Contractual private securities investment funds are important dealers on the secondary market. Many investment advisers and investors will cover margin calls independently when items they use for assets management can hardly meet the minimum requirement. Controversies over who owns margin call amounts and rights and obligations of channels, investors, advisers and other parties involved have never stopped. Arbitration authorities and courts in Shanghai dealt with a lot of securities investment cases during the stock market crash in June 2015. One of the typical cases is the Shanghai Linfo Investment Partnership (General) v. Dongwu Fund Management Co., Ltd. investment consulting contract case arising from a margin call amount, decided by a court in Shanghai directly referring to the bona fide principle of Article 7 of the General Principle of the Civil Law. The court decision can be used for reference in the future. 

Case Brief

The “Dongwu Dingli No.5012 - Linfo Xinshan Jinqu No.2 Assets Management Plan” was a contractual securities investment fund with RMB 135 million established in June 2015 by Shanghai Linfo Investment as investor and Dongwu Fund Management Ltd. as fund manager.

In June 2015 a rare stock market crash happened in China. To prevent the assets management plan from suffering a margin closeout, Shanghai Linfo Investment pay a margin call amount of RMB 7,600,000 for the plan on 29 June 2015 after receipt of the fund manager notice. A dispute arose from ownership of the margin call amount between the parties involved when the plan lapsed on 5 June 2016. The fund manager claimed that the margin call amount was paid by Linfo Investment on behalf of all the clients and should be distributed as part of the plan instead of being repaid to Linfo. Linfo sued to the court.

Key issue in dispute 

The courts of the first and second trials summarized the key issue in dispute as whether the margin call amount of RMB 7,600,000 be repaid to Shanghai Linfo Investment. As lawyer of Linfo, we argued that the margin call amount should be repaid to Linfo.

1.The assets management contract was based on the assumption that all the general clients pay margin call amounts together in proportion to their net general interests in total general interests. However, the disputed amount of RMB 7,600,000 was fully paid by Linfo and therefore should not be seen as part of total assets under the plan that shall be distributed in proportion to interests of general clients.

2. Dongwu Fund was obligated to notify all the general clients, but actually it only notified the legal representative of Linfo when the plan failed to meet the minimum requirement. At that moment, if the margin call was not left covered, the plan would be terminated, causing a serious loss to all the general clients. The act of Linfo covering the margin call was bona fide and in good faith.

3. As the manager of the plan, Dongwu Fund had no interests in the disputed amount of RMB 7,600,000 and cannot continue holding the money after the end of the plan. The disputed amount of RMB 7,600,000 should be fully repaid to Linfo. Furthermore, as the general clients had benefited from the payment for the margin call by Linfo, non-repayment of the amount would be in contrary to the actual meaning of justice and the bona fide and fairness principles.

Court Decision

1.The court of Pudong, Shanghai decided by only referring to Article 7 of the General Principles of the Civil Law that Dongwu Fund Management Co., Ltd. should repay Shanghai Linfo Investment the margin call amount of RMB 7,600,000 with interest. Dongwu Fund Management Ltd. appealed to the Shanghai No.1 Intermediate Court, but the court of the second trial affirmed the first court decision.

2. The Shanghai Arbitration Committee had decided a large number of cases arising from ownership of margin call amounts before this case, few of which ended in people paying margin call amounts winning. In this case we brought the action by claiming that securities investment consulting related matters could not be dealt with through arbitration under the contract, making a progress in improving the current procedures.

3. The two parties had a serious disagreement over the basis of the claiming right. The court finally decided by referring to the bona fide principle of the General Principles of the Civil Law, which is rare.

Comments

Article 7 of the General Principles of the Civil Law states that “people defined in the civil law should follow the bona fide principle, be honest and stick to their commitments when doing activities under the civil law”. This clause is called the highest principle of the civil law, also known as the “king rule”. The bona fide principle which is defined in abstract terms should be prudently used in legal practice.

In this case the court adjudicated the disagreement between the parties involved over the basis of the claiming right by directly referring to the bona fide principle in order to rectify omissions in laws, improve the flexibility of laws and make up for weak points in laws based on its own judgment, which will help correct and reasonable application of law. It should be noted that of all the principles included in the General Principles of the Civil Law, only the bona fide principle and the no right abuse principle (under Article 132) can be used as the basis of a court decision.