In recent years, instances of private fund managers absconding, defaulting, delaying payment or even being suspected of committing the crime of illegally attracting deposits from the public have repeatedly occurred, giving rise to a large increase in private fund litigation and arbitration cases. This article looks at breaches of contract by private fund managers, analyses the damages bearable by them for breach of contract, and assists them in guarding against risks and protecting investors’ rights.
Breaches of contract
Depending on whether a manager has breached its major obligations under the fund contract, and whether the same has made the investors’ or limited partners’ investment objectives unrealisable, breaches of contract by a private fund manager can be divided into fundamental breaches of contract and general breaches of contract. The legal consequences and bearing of civil liability associated with these differ quite substantially.
In practice, such breaches include: (1) failure by the fund to carry out recordal/registration procedures, resulting in the fund product not being validly established; (2) failure by the fund manager to establish the limited partnership in accordance with the contract, making investment operations according to the contract impossible; (3) failure by the fund manager to amend the partnership’s business registration, resulting in the investors being unable acquire the status of partner; (4) wrongful investment orientation; failure by the fund manager to accord with the investment orientation specified in the contract in carrying out the investment, or failure by it to consult with the investors before modifying the investment orientation; (5) absconding by the fund manager, or its inability to operate normally, making normal performance of the contract impossible; and (6) failure by the fund manager to pay the investors’ returns in accordance with the contract.
General breaches carry many forms. With the exception of those above, any failure by a manager to perform its obligations in accordance with the contract in the course of its management of the fund may constitute a general breach of contract, such as: (1) failure to disclose the net value of the fund shares and quarterly report as agreed; (2) failure to perform its notification obligations; (3) failure to perform its early warning or stop-loss obligations; (4) extension by the manager of the investment term in a manner inconsistent with the procedure set out in the fund contract; (5) failure to arrange for liquidation; and (6) failure to buy back the investment units.
Bearing of civil liability
Bearing of civil liability for fundamental breach
Pursuant to item (4) of article 94 of the Contract Law, and item (4) of article 563 of the Civil Code, “if a party is late in the performance of its debt obligations, or commits another breach of contract, making realisation of the objectives of the contract impossible”, the other party may terminate the contract. In accordance with the law, where the fund manager is in fundamental breach of contract, the investors may request termination of the fund contract or partnership agreement and demand that the manager refund their investment funds and compensate for their losses.
Bearing of civil liability for general breach
The People’s Court will, depending on the actual breach by the manager, usually render a judgment ordering the manager to bear liability by compensating for losses or paying liquidated damages, for example: (1) ordering the manager to bear liability at the rate of 20% of the investment losses incurred by the investors; (2) determining the liability for breach of contract bearable by the manager as being the difference between the amount of the investors’ capital contributions and the capital contribution amounts recovered upon withdrawal from the partnership; (3) taking the difference between the specified net value of the fund after the closing and reduction of positions, and the net value of the fund on the liquidation date, as the basis of the losses; and (4) ordering the manager to compensate for interest losses on the funds in its possession at the interest rate on loans, or the interest rate quoted on the national interbank loan market.
Determination of losses incurred as a result of breach and liquidation of the fund
In practice, if the private fund has not been liquidated, that is to say, that the investors’ losses have yet to be finally determined, can the investors’ demand that the manager refund their investment funds or compensate for their losses be upheld?
In sifting through cases, the author discovered that where the manager has committed a fundamental breach of contract, an argument by the manager that it is not liable for damages for breach of contract because the fund has not yet been liquidated was rejected in a significant number of judgments. As for instances where the manager has committed a general breach of contract, judgments vary.
In Civil Judgment (2018) Yue 01 Min Zhong No. 13011, the court rejected the investors’ claim for compensation on the grounds that they had not demanded liquidation of the partnership, and that it was unclear whether they were still in a position to recover their money, and the amount, if any, that they could recover. In contrast, in case (2017) Yue 03 Min Zhong No. 17328, the court held that although the two partnerships had carried out liquidation distribution, their terms of operation had long before expired, the investors were unable to realise recovery of their investment principal and returns as specified, and the losses of the petitioners for compensation had already been incurred. Accordingly, the court rendered a judgment ordering the manager to bear damages for breach of contract.
Under normal circumstances, liquidation of a fund is required before determining the losses. However, if it can be established that the fund manager has actually lost its capacity to pay, and the fund has no remaining property, the court will usually order the manager to refund the investment funds or compensate for losses even if the fund has not been liquidated, and the investors’ losses have nonetheless been made concrete.
Additionally, in some cases where the fund had not been liquidated, the court directly ordered the manager to bear damages for breach of contract, even though it had not been ascertained whether the fund still had remaining property, reflecting the tendency toward judicial protection of investors.
Yao Weiwei is a consultant at Dentons
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