Disputes involving private equity funds have attracted more attention in recent years, with soaring numbers and complicated situations. The liability of fund managers is one of the most controversial issues. When investors claim managers should bear liability in arbitration cases, they often allege that fiduciary duty was breached during four key stages of a fund – fundraising, investing, managing or redemption.
In this article, the author discusses common controversies for manager liability based on studies of cases accepted by the Beijing Arbitration Commission/Beijing International Arbitration Centre (BAC/BIAC).
Disputes in the fundraising phase tend to focus on the manager’s suitability obligations. Investors often argue they failed to fully disclose the risks of fund products to them, that questionnaires were unilaterally completed by managers/agents without their consent, or that managers were obliged to conduct a substantive review on the investor’s proof of income and education background.
In hearing such issues, the tribunal will pay attention to evidence submitted by the parties to: find out whether investors have signed a risk disclosure statement or letter of qualified investor’s commitment; whether managers or agents can provide audio or video recordings to determine if they have performed the suitability obligations; and to review the investor’s experience and background.
Whether managers have made the investment as agreed during the investment phase is often the focus of disputes. When considering this issue, the tribunal will prudently consider the following aspects, including but not limited to: (1) whether the specific investment target, investment mode and investment ratio are specified in the fund contract; (2) whether the investment scope or target agreed in the contract is consistent with fund promotion materials; and (3) whether the fund contract has stipulated the changing way of the investment scope or investment target.
Although manager investment that breaches the contract is often deemed to be a grave violation, tribunals will still make a comprehensive judgment having regard to whether there is a justifiable basis for the manager’s failure to make the investment in accordance with the agreement, and whether there is a causal relationship between the failure and the investor’s ultimate loss if only part of the investment is in breach of the agreement.
In the management stage, investors often argue that managers failed to disclose information as agreed. Usually, investors and managers will have detailed stipulations of information disclosure in the fund contract.
Tribunals often pay attention to whether there is a causal relationship between the failure to disclose information as agreed and the investors’ loss. The focus of the dispute is often: whether funds are closed-end, semi-closed-end or open-ended; the importance of information to be disclosed; the timing of the disclosure; and the impact on net value of the fund.
Investors sometimes also claim that the manager has extended the term of the fund contract without authorisation. If so, in addition to stipulations of the fund contract, the tribunal may also pay attention to whether a general meeting of the fund shareholders is convened, and the rationality of unilateral extension of the contract term by the fund manager.
At the redemption stage, parties are generally most concerned about whether the investors’ loss can be determined if the funds have not been liquidated.
Usually, liquidation is the prerequisite for determining losses. However, where a manager is grossly at fault, fund properties become valueless or unable to be realised for various reasons, or the manager’s enterprise is even cancelled.
That results in redemption of fund properties becoming difficult or taking a long time. If so, the tribunal may consider whether it would be unfair to investors but would condone the manager’s breach of fiduciary duty if it determines that investors are required to wait for the liquidation result.
However, even if the tribunal determines that the manager shall still bear liability for compensation when the fund is not liquidated, such liability shall be limited to property owned by the manager, and redemption of fund property still needs to wait for the liquidation.
Liu Nianqiong is a case manager at the BAC/BIAC