an actively or passively managed trust, a court may consider the following materials prepared by the trustee after the creation of the asset management product concerned and determine assumption of liability based on these materials: internal decision-making procedures and other approval materials produced during its investment management, day-to-day management materials produced during the term of the project, and relevant materials produced during the liquidation and risk resolution of the project. In this case, during its due diligence investigation of the industrial company, the trust company failed to engage a third-party professional institution to issue a review opinion on the financial health and future solvency of the industrial company, or to personally verify the key items and data in the audit report or financial statement of the industrial company; instead, the trust company made its analysis only based on the financial data from the industrial company and the gold trading company. In other words, as the trust company failed to verify the key decision-making related data from the counterparties during its operations, it is determined that the company have failed to perform its duty of due diligence and is thus at fault. Moreover, during its risk management after the creation of the trust, the trust company is also negligent in that it failed to promptly notice the litigations involving its counterparties. Such lack of due diligence is, in part, causally linked to the bank’s losses, and should be considered to determine the scope of the trust company’s liability. Second, regarding the share of the trust company’s liability. The disputed trust is primarily exposed to the solvency risk from the industrial company. As the trust company had fully disclosed to the bank the transaction structure and risks of the product concerned, the bank, as a professional financial institution and institutional investor, should have known the above risks in a transaction for equity income rights transfer and repurchase. In view of the above reasons, the trust company should bear secondary liability for the bank’s losses, and it is determined in discretion that the trust company is liable for 10% of the bank’s lost principal.
Significance
This case concerns a business trust dispute where a commercial bank, as beneficiary, demanded compensation from a trust company for all investment and income losses on the grounds of the company’s breach of fiduciary duty. Issues in this case include, among others, the criteria to distinguish the types of trust activities under the bank-trust cooperation model, performance standards for the trust company as the trustee of an atypical actively-managed trust, and the determination of compensatory liability. These issues relate to the business norms and predictability of liability coverage in the trust industry, sparking concerns in the industry. In line with the basic principles of trust law and the spirit of the Minutes of the National Court Work Conference for Civil and Commercial Trials, the original judgment reasoned around the following issues: the key criteria to distinguish between actively-managed trusts and passively-managed trusts, a trust company’s liability as a trustee under different types of trust, and the criteria to determine a trustee’s compensatory liability in case of its improper performance of duty. The judgment sets a positive example for hearing similar cases in the future and facilitates the compliant operation of trust institutions.
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