How courts view responsibility of private fund managers

By Jiang Mingze and Yang Qiuci, Shihui Law Office

Investors often turn to litigation or arbitration to recoup their money when a private fund suffers losses or the returns are not up to their expectations. In this process, the responsibilities of fund managers in the stages of fundraising, investment and management often become the focus of disputes. Looking at recent precedents, we can seek to clarify and summarise the common default behaviours and legal responsibilities of private fund managers in the eyes of the courts.

Judges in disputes related to the responsibilities of private fund managers usually focus on the fiduciary duty and duty of diligence of managers in business processes, such as registration and filing, suitability reviews, prudent investment and information disclosure. As private fund investment is a venture investment, investors are usually required to bear the burden of proof on the fact that they suffered losses and the causal relationship between the fund manager’s behaviour and those losses. Courts are relatively cautious in judging the fund manager’s responsibilities.

Registration and filing. If the fund manager fails to fulfil the registration and filing obligations when there are no special provisions in the relevant fund agreement, the court will usually determine whether there is the essence of fund investment in combination with the following elements:

    • The agreement involved has already specified the main arrangements for fund investment, such as the rights and obligations of the fund manager, fund operation mode, capital contribution mode, fund income distribution principle, liquidation for withdrawal, etc.
    • No commitment is made on fixed income.
    • The main procedures of fund investment have been fulfilled, such as warning investors of risks in writing, issuing a fund subscription confirmation, and conducting follow-up confirmation.

If the fund meets these conditions, the court usually further judges whether the reasons for the investor’s request are sufficient if the manager fails to complete the fund filing. Take the common reason of investors that “the purpose of the contract cannot be achieved” as an example, for which there are different opinions in judicial practice at present. Some courts hold that the provision of fund filing is subject to administrative regulations, and failure to file the fund does not necessarily lead to the failure to achieve the purpose of the contract.

Jiang Mingze
Shihui Law Office

Other courts hold that failure to file the fund will lead to the failure to achieve the purpose of the contract, which should be attributed to the fund manager’s failure to fulfil the corresponding obligations. Therefore, investors shall have the right to demand the rescission of the contract, return of the funds invested and compensation for losses.

If the fund does not meet the conditions, the courts tend to determine the nature of the contract as a private lending relationship or entrusted financial management relationship, and determine the manager’s responsibility accordingly. In this case, if the “investment period” specified in the contract has expired, the court usually supports the investor’s request for principal and interest.

Suitability review. Private fund managers must assess the risk identification and bearing capacity of investors, and ensure that their profile matches the risk rating of the funds they are being sold. The manager must prove to the courts that he has fulfilled his obligation of suitability review by presenting the following facts: The fund manager has provided a risk disclosure statement, and investors have participated in and confirmed the questionnaire of risk tolerance; the manager has fully informed investors of the risk and return characteristics and product conditions of the fund products; and the investors have confirmed in writing that they voluntarily undertake the risks.

It is worth noting that the contents confirmed by investors should include the types and risks of private funds they invest in, otherwise the signatures of investors cannot directly infer that the private fund managers have fulfilled their obligations of suitability review.

As for the legal consequences of violating the obligation of suitability review, the Minutes of the National Working Conference on the Trial of Civil and Commercial Cases by Courts clearly provide that the compensation for losses should be the actual losses suffered by financial consumers. The actual loss is the lost principal and interest, and the interest is calculated at the benchmark interest rate of similar deposits for the same period issued by the People’s Bank of China. Therefore, if an investor claims to calculate the amount of loss at the annualised rate of return stipulated in the contract involved, the court usually does not support the claim.

Prudent investment and information disclosure. According to the authors’ experience, a fund manager may be found to have failed to fulfil his prudent investment obligation in the following situations: failing to prudently investigate the operation, equity structure, legal compliance and feasibility of compensation arrangement of investment projects; failing to invest in the way stipulated in the contract, such as failing to use the fund property according to the specified investment scope, or changing the investment objective without authorisation; and failing to continuously monitor the investment situation and make reasonable investment decisions.

Yang Qiuci
Shihui Law Office

In addition to examining prudent investment obligations, the court will also judge whether the manager bears the legal liability and the scope of liability by considering other default behaviours of the manager, such as failure to disclose information accurately and in a timely manner, and whether there is a causal relationship between the default behaviour and the losses for investors.

If the fund manager seriously violates the prudent investment obligation, the court usually rules that it shall compensate the investor for the loss of investment principal and interest. It is worth noting that the court will take a relatively cautious attitude towards the request of investors to rescind the contract.

In the absence of an explicit provision in the contract, if the investor exercises the statutory rescission right, the court usually examines the following factors to judge whether the fund manager is in fundamental breach of contract: whether the investor has raised any objection to the manager’s breach of contract; whether the investor has accepted the investment income and has preliminarily achieved the purpose of the contract involved; and whether the fund manager gives a reasonable explanation and takes remedial measures in time for its breach of contract.

Jiang Mingze is a partner at Shihui Law Office. He can be contacted on +86 21 2043 7585 or by e-mail at

Yang Qiuci is an associate at Shihui Law Office. She can be contacted on +86 21 2043 7509 or by e-mail at