Formulation of questions

Trust companies (representing the trust plan) as senior limited partners (hereinafter referred to as "senior LPs"), other investors as inferior partners, and trust companies as senior LPs give priority to the allocation of priority investment principal and benchmark income according to the agreement. Regarding the above transaction structure arrangement, customers often ask the following questions:

1. If the partnership suffers a loss, can the senior LP still prioritize the allocation of investment principal and benchmark income in the agreed distribution order?

2. If the partnership is a private equity investment fund, in the event of a loss of the partnership, can the senior LP still give priority to the allocation of investment principal and benchmark income in the agreed distribution order?

Legal analysis

(1) Whether the priority LP can still prioritize the distribution of investment principal and benchmark income in the agreed distribution order when the partnership suffers a loss

Article 60 of Chapter III "Limited Partnership" of the Partnership Law stipulates: "The provisions of this Chapter shall apply to a limited partnership and its partners; Where there are no provisions in this Chapter, the provisions of Sections 1 to 5 of Chapter II of this Law concerning general partnerships and their partners shall apply. Article 69 of Chapter III stipulates: "A limited partnership shall not distribute all its profits to some of its partners; However, unless otherwise agreed in the partnership agreement. Article 33 of Chapter 2, Section 3 stipulates: "The distribution of profits and losses of a partnership enterprise shall be handled in accordance with the provisions of the partnership agreement; Where the partnership agreement is not stipulated or the agreement is unclear, it shall be decided by the partners through negotiation; If the negotiation fails, the partners shall distribute and share it according to the proportion of paid-up capital; Where the proportion of capital contribution cannot be determined, it shall be divided and shared equally by the partners. The partnership agreement shall not stipulate that all profits will be distributed to some partners or that some partners shall bear all losses. Article 89 stipulates: "The remaining property of a partnership enterprise after paying liquidation expenses, employees' wages, social insurance fees, statutory compensation, and paying the taxes owed and the settlement of debts shall be distributed in accordance with the provisions of the first paragraph of Article 33 of this Law." ”

Based on the above provisions, the author understands: (1) Each partner may stipulate in the partnership agreement the method of profit distribution of the partnership enterprise. (2) Each partner may stipulate in the partnership agreement the method of sharing losses, but cannot stipulate that some partners shall bear all losses.

If a partnership investment project suffers losses, the corresponding loss bearing method may be agreed upon by the partners themselves on the premise that it does not violate the above provisions. Generally speaking, for structured arrangements, inferior partners bear greater investment risks but may also enjoy the most investment returns, and priority LPs are allocated first but usually have limited returns, and the author understands that this commercial arrangement is the choice of investors with different risk appetites and is reasonable. If the parties agree that when a loss occurs, the inferior partner will first bear the loss within the limit of its subscribed capital contribution, and then the priority partner will bear the loss within the limit of its subscribed capital contribution, such agreements are an agreement on the order of loss bearing, if a serious loss occurs in the project, the investment principal of the senior LP also has the possibility of loss, so the author believes that this is not an agreement that some partners must bear all losses, and all partners may lose money. If a loss occurs in the project, the author understands that the partnership has no income for distribution, but the remaining partnership property can be distributed according to the provisions of the parties in the partnership agreement after deducting the necessary taxes and fees, and according to the provisions of the Partnership Law, the distribution of the remaining property shall be carried out in accordance with the agreement on profit distribution and loss bearing. Therefore, the parties agree on the order of distribution of surplus property and the amount that each party can distribute under such circumstances (if the amount allocated to the priority LP is actually calculated based on the investment principal and benchmark income of the senior LP), the author believes that such arrangement falls within the scope of the autonomy of the parties in commercial acts, and does not violate the mandatory provisions of laws and administrative regulations.

At present, there are few supporting provisions and interpretations of the Partnership Law in China, and there are no provisions involving the first/inferior structure of partnership shares, and there are more similar "preferred shares" under the company. The Guiding Opinions of the State Council on Carrying out the Pilot Program of Preferred Shares defines preferred shares as: "Preferred shares refer to other types of shares specified in addition to the general types of shares in accordance with the Company Law, and the holders of the shares have priority over the ordinary shareholders in distributing the company's profits and residual property, but their rights to participate in the company's decision-making and management are restricted", and the "preferential rights" for preferred shares clearly include "priority distribution of profits" and "priority distribution of surplus property". That is, at the company level, the establishment of preferred shares with preferential dividends and preferential distribution is allowed, which we believe has certain reference significance for the "senior limited partnership share" under the partnership.

(2) Whether the preferred LP can still prioritize the distribution of investment principal and benchmark income in the agreed order when the partnership is a private equity investment fund

Article 21 of the Guiding Opinions on Regulating the Asset Management Business of Financial Institutions (hereinafter referred to as the "Guiding Opinions") stipulates: "... Tiered asset management products shall not directly or indirectly provide principal and income protection arrangements to priority share subscribers. "Graded asset management products" as used in this article refers to products in which there are shares of more than one level to provide certain risk compensation for other levels of shares, and the distribution of benefits is not calculated according to the proportion of shares, and is otherwise agreed in the asset management contract.

Paragraph 1 of Article 1 of the Notice on the Filing of Private Investment Funds (2019 Edition) stipulates: "In the course of raising and investing in private investment funds, private investment funds shall strictly abide by the Securities Investment Fund Law, the Interim Measures for the Supervision and Administration of Private Investment Funds, the Measures for the Administration of the Suitability of Securities and Futures Investors, the Interim Provisions on the Operation and Administration of Private Asset Management Business of Securities and Futures Operators, the Measures for the Registration of Private Investment Fund Managers and Fund Filing (for Trial Implementation), Announcements on Further Standardizing Certain Matters Concerning the Registration of Private Equity Fund Managers, Guidelines for Private Equity Investment Fund Contracts, Measures for the Administration of Private Equity Investment Fund Raising Behavior, Administrative Measures for Information Disclosure of Private Equity Investment Funds, Administrative Standards for the Filing of Private Asset Management Plans of Securities and Futures Operators No. 1-4, Guidelines for the Naming of Private Investment Funds, and Answers to Questions Related to Private Equity Fund Registration and Filing. Item (18) of Article 1 stipulates: "Private securities investment fund managers shall not set extreme income distribution ratios in graded private securities investment funds, shall not use hierarchical arrangements for benefit transmission, covertly carry out 'capital allocation' and other illegal businesses, and shall not violate the principles of benefit sharing, risk sharing, and matching risks and returns." ”

Article 2 of the Interim Provisions on the Operation and Administration of Private Asset Management Business of Securities and Futures Operators (hereinafter referred to as the "Interim Provisions") stipulates: ""Securities and futures business institutions as used in these Provisions refer to securities companies, fund management companies, futures companies and their lawfully established subsidiaries engaged in private equity asset management business. Article 4 stipulates: "When a securities and futures business institution establishes a structured asset management plan, it shall not violate the principles of benefit sharing, risk sharing, and matching risks and returns, and shall not have the following circumstances: (1) directly or indirectly provide principal and income protection arrangements to priority share subscribers, including but not limited to stipulating in the contract of the structured asset management plan that the preferential share income is accrued, the penalty interest is terminated early, the inferior or third-party institution makes up the priority income by the difference, and the risk margin is used to make up the priority return, etc.; Article 15 stipulates: "Private securities investment fund managers shall refer to these Provisions. These Provisions do not apply to asset securitization business carried out by securities companies and subsidiaries of fund management companies in accordance with law. ”

Article 1 of the Administrative Standard for the Filing of Private Asset Management Plans of Securities and Futures Operators No. 3 - Structured Asset Management Plans issued by the Asset Management Association of China stipulates: "Structured asset management plans are designed in strict accordance with the principles of 'benefit sharing, risk sharing, and risk and return matching'. The so-called benefit sharing, risk sharing, risk and return matching means that when the structured asset management plan generates investment income or investment losses, all investors should enjoy gains or bear losses, but priority investors and inferior investors can reasonably stipulate in the contract the proportion of enjoying returns and bearing losses, and this ratio should be equally applicable to the two situations of enjoying returns and bearing losses. Article 2 stipulates: "The contract of a structured asset management plan shall not stipulate that the principal of inferior investors shall bear losses first, unilaterally provide enhanced funds, and other contents to protect the interests of priority investors." ”

Article 2 (1) of the Notes on the Formulation of the Interim Provisions on the Operation and Management of Private Asset Management Business of Securities and Futures Operators (hereinafter referred to as the "Interim Provisions") "Clarify the scope of application" mentions: "The Interim Provisions mainly apply to the private asset management business carried out by securities and futures operators through asset management plans, and the asset securitization business carried out by securities companies and subsidiaries of fund management companies in accordance with the provisions is not applicable. At the same time, in order to unify regulatory standards and avoid regulatory arbitrage, private securities investment fund managers registered with the Asset Management Association are required to refer to the implementation, which is temporarily not applicable to private equity investment funds and venture capital funds. ”

In summary, for the structured arrangement of private securities investment funds, all investors should bear losses in the event of investment losses, and all parties may reasonably stipulate in the contract the proportion of enjoying profits and bearing losses, and this ratio should be equally applicable to the two situations of enjoying profits and bearing losses, and it shall not be agreed that inferior investors shall bear losses first. The Interim Provisions are not applicable to private equity investment funds, but considering the principle of "benefit sharing, risk sharing, and matching of risks and returns" consistently emphasized by securities regulatory authorities, it is not ruled out that the regulatory authorities or AMAC may require private equity investment funds to apply the above structured provisions by reference when actually reviewing them.

(This article is translated by software translator for reference only.)