Abstract
In a two-layer nested asset management contract, an investor should, in principle, be bound by the doctrine of privity of contract if it claims right against the manager of a secondary investment project. However, the investor may directly claim tort liability against the manager according to law, if the manager, knowing the actual investor of the project and his reasonable investment reliance, commits any tortious act in violation of laws, regulations and other normative documents governing investor protection or public order and good morals, resulting in damage to the investor’s lawful rights and interests.
Basic Facts
Juchao-CSC A Asset Management Plan (the “AMP”) was issued by Shanghai Juchao Asset Management Limited Company (“Juchao”) for a term of 24 months extendable for 12 months. Juchao acted as the manager of the AMP, and Huatai Securities Co., Ltd. (“Huatai Securities”) acted as the custodian. According to the Asset Management Contract, during the investment period, no less than 95% of the AMP’s capital should be invested in the limited partner shares of a limited partnership enterprise (LPE) where China Science & Merchants Investment Management Group (“CSC”) acts as the general partner and managing partner. The LPE would mainly invest in the stocks of companies admitted to the National Equities Exchange and Quotations (the “NEEQ”) and equities of pre-IPO companies, including but not limited to equities of companies planning listing on the main board, growth enterprise market (GEM) board, small and medium enterprises (SME) board or admission to the NEEQ, as well as in deposit facilities. In addition, the LPE’s cumulative investment in a single company may not exceed 20% of the AMP’s net value.
In January 2016, Huatai Securities organized several road shows for the AMP as the sales agency. Some road shows were participated in by designated staff from the CSC, who presented the CSC’s previous performance and the LPE’s (the fund’s) basic information and expected return.
After fundraising, Juchao, on behalf of the AMP, entered into a Partnership Agreement with CSC, under which: (1) the LPE would be named CSC Huahai; CSC would contribute 5% of the capital as the general partner, and Juchao would contribute 95% of the capital as the limited partner; Huatai Securities would act as the custodian for the LPE’s asset; (2) the LPE would set up an Investment Decision-Making Committee (IDMC) comprising of members appointed by the general partner and the limited partner and an investment decision must be approved by all the members; and (3) the investment projects and relevant restrictions should be consistent with those under the Asset Management Contract. CSC, on behalf of CSC Huahai, entered into a Custody Agreement with Huatai Securities.
CSC Huahai conducted the following investments and transactions: (1) In August 2016, the IDMC resolved to buy RMB 180 million worth of a bank’s short-term wealth management product. To this end, CSC required Huatai Securities to transfer RMB 180 million to a China Minsheng Bank account that CSC had opened with the name of CSC Huahai, and agreed to return the funds to the custody account upon capital recovery. It turned out that CSC invested all of the funds into a trust plan created by Minmetals International Trust Co., Ltd. (2) From October 2016 to April 2017, the IDMC resolved to invest around RMB 30 million into four companies, namely Dongming Petrochemical, Weisheng Industrial, Shaoshan Runze and Zhongchang Health, in the form of capital increase, equity transfer or capital contribution. According to CSC’s Analysis Report, Dongming Petrochemical and Weisheng Industrial had already had, or were about to have, intermediaries to supervise their proposed equity restructuring and admission to the NEEQ. However, CSC did not provide any further evidence after the event. CSC’s report on Shaoshan Runze and Zhongchang Health did not indicate the two companies had any plan for public listing. Eventually, none of the four companies went public. (3) In June 2017, without CSC Huahai IDMC’s approval, CSC applied the remaining RMB 60.3 million in the China Minsheng Bank account, which should have been returned to the custody account, toward buying Hengyu No. 55 Fund. As a result, the LPE’s actual investment exceeded the limit of proportion under the Partnership Agreement. After knowing the situation, Juchao initiated an arbitration with the China International Economic and Trade Arbitration Commission, which decided that CSC should pay to CSC Huahai 80% of the difference between RMB 60.3 million and the value after the liquidation or claim disposal of Hengyu No. 55 Fund as well as corresponding interest.
The AMP failed to exit upon its expiry in 2018.
In December 2019, Juchao, Huatai Securities, and CSC entered into a Memorandum, which specified that: (1) as CSC Huahai was unable to recover its investments in underlying assets in the short run, CSC designated its affiliate Zhongke Shengxiang as the transferee of all of Juchao’s shares in CSC Huahai; (2) the parties undertook that from the date that the transferee begins to perform the payment obligation, they would not, by themselves or through any other parties, provide any legal assistance of any form to investors. The parties determined the share transfer price based on a third party’s evaluation of CSC Huahai’s four invested companies (totaling RMB 29,856,000), and the damages payable by CSC awarded by the arbitral award (on the basis of zero liquidation value of Hengyu No. 55 Fund), and a premium compensation of RMB 19,389,804. They announced the share transfer price to investors.
On February 3, 2021, the AMP was deregistered upon liquidation after Zhongke Shengxiang paid up the transfer price in five installments and Juchao distributed the last installment received by the AMP.
In this case, investor Dai XX had subscribed to RMB 3 million of the AMP’s shares and lost RMB 1,318,033.83 of principal. Dai XX sued Juchao, CSC, and Huatai Securities for tort liability, claiming compensation for loss of principal, expected return, loss of interest, and attorney fee.
CSC and other defendants argued that they did not commit any tort. CSC further argued that Dai XX had no right to sue it for CSC Huahai’s investments.
Holding
On November 6, 2021, Shanghai Hongkou People’s Court (the “original court”) issued a civil judgment ((2020) Hu 0109 Min Chu No. 5898), ruling that: (1) Juchao and CSC should jointly and severally compensate Dai XX for loss of principal of RMB 922,623.68 and the interest thereon from February 4, 2021 to the date of actual payment; (2) Juchao and CSC should jointly and severally compensate Dai XX for an attorney fee of RMB 50,000; and (3) Dai XX’s other claims were dismissed. After the first instance judgment was pronounced, Juchao and CSC were dissatisfied and filed an appeal.
On October 28, 2022, the Shanghai Financial Court (the “appellate court”) rendered a civil judgment ((2022) Hu 74 Min Zhong No. 43), deciding that: (1) the first instance judgment was dismissed; (2) Juchao and CSC should jointly and severally compensate Dai XX for loss of principal of RMB 876,597.95 within ten days of the effectiveness of the judgment; (3) Dai XX’s other claims in the first instance were dismissed; (4) Juchao’s other claims in the appeal were dismissed; and (5) CSC’s other claims in the appeal were dismissed.
Reasoning
The original court held that, in this case, Huatai Securities was not at fault because it did not violate its suitability obligation and custody obligation; Juchao and CSC were at fault for failing to decide on and manage CSC Huahai’s investment projects pursuant to the Asset Management Contract and the Partnership Agreement. Specifically, the four project companies invested by Juchao and CSC upon joint decision-making did not meet the requirements for “pre-IPO companies;” CSC invested in Hengyu No. 55 Fund in violation of rules and caused losses, and Juchao failed to exercise supervision over the violation; Juchao transferred its shares to an unsuitable transferee at an unreasonable price when exiting from the private equity fund. Considering the market risk factor, DaiXX should be liable for 30% of the loss, and Juchao and CSC should be jointly and severally liable for 70% of the loss, the interest thereon, and the attorney fee. On November 16, 2021, the original court issued the civil judgment (the (2020) Hu 0109 Min Chu No. 5898), ruling that: (1) Juchao and CSC should jointly and severally compensate Dai XX for loss of principal of RMB 922,623.68 and the interest thereon from February 4, 2021 to the date of actual payment; (2) Juchao and CSC should jointly and severally compensate Dai XX for an attorney fee of RMB 50,000; and (3) Dai XX’s other claims were dismissed. After the judgment was pronounced, Juchao and CSC appealed, asserting that they were not at fault and Dai XX’s loss was caused by market risks. CSC further argued that Dai XX had no right to directly sue it because they did not stand in the same legal relation and that Dai XX could no longer request compensation after the transfer of shares in CSC Huahai.
The appellate court opined after the trial that the transaction in question is twofold in structure: (1) Dai XX’s investment in the AMP under the Asset Management Contract with Huatai Securities and Juchao; and (2) Juchao’s investment in CSC Huahai as a limited partner under the Partnership Agreement it signed on behalf of the AMP with CSC. In general, as dictated by the doctrine of privity of contract, Dai XX has no right to directly sue CSC for Dai XX’s own interests, but only to request the manager Juchao to sue CSC on behalf of the AMP for breach of contract, or in case of Juchao’s neglect of doing so, to seek remedy through a derivative action. But the case is peculiar in that Juchao and CSC had agreed not to sue each other nor to provide legal assistance to investors, and that the AMP had completed liquidation before the first instance judgment. In other words, the grounds no longer exist that justify Juchao’s or investors’ filing of a lawsuit on behalf of the AMP, meaning that investors can hardly seek remedy via the conventional path. Dai XX’s beneficial right in the AMP is a lawful property right and interest protected by the Tort Liability Law of the People’s Republic of China. By analogy with rules governing infringement of claims by a third party, CSC, as a third party to the Asset Management Contract, should bear corresponding tort liability if it, having known or should have known the creditor-debtor relation, violates its duty of diligence and other legal duties designed to protect the said property right and interest under the Trust Law of the People’s Republic of China and thus harms the investor’s lawful rights and interests. Therefore, in light of the wrongful acts of the parties and the resultant losses, Dai XX can sue CSC for tort liability according to law.
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