Fiduciary duty in asset management transactions

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With the rising number of disputes from asset management transactions in recent years, dealing with such disputes properly is worth discussion. The legal relationship between a client and a manager in asset management transactions – commonly referred to as the fiduciary relationship – should be dealt with under the analytical framework of the fiduciary duty.

Notably, although the process of sale is within the contract negotiation stage, the ultimate goal of the parties is to establish a relationship under the asset management contract. As such, a manager who fails to undertake explanations or clarifications regarding the asset management contract, does not disclose risks, fails to fulfil investor review obligations, or does not arrange a return visit by an individual outside of the promotional team after the expiration of the cooling-off period, can be perceived as harbouring other faults in conclusion of the contract. Each of these situations may constitute a ground for the client to cancel the contract, or claim for the invalidity of the contract, or even constitute a ground for tort, which allows the client to be rid of the contractual relationship.

The asset management contract should be carried out under the framework of the fiduciary duty. Under Chinese law, this fiduciary duty is an abstraction and generalisation of the legal relationship between a client and a manager and is comprised of two types of duties: the duty of loyalty; and the duty of care.

In fiduciary relationships, one party (the client) wholly entrusts their interests to the other party (the fiduciary). If no effective restrictions as default rules apply, the client’s interests can be easily harmed, which may make it impossible to reach a genuine agreement. This suggests that the fiduciary duty is fundamentally an “altruistic” duty, differing from the values of “selfishness” (e.g., sales) or “prudent management” (e.g., custodianship) within regular transactions.

The different emphasis would be reflected in the contract arrangements that the fiduciary shall fully disclose information to the client, surrendering the entirety of their own benefits and not pursuing any personal interests (beyond the management fees). Acknowledging this emphasis enables a better understanding of the seriousness of information disclosure in asset management and securities transactions. It further recognises that many practical effects of the controversial “right to know” are not inconsequential questions of information acquirement and transmission.

The duty of loyalty requires that the obligor must not misappropriate the client’s assets or seize the client’s opportunities. If the duty of loyalty is breached, the manager should compensate the client’s corresponding losses. In private equity investments, the fiduciary is not permitted to deviate from the original stipulated purpose of the investment. Exceeding an explicit and previously arranged investment scope and investment ratio – particularly from low risk to high risk, related party transactions, diverting investment assets – naturally constitutes a grave violation, given that most circumstances involve conflicts of interest and can thus be seen as breaches of the duty of loyalty.

Breaches of the duty of loyalty should be met with strict and punitive approaches. First, in determining causality, the requirements for a but-for test, a test commonly used in both tort and criminal law to determine actual causation, can be reduced when necessary. When there are multiple causes of incurred loss, as long as the breach of the duty of loyalty is among them, the manager should be held accountable. Second, it is preferable that the manager breaching loyalty should bear full responsibility for the amount of damages.

Duty of care requires the manager to work hard. If this duty of care is breached (if a stop-loss alert should be issued but the stop-loss is not promptly executed, or if accounts are not settled in a timely manner), then the severity of breach, content of loss, causality, etc., should be collectively assessed to determine the amount of compensation available to the client.

Notably, the plaintiff is allowed to be compensated only for losses corresponding to conduct related to the manager’s breach of the duty of care. In determining the duty of care, the applicability of the business judgment rule is particularly worth considering. For example, in an arbitration case, the client’s claim that the market value of the stock related to the asset management plan has not changed, or fell instead of rising while the stock market is prosperous and the stocks’ price generally went up, may not be a basis for the manager’s liability. Another example is that a manager is disqualified because of criminal charges. It will at best be equivalent to the manager not working, and is also a matter of the duty of care.

During the performance process of the asset management contract, information disclosure obligations are supplementary duties to the duty of loyalty and the duty of care – acting as a facilitating mechanism that assists the client to investigate whether or not the fiduciary is fulfilling these duties. Thus, a breach of the information disclosure duty itself will not necessarily result in compensatory liability or grounds for finding a breach of the duty of care or duty of loyalty; instead, this determination should be made by considering the aggregation of specific circumstances relevant to breaches of the duty of loyalty and the duty of care.

Xu Defeng is an arbitrator with Beijing Arbitration Commission/Beijing International Arbitration Centre (BAC/BIAC), and a professor at Peking University’s Law School. Catherine Zhou, from the University of Melbourne, also contributed to this article.

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