Liability Assessment in Unfair Distribution by A Trustee¡ªYu X v. Shanghai X Zhou Fund Company for Dispute over Wealth Management Agreement

ABSTRACT

Fair distribution is an essential part of a trustee¡¯s fiduciary duty. Although a trustee may arrange distribution of proceeds pursuant to the trust instruments, any differentiated arrangement should be sufficiently justified rather than arbitrary. Notably, a trustee should distribute proceeds pursuant to trust instruments and in the interest of the trust, in particular balancing the conflicting interests of the beneficiaries. If a beneficiary does not receive his due share because of unfair distribution, he is entitled to seek compensation from the trustee.

FACTS

On February 11, 2017, Yu X entered into a Fund Agreement with Shanghai X Zhou Fund Company (¡°Shanghai XZ¡±), a private fund administrator, to subscribe to RMB 1 million worth of Class A units of a fund managed by Shanghai XZ. The agreement specified that the fund would primarily invest in the accounts receivable from construction projects undertaken by Jiangsu X Long Marine Engineering Co., Ltd. (¡°Jiangsu XL¡±), with an 18-month investment term. During subsequent distributions, Yu found out that Shanghai XZ did not distribute the income proportionally according to investors¡¯ unitholding. Specifically, certain investors received full repayment of principal and distributed income, while Yu, also an investor, did not receive his proportional share. Consequently, Yu filed a lawsuit to claim compensatory damages against Shanghai XZ, citing such unfair distribution injured his lawful rights and interests.

Shanghai XZ put forward two arguments in its defense. First, it argued no unfair distribution had occurred; certain investors had received their principal solely because they invested earlier than Yu. Second, Yu¡¯s losses could not be definitively determined at this point, as the fund had yet to be liquidated and recovery effortsagainst borrowers was still ongoing.

The trial court examined the bank statements for the fund¡¯s subscription and custody accounts, which showed the fund raised RMB 119,875,000. Through several payments made from the custody account between December 16, 2016 and April 21, 2017, Shanghai XZ paid RMB 119,875,000 to Jiangsu XL for the accounts receivable. The fund had 75 investors, including 67 Class A unitholders contributing RMB 88,675,000 collectively, and 8 Class B unitholders contributing RMB 31,200,000. With regard to the receivables and distributions collected and made by the fund, Shanghai XZ noted that according to its records, it had distributed RMB 74,617,763.49 in principal and income to investors via the fund¡¯s custody account and other relevant accounts in its name, and acknowledged that these distributions were exclusively funded by the receivables collected by the fund.

In addition, the Fund Agreement included the following terms: (1) Each unit of the fund would enjoy equal rights and interests unless otherwise specified in the agreement; (2) Each unit in the same class would enjoy equal rights to distribution; (3) The private fund administrator was obligated to finalize the distribution plan according to the terms of the agreement and make timely distributions to investors, and would be liable for compensating for any losses suffered by the fund or any harm to the interests of the unitholders that arise from its breach of the agreement, with such liability surviving its exit as the administrator.

HOLDING

On May 31, 2023, the Fengxian District People¡¯s Court of Shanghai rendered civil judgment (2022) Hu 0120 Min Chu No. 9273, denying all claims of Yu. Yu then appealed to the Shanghai Financial Court (¡°Court¡±).

On May 31, 2024, the Court rendered civil judgment (2023) Hu 74 Min Zhong No. 2060, which (1) vacated the judgment (2022) Hu 0120 Min Chu No. 9273; (2) ordered Shanghai XZ to pay RMB 382,316.74 to Yu for distribution losseswithin ten days of effectiveness of the judgment; and (3) ordered Shanghai XZ to compensate Yu for interest losses within ten days of effectiveness of the judgment.

REASONING

Yu sought a court order holding Shanghai XZ liable for breach of contract for its unfair distribution. The Court identified two main issues of this case: (1) whether Shanghai XZ made unfair distribution in violation of the Fund Agreement (¡°Agreement¡±), and if so, whether it needed to make compensations; and (2) if compensatory liability is established, how to determine its scope.

Regarding the first issue, Shanghai XZ, while admitting to making early distributions, asserted its right to decide the distribution of income under Article 19 of the Agreement. It also claimed that it did not breach the terms of the Agreement in making distributions in the order of subscriptions by investors.

The Court does not share this view. First, Article 5 of the Agreement stipulates that, unless otherwise agreed in the Agreement, each unit of the fund enjoyed equal rights and interests. Article 19 provides that distribution of the private fund was to be made such that each unit in the same class enjoyed equal right to distribution¡­ If the funds in the capital account were insufficient for distribution, they would be allotted to unitholders in proportion to their unitholding percentage, with the shortfall to be allotted and made up in the next distribution or upon termination of the fund. According to these provisions, the fund units in question were divided into Class A and Class B units, which differed from one another primarily in the performance benchmark used (which was chosen based on the initial investment amount), but not in the order of distribution.

Furthermore, the Agreement stipulates that the investment term for each issue of units was from the start date of the investment term to the corresponding date 18 months later, and the issue that included Yu was to purchase the accounts receivable due from Fengdu X Tong Shipping Development Co., Ltd. to Jiangsu XL. These provisions evidence that the fund in question was a closed-end fund and had a single investment target, which means investors should exit at the same time.

Lastly, subscription to the relevant fund units was made between December 2016 and April 2017, and all the subscription money was used to purchase the accounts receivable. If distribution was made according to the order of subscription as stated by Shanghai XZ, then in the same closed-end fund, earlier subscribers might receive all their principal plus the investment returns, while later subscribers could lose their entire principal. This is a clear violation of the terms of the Agreement and the principle of fair distribution.

In summary, Shanghai XZ¡¯s distribution to certain investors in violation of the Agreement harmed Yu¡¯s right to fair distribution and made it liable for compensation.

Regarding the second issue, the compensatory liability of Shanghai XZ should be limited to the amount Yu did not receive due to the unfair distribution arrangement. During the second-instance hearing, the total distributed amount was calculated based on evidence provided by Yu and the distribution statements submitted by Shanghai XZ. The amount was not contested by Yu. To determine the amount underpaid to Yu, the Court multiplied Shanghai XZ¡¯s total distributions by Yu¡¯s unitholding percentage, then subtracted from it the income already received by Yu. Additionally, Shanghai XZ should compensate Yu for interest losses resulting from the delayed distribution.

SIGNIFICANCE

This case represents China¡¯s first court decision holding a private fund administrator liable for compensation for unfair distribution. Most trusts in China today are express trusts, where matters such as the intentions of the settlor and the rights of the beneficiaries are set out in the trust instruments. Similarly, the duties of the trustee are primarily established by the agreements between the parties.

In this case, an investor accused the trustee of making an unfair distribution and the trustee defended its action by citing its right to decide distribution under the trust agreement. However, the right to decide distribution is not equal to a right to make arbitrary distribution. Absent explicit provisions in the trust instruments that can help one determine whether a trustee¡¯s conduct in a specific circumstance is in line with the agreed terms, judicial discretion should be exercised to reflect the general duties of a trustee prescribed by the statutes.