China: Calculating liquidation losses in trust margin share trading accounts

Last Updated: 14 October 2015
Article by You Yang, Lin Kaiyi and Zhang Xiang

General introduction to trust margin trading

From the end of 2014 through the first half of 2015, China's share market soared, attracting large numbers of investors and a rapid expansion of investment capital. This very feast of capital market activity witnessed the springing up of numerous umbrella and other types of structured trusts. Lots of bank wealth management funds and private capital entered the stock market through trusts, and these became the mainstream model for participation in margin account share trading ("trust margin trading"). In April 2015, the CSRC decided that trust margin trading amplified fluctuations in the stock market and should be restricted because it was not beneficial to the healthy development of the market. At the time, the scale of trust margin trading had already reached a considerably high level.

Forced liquidation of trust margin trading accounts has caused controversy

From mid-June 2015, the stock market underwent fierce turbulence when thousands of stocks dropped to the daily limit set by regulation or were suspended from trading. Trust margin trading accounts also suffered heavy blows, the net value of many trust margin products reached or even fell below the stop-loss line. Trust companies had to forcibly liquidate margin accounts, inflicting calamitous losses on investors (mainly inferior-ranked investors). Some investors made claims against trust companies, triggering a variety of disputes.

We have been representing trust companies in dozens of complaints and litigation cases triggered by forced liquidations. Most of the claims have been brought by subordinate investors (margin borrowers) in trust schemes and a few by preferential investors (suppliers of margin funding).

What type of forced liquidation is liable for damages?

The anxiety of investors who have suffered losses is understandable, but many claims for damages we have seen have not been realistic. Extreme market conditions are a severe test of trust company management of margin trading, but also one of the risks all participants have to endure. Trust products are not supposed to guarantee profits and investment in securities by margin trading is inherently risky.

In trust schemes using margin funding, trust companies set clear stop-loss lines to protect the returns for preferential investors and also to control the investment risks for subordinated investors. When the net value of the property held in trust reaches the stop-loss line and subordinate investors fail to deposit additional funds within the agreed time limit, trust companies are entitled to liquidate the property held in trust. Whatever the consequences, a forced liquidation in conformity with the trust agreement is the fulfillment of the trust company's duty as a trustee. In principle, exercise of this function should not incur a liability to beneficiaries whether senior or subordinated investors.

Although there are explicit provisions for forced liquidation in trust agreements, in practice some liquidations are defective because of exceptional circumstances, for instance "erroneous" or "delayed" liquidations. A trust company which takes defective forced liquidation action in violation of its obligations under its trust may be liable in tort for investor losses. Different defective liquidations will trigger different liabilities.

How to calculate losses caused by defective forced liquidations?

The calculation of losses caused by defective forced liquidations is a critical issue in disputes. In terms of the basis for calculation, there are concurrent liabilities; for breach of contract and for tort. In relation to causation, factors like price fluctuation in the securities market and uncertainty of transactions have to be considered and analyzed case-by-case.

There are no explicit legal criteria for calculating losses caused by erroneous or delayed forced liquidations, and a number of views have emerged in the judicial practice.

View 1: a point in time before the liquidation as the base day to calculate losses

In Hu Er Zhong Min Liu (Shang) Zhong Zi No. 170 (2001), the Second Intermediate People's Court of Shanghai held that it is not reasonable to calculate the loss based on the stock price at a point in time after the liquidation, since this would call for the prediction of future prices. Accordingly a loss caused by forced liquidation should be calculated with reference to a base day before the liquidation. The Supreme Court expressed a similar view in respect of the futures market in the case of Min Ti Zi No. 111 (2010).

The calculation of loss should be based on prices at a reasonable point in time before the date of the forced liquidation, and any difference in the net property value between this time and the forced liquidation is deemed to be the loss caused by an erroneous or delayed liquidation.

View 2: no compensation for losses due to stock price fluctuation, but only compensation for loss of interest

The Intermediate People's Court of Changsha found in Chang Zhong Min Zai Shen Chu Zi No. 0101 (2009) that: "erroneous liquidations infringe an individual's right to his or her property and shall be deemed a tort. Given the risks and unpredictability of the securities market, the loss caused by the tort is calculated based on the value of the property when the tort occurred plus the loss of interest on that value."

Accordingly, the value of the property at the time of the erroneous liquidation is treated as the principal amount, and the loss is the interest accrued on this principal amount from the date of the liquidation.

View 3: compensation at the discretion of the court

In the case of Yang Min Wu (Shang) Chu Zi No.979 (2013) a decision of the Shanghai Yangpu District People's Court, the plaintiff lost a trade opportunity because of the defendant bank's action somewhat similar to an erroneous liquidation. The court determined the plaintiff's losses on a discretionary basis, taking into account factors such as the market conditions, the monetary amount in the plaintiff's account, the margins and the fees.

In considering these three views, we are inclined to prefer the first method, because it is more practical and minimizes the impact of market price fluctuation when assessing losses. The other two methods are applicable to special cases, and are not fully compatible with margin share trading through trust companies.

We find reasonable the "tracing-back calculation" method adopted under the first view, namely, that the loss is the difference between the net value of the property held in the trust account at the time of the delayed liquidation and the net value of the property held in the trust account at the agreed time of liquidation.

Possible defenses by trust companies against forced liquidation claims

In our experience investors' claims are almost invariably calculated using a "looking-forward" approach. Fluctuations in share prices cannot be foreseen by any market player, and calculations based on future prices is legally baseless and unreasonable. Basing values on prices that may occur at a future time can even result in an endless chain of losses. Thus a "tracing-back calculation" should be the first consideration when looking at losses.

It should be noted that "erroneous" or "delayed" liquidations will not necessarily lead to losses of property held in a trust account, and any calculation method should be flexible enough to take account of actual circumstances. For example, if the stock price tumbles after an erroneous liquidation or surges before a delayed liquidation, the following questions arise: is there a causal link between the forced liquidation and the losses or the worsening of losses? Would this objectively mitigate the losses? What's the most reasonable base day for loss calculation in different situations? How to reasonably exclude other factors that might influence the calculation of losses?

In general, whether there is any defect in the forced liquidation of a trust margin account, and how to calculate the losses caused by defective forced liquidations are hugely complex and case-specific questions. In this article, we have summarized judicial practice in the calculation of losses caused by defective forced liquidations. We hope this article will help all players to find suitable resolutions for the disputes they may face.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions