Asset management has been growing rapidly as an industry across China in recent years. Now, banks, securities companies, insurance companies and other institutions provide overlapping financial services. The sector is a model of mixed operations, giving rise to complex multi-tiered financial instruments, implicit guarantees, leverage limit breaches, “passageway” deals and cash pooling. All of these pose great challenges to financial supervision.
Unsurprisingly, disputes in this sector are demonstrating increasing novelty, complexity and variability.
Significant work has been done to unify regulatory standards for similar asset management plans in order to regulate the asset management business of financial institutions.
The People’s Bank of China, the former China Banking and Insurance Regulatory Commission, the China Securities Regulatory Commission and the State Administration of Foreign Exchange jointly issued the Guidelines for Regulating the Asset Management Business of Financial Institutions on 27 April 2018. The guidelines explicitly require “penetrative supervision” of the asset management business.
From an adjudicative perspective, the Supreme People’s Court introduced a “penetrative approach to adjudication” in the Minutes of the National Courts’ Civil and Commercial Trial Work Conference, issued in 2019. Accordingly, when hearing asset management disputes, courts generally focus their examination on the transactional purpose and nature of the asset management products in question. The legal relationship in the asset management contract and its enforceability are usually the core contention of such cases.
A “penetrative approach to adjudication” centres on the idea of going beyond the pro-forma legal relationship indicated by the parties’ agreement or related transaction document. Instead, by following a “substance over form” principle, the courts can identify the parties’ true expression of intent and determine the substance of a juristic act.
Evidently, since the release of the minutes, the penetrative approach to adjudication has seen much action at all levels of the justice system.
By searching the Wolters Kluwer legal database with keywords “penetrative” and “approach”, the authors retrieved 677 civil cases in the past three years, including 12 heard by the Supreme People’s Court, 347 by high courts, 255 by intermediate courts, 62 by primary courts and one by a special court. By year, 466 cases were heard in 2020, 123 in 2021, and 88 in 2022.
A review of cases shows that when a court finds the transaction purpose or nature inconsistent with that stated in the transaction documents, it usually proceeds along one of the following three adjudication routes, each representing varying legal consequences.
Route 1. The court finds the true expression of intent of the parties is inconsistent with that indicated by the transaction documents or behaviour. This invokes article 146 of the Civil Code (the former General Provisions of Civil Law) with respect to the validity of concealed civil juristic acts.
According to this rule, civil juristic acts based on a false expression of intent are void, and the substantive legal relationship between the parties should be redefined. Most typical of this model are “in disguise of” cases, such as “lending in disguise of trading”, “lending in disguise of partnership”, and “lending in disguise of debt transfer and co-operative collection of non-performing assets”.
Route 2. The court finds the juristic act in question or the real transaction behind the false expression of intent of the parties violates certain mandatory provisions of laws or administrative regulations, or seriously violates certain regulatory rules and harms the public interest. This invokes article 153 of the Civil Code and article 52 of the Contract Law. In other words, a civil juristic act is void if it violates mandatory provisions of laws or administrative regulations, or if it goes against public order or good morals.
Route 3. When examining civil or commercial cases, the court finds that the relevant juristic act of a party involves criminal offence. In this scenario, the court will dismisses the action and transfer the case to a public security authority.
Identifying the boundary
To a certain extent, the penetrative approach to adjudication gives the judge more discretion in fact-finding and law application, while placing higher requirements on the process and outcome of adjudication.
Academics have argued that the penetrative approach involves judicial autonomy in substantive dispute resolution, and does not lead to judicial arbitrariness or lack of restraint. This viewpoint is seconded by the authors.
However, externalism – essentially relating to the standardisation, independence and formality of commercial behaviour – is an important principle in commercial matters.
Excessive judicial intervention in financial transactions will inevitably hinder innovative development of the financial market and threaten to destabilise the expectations of market participants.
Therefore, the authors believe that fact finding should be subject to the doctrine of burden of proof in civil trials and the underlying logic that “the burden of proof is borne by the claimant” to avoid overturning the apparent commercial facts where possible and to restrict the judge’s investigative power.
As for the application of law in asset management disputes, prudence should be exercised in applying legal provisions regarding the “in disguise of” model and “offending public order or good morals”, and respect should be given to the ostensible legal relationships in commercial matters, thus minimising the invalidation of transaction contracts.
In general, the penetrative approach to adjudication is conducive to forestalling and defusing financial risks. However, adjudication should not excessively intervene in commercial transactions to the extent that it hinders financial market innovation and development.
The authors believe that with deeper insights into the penetrative approach to adjudication and how far it should go, judgment of asset management disputes will be able to better accommodate financial innovation and enhance stability of the financial market.
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