Structured trusts are tiered arrangements of the beneficial rights made based on different risk preferences of investors. Based on these tiered configurations, beneficiaries at different levels enjoy and bear different benefits and risks. A senior beneficiary is characterized by its “priority in receiving payment”, while the inferior one is usually used as a cushion to guarantee the senior one. However, such structural design is often controversial in practice, due to different rights and obligations and legal relationships between beneficiaries.
Article 90 of the Minutes of the National Working Conference on the Trial of Civil and Commercial Cases (draft for comment) recently published by the Supreme People’s Court (SPC), stipulates: “It may be decided generally that a loan contract exists between a senior beneficiary and an inferior beneficiary who is obligated to guarantee the principal and expected income of the former.” Coincidentally, the SPC made a similar decision in the “Min Zhong No. 604” judgment in 2017.
In that case the plaintiff, Xu Wenyu, subscribed the specific beneficial rights under the trust plan at issue and became an inferior beneficiary, and this case involved the general beneficial rights under the trust plan at issue. The contract stipulated that when the trust property could not be fully realized, or had been realized but was insufficient to pay the principal and expected income to the general beneficiary, the inferior beneficiary had the “responsibility for paying additional funds” for the general beneficiary.
Accordingly, the court held that Xu Wenyu, as an inferior beneficiary, had the obligation to return the principal and pay the income to the general beneficiary after the trust expired, and to bear the risk of changes in the price of the stock purchased by the trust plan. She had the right to enjoy the rest of the property benefits after paying corresponding expenses and the principal and expected income of the general beneficiary. There was a loan contract between her and the general beneficiary. In addition, Xu should perform the responsibility of paying additional funds based on the contract, and supplementing the principal and income of the general beneficiary.
Although in this case a loan contract was decided by the court as existing between the inferior beneficiary and the general beneficiary, the authors cannot make a general conclusion that such a contractual relationship applies to all structured products.
Trust legal relationship
Under normal circumstances, the commercial arrangements for the benefits and risks of different beneficiaries in a trust transaction are the true declaration of intention of the parties, and a trust legal relationship exists between the senior beneficiary and the inferior beneficiary. In such a relationship, it is not the obligation of the inferior beneficiary to indemnify the senior one. An inferior beneficiary’s unilateral undertaking to indemnify the senior beneficiary is a credit enhancement measure that is independent of the trust legal relationship, and has legal effect if it conforms to the mandatory provisions of laws and administrative regulations.
In addition, the unilateral undertaking should not be regarded as guaranteed payment. Although the Guiding Opinions on Regulating Asset Management Business of Financial Institutions provides that guaranteed principal and income arrangements shall not be made for senior share subscribers of tiered asset management products, the purpose of such provision is only to regulate the management behaviour of trustees, rather than to bind inferior beneficiaries.
Loan contract relationship
A loan contractual relationship may exist between a senior beneficiary and an inferior beneficiary in certain cases, that is, there is a false declaration of intention on trust investment between the beneficiaries. If the true declaration of intention between the beneficiaries is a loan, a legal relationship of loan contract is constituted between the beneficiaries, the effectiveness of which should be determined in accordance with relevant laws and regulations.
As in the above-mentioned No. 604 judgment, the SPC decided that a legal loan relationship was constituted between the beneficiaries. Although the parties in the case adopted the form of structured trust, their arrangements of rights and obligations were different from those of structured products, because no declaration of intention of setting up a real structured trust was made between the parties. Therefore, the SPC decided that a loan relationship was constituted between the beneficiaries after examination of the particular facts of the case, and it did not deny the essence of structured trusts.
First, from the perspective of transaction structure, structured trusts adhere to two basic principles of “risks match benefits” and “focus on protecting the legitimate interests of senior beneficiaries”. In other words, both senior beneficiaries and inferior beneficiaries bear the risk of loss of principal. With respect to case No. 604, the inferior beneficiary guaranteed payment of principal and fixed income to the general beneficiary, and assured the general beneficiary that the latter would not be required to assume any business or credit risk.
Second, from the perspective of management and use of trust funds, structured trusts are actively managed business trusts in which trust companies collect trust remuneration, and manage and dispose of trust funds at their own discretion. The trust company in case No. 604 did not take any active management duties but acted under the instruction of Xu Wenyu as the general beneficiary. Xu actually controlled and used the trust fund, while the trust company only played the role of a capital channel and a nominee of shareholders of a listed company.
Third, from the perspective of trading purpose, a beneficiary of a structured trust delivers the trust property to a trustee for management and disposal. The senior beneficiary in case No. 604 knew that the trust fund was actually controlled and used by the inferior beneficiary, rather than the trust company. Therefore, the purpose for the senior beneficiary to enter into the trust contract at issue was to lend the funds and obtain interest income, without bearing any investment risk.
In summary, the decision that a loan relationship exists between a senior beneficiary and an inferior beneficiary should not be applied simply to all structured trust products. This is also the dominant view of the existing judicial decisions. Whether an inferior beneficiary should bear additional liability for damages involves the determination of the legal relationship between different categories of beneficiaries.
Yang Guang is managing partner and Cynthia Lian is an associate at Lantai Partners
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