Private Equity Fund Civil and Commercial Dispute Resolution Series III

In our agency work in private fund manager dispute resolution cases, we have identified some common controversial points that determine the direction of relevant cases. This series of articles analyzes relevant issues from the perspective of safeguarding the rights and interests of fund managers. One of the articles in this series, "Consequences of Chapter 5 of the Minutes of the Nine People's Republic of China and How Private Fund Managers Should Respond", and the second, "How Private Fund Managers Demonstrate Fulfillment of Investor Suitability Obligations in Dispute Resolution", respectively analyze the applicability of Chapter 5 of the Minutes of the Nine People's Republic of China and the investor Suitability Obligations. This article will discuss issues related to rigid cashing.

Due to the inevitable use of performance comparison benchmarks, expected returns, and other expressions and concepts in private fund promotional materials and fund contracts. Once the project fails to exit smoothly, civil and commercial disputes over private equity funds may arise because the returns received by investors do not meet corresponding earnings expectations. In such disputes, in addition to claiming repayment of principal, investors often require that interest be calculated based on performance benchmarks or expected returns. This article will explore the defense strategies that private fund managers can adopt to refute rigid cashing in such scenarios. We believe that the defences that private fund managers can take include:

1. The fund contract is not agreed upon and lacks a contractual basis

In the context of regulatory regulations such as the Interim Measures for the Supervision and Administration of Private Equity Investment Funds and the Guiding Opinions on Regulating the Asset Management Business of Financial Institutions that restrict rigid cashing, currently private equity fund contracts generally do not directly contain provisions that violate the principle and income guarantee rules. Therefore, when the plaintiff/applicant proposes a claim for rigid repayment, the private equity fund manager can demonstrate that the contract has reached an agreement on the risk and assumption of investment principal losses based on the fund contract agreement, and the plaintiff/applicant's claim is inconsistent with the contractual agreement between the two parties.

Moreover, in accordance with regulatory regulations such as the "Measures for the Administration of the Appropriateness of Securities and Futures Investors" and industry self-discipline rules such as the "Measures for the Administration of the Raising Behavior of Private Investment Funds" and the "Guidelines for the Implementation of the Appropriateness Management of Fund Raising Institutional Investors (for Trial Implementation)", the manager will disclose risks during the fundraising process and further clarify to investors whether to maintain capital or return. In practice, managers can also combine risk disclosure documents to defend claims of rigid cashing.

2. The roadshow documents are not recorded and there is no prior contractual obligation

In practice, managers may use controversial expressions such as performance comparison benchmarks or expected returns (target returns, benchmark returns) in their private equity fund promotional materials (and some of them are prohibited by regulations), and plaintiffs/applicants may use this claim to pursue the responsibility of the manager for contracting negligence. In this case, the correct meaning of performance comparison benchmarks and expected returns can be combined, which means that managers calculate the expected target rate of return based on past performance and historical performance of the same type of product, and is not a guarantee of fixed income to defend.

3. If the fund sale is conducted by a third party, it is claimed that the manager is not at fault

In the case where the manager entrusts a sales company to act as an agent for sales, the plaintiff/applicant may jointly identify the manager and the sales company as the defendant/respondent, or may only file a lawsuit/commercial arbitration against the manager. In either case, managers can prove the compliance of their commissioned sales behavior by providing evidence of the compliance of the fund sales company's qualifications and the provisions of the agency sales contract. At the same time, the sales company's own violations can be defended by asserting that the manager is innocent.

4. Rigid cashing violates departmental regulations

Article 15 of the Interim Measures for the Supervision and Administration of Private Equity Investment Funds stipulates that "Private equity fund managers and private equity fund sales institutions shall not promise investors that the investment principal will not be lost or that they will promise a minimum return.".

Given that regulatory regulations such as the Interim Measures for the Supervision and Administration of Private Equity Investment Funds and the Guiding Opinions on Regulating the Asset Management Business of Financial Institutions have clearly restricted rigid cashing, the manager can defend rigid cashing from the perspective of violating regulatory regulations in combination with the provisions of the fund contract and relevant regulatory regulations.

5. The fund has not yet been liquidated

At present, there are adjudicative cases that believe that when the fund is not liquidated, it is impossible to determine the investment income enjoyed by investors or the existing investment losses, thereby rejecting investors' claims for compensation for losses. Although there are also judicial practices that adjudicate fund managers to compensate for losses when funds are not liquidated, in these cases, there are the following situations: (1) fund managers lose their qualifications, including being deregistered by the China Foundation Association; (2) Unknown whereabouts; (3) Being convicted of a criminal offence; (4) Changes in the use of funds, etc. In these circumstances, it is no longer possible for the fund manager to liquidate the fund, so it is meaningless to require that losses be determined after the fund has been liquidated.

Therefore, the administrator can refer to the above judgment ideas and defend the rigid cashing claim from the perspective that the fund has not yet been liquidated and the loss cannot be determined.

In general, considering the current regulatory background of prohibiting rigid cashing, the probability of explicitly agreeing to maintain capital and earnings in fund contracts is not high. However, in practice, it often occurs during the sales process that some fundraising staff or sales agencies make some expanded or false statements regarding breakeven and guaranteed returns. In addition, although investors may be aware that they will not be legally guaranteed, they still take chances with rigid cashing and lack the fear of market and investment risks. Once the project exits with difficulties, it is too late to repent. In this situation, some investors often want to seize some clues during the fundraising and operation period and require the manager to provide rigid cashing. We believe that in this case, private fund managers can actively defend and strive for impairment in combination with regulatory regulations and fund contract agreements.