Introduction

In 2014, the default of “11 Chaori Bond” marked the first year of defaults in China’s bond market, and this case also became the first bond market misrepresentation lawsuit in China. Since 2018, bond defaults have occurred frequently, reaching a peak in 2020, with annual default scales reaching hundreds of billions during these three years. Since 2022, bond defaults have begun to slow and have significantly improved. Alongside bond defaults, some companies have also revealed issues of fraudulent issuance or misrepresentation at the time of bond issuance. However, the intervention of litigation procedures has a lag. Civil lawsuits resulting from bond defaults began to surge only in 2019. Bond misrepresentation lawsuits in China attracted widespread attention in the industry starting from 2020, particularly the Wuyang Bond case, which caused a huge shock to the capital market and the legal community. Subsequently, the Dalian Machine Tool case, decided at the end of 2022, and the Shengtong Bond case and the first ABS fraudulent issuance case since 2023 have also drawn significant attention. The huge compensation amounts and different adjudication standards naturally sparked continuous controversy.

To study the history and development trends of bond market misrepresentation lawsuits in China and to explore the adjudication standards and rules of such cases through judicial practice, the author has compiled a total of 10 bond misrepresentation cases since the Chaori Bond case. These cases are compared and analyzed from various aspects, including legal application, sued parties, scope of liability, and loss calculation, in the hope that readers may gain some insights.

Bond dispute cases in China mainly involve corporate credit bonds, including corporate bonds, enterprise bonds, and non-financial enterprise debt financing instruments. According to the central bank’s statistical caliber, they also include asset-backed securities (ABS) and asset-backed notes (ABN). The bond varieties mentioned in the National Court Symposium Summary on Trial of Bond Dispute Cases (hereinafter the “Bond Summary”) are corporate bonds, enterprise bonds, and non-financial enterprise debt financing instruments. Currently, the bond misrepresentation cases tried by courts mainly involve corporate bonds and non-financial enterprise debt financing instruments, in addition to the first ABS fraudulent issuance case decided in the first half of 2023. Therefore, the research objects of this article include misrepresentation lawsuits arising from information disclosure violations related to corporate credit bonds such as corporate bonds, enterprise bonds, non-financial enterprise debt financing instruments, and ABS. See the table below for details:

Table 1: Past 10 Bond Misrepresentation Cases

I. Legal Application in Bond Market Misrepresentation Cases

From past cases, before 2020, bond market misrepresentation lawsuits in China only appeared in exchange-traded bonds, including both public offering bonds (including convertible bonds) and private placement bonds. In 2020 and 2021, the Beijing No. 3 Intermediate People’s Court and the Beijing Financial Court successively accepted cases involving non-financial enterprise debt financing instruments in the interbank market related to Kangde Group and Dalian Machine Tool Group[4], and the Shanghai Financial Court also accepted the first ABS fraudulent issuance case in 2020[5]. By then, the scope of acceptance for bond misrepresentation cases in China covered both the exchange market and the interbank market, as well as public and private placements.

Generally, there is little controversy in the industry and academia regarding the application of the Securities Law and the judicial interpretation on misrepresentation to publicly offered bonds in the exchange market. The first bond misrepresentation case in China, involving the “11 Chaori Bond,” was a publicly issued corporate bond on the Shenzhen Stock Exchange. At the same time, there are differing views on the legal application for private placement bonds, especially those in the interbank market.

The 2003 Provisions of the Supreme People’s Court on Several Issues Concerning the Trial of Civil Compensation Cases Arising from Misrepresentation in the Securities Market (hereinafter the “Old Several Provisions”) explicitly excluded securities disputes arising from non-public offerings and negotiated transfer methods. Theoretically, this judicial interpretation is generally considered to be based on the efficient market hypothesis and fraud-on-the-market theory, and was formulated according to the model of “fraud-causing increase” misrepresentation using centralized auction methods. Bonds traded through non-public offerings or negotiated transfer methods cannot apply it. Therefore, it was generally believed at that time that although private placement bonds issued on the exchange market are securities under the Securities Law, the Old Several Provisions could not be directly applied. The Jiliang Bond case, which concluded in the second instance in March 2020, held this view. In that case, Jiliang Bond was a private placement bond and was traded by negotiated transfer; the court held that the Old Several Provisions did not apply, but the Securities Law did, and directly cited Article 69 of the 2005 Securities Law to order the defendant to bear compensation liability.

In July 2020, the Supreme People’s Court formulated the Bond Summary, requiring the application of the same legal standards to corporate bonds, enterprise bonds, and non-financial enterprise debt financing instruments, which share the common attribute of repayment of principal and interest. The Provisions of the Supreme People’s Court on Several Issues Concerning the Trial of Civil Compensation Cases for Misrepresentation in the Securities Market (hereinafter the “New Several Provisions”), effective from January 2022, also relaxed applicability to non-public offerings and negotiated transfers. Since the formulation of the Bond Summary, regardless of academic views, both public and private placement bonds, and whether traded by centralized auction or negotiated transfer, can uniformly apply the Bond Summary and even the Old or New Several Provisions for adjudication. In cases concluded after the Bond Summary, such as the Hongrun Bond case, the Zhifu Bond case, and the Wuyang Bond case, the courts all found that the Securities Law and the Old Several Provisions applied.

There is significant controversy over whether the Securities Law and the judicial interpretation on misrepresentation apply to interbank market bonds. Before the publication of the Bond Summary, the Supreme People’s Court stated in a ruling in May 2020 that bonds issued through book-building and centralized placement in the interbank bond market did not meet the application conditions of the Old Several Provisions[6].

Subsequently, although the Bond Summary included interbank market bonds (i.e., non-financial enterprise debt financing instruments) within its unified provisions, the controversy persisted. Some scholars argue that since neither the old nor the new Securities Law explicitly stipulates interbank market bonds, and it is disputed whether the interbank market falls within the definition of “other national securities trading venues approved by the State Council” under the New Several Provisions, coupled with reasons such as the interbank market being a private placement and non-efficient market, the Securities Law and the New Several Provisions should not apply to interbank bond market misrepresentation[7].

In the retrial of the Kangde Bond case, the Beijing High Court avoided the controversy over the application of the judicial interpretation on misrepresentation. Instead, in the “Opinions of the Court” section, when specifically analyzing the reasons for legal application, it reasoned based on the relevant provisions of the Bond Summary[8].

However, from subsequent cases such as the Dalian Machine Tool case and the Shengtong Bond case, after the implementation of the New Several Provisions, the Beijing Financial Court and the Qingdao Intermediate People’s Court both determined that interbank market bonds are subject to the Securities Law and the New Several Provisions. In the Dalian Machine Tool case, the Beijing Financial Court held: “The interbank bond market is the largest bond issuance and trading market in China. Bonds applying for issuance and trading in the interbank market, as well as intermediary institutions providing corresponding services, come from all over the country. The issuance, listing, trading, settlement, and other mechanisms of interbank bonds all have nationwide uniform standards. Based on this, the interbank bond market should be considered a national securities trading venue under the Securities Law. The issuance and trading of interbank bonds constitute the issuance and trading of other securities recognized by the State Council according to law, and should be subject to the Securities Law and its judicial interpretation.”

The author believes that the second-instance trial of the Kangde Bond case concluded relatively early and was itself highly controversial. The decisions in the Dalian Machine Tool case and the Shengtong Bond case better reflect the mainstream view of current judicial authorities and are more in line with the legislative purpose of the Supreme People’s Court’s Bond Summary to correctly adjudicate various bond disputes and unify legal application and adjudication standards. Therefore, although this issue remains controversial in academia, the mainstream view of judicial authorities has been settled.

Regarding the legal application of ABS misrepresentation cases. The Meijite ABS case, as the first ABS fraudulent issuance case in China, involved asset-backed securities issued in 2016. The 2014 Securities Law had not yet explicitly included asset-backed securities within its scope of application. However, the Shanghai Financial Court held that previous relevant policy documents had clearly included asset-backed securities within the bond market for regulation. The asset-backed securities involved in the case were securities listed and traded on the Shanghai Stock Exchange, and their concept, characteristics, operation, and rights and obligations of various parties were clearly stipulated in the Administrative Provisions on Asset Securitization Business. Furthermore, Article 1 of those provisions explicitly states that they are formulated based on the Securities Law, the Securities Investment Fund Law, the Interim Measures for the Supervision and Administration of Private Investment Funds, etc. Therefore, the 2014 Securities Law should apply to this case. At the same time, the New Several Provisions also clarify that their scope of application is “civil compensation cases for infringement caused by misrepresentation in the process of issuing and trading securities on securities trading venues,” which fits the circumstances of this case. Moreover, this case had not yet become final after the implementation of the New Several Provisions, so those provisions should apply. See Table 2.

Table 2: Application of the Securities Law and Judicial Interpretation on Misrepresentation in the Past 10 Cases

II. Sued Parties and Their Liability

(A) Scope of Defendants

According to the Securities Law and relevant judicial interpretations, if an issuer causes losses to investors through fraudulent issuance or misrepresentation, investors may, in accordance with the provisions, require the issuer, its controlling shareholders, actual controllers, directors, supervisors, senior management, and other directly responsible persons, as well as sponsor-underwriting institutions[9] and securities service institutions, to bear joint and several liability for compensation. However, in practice, due to practical constraints or various other reasons, investors generally do not “sweep in all at once” but selectively choose their opponents based on actual circumstances.

Figure 1: Identity of Defendant Parties

As shown in Figure 1, among the past 10 cases, only half (5 cases) sued the bond issuer; only 2 cases sued the controlling shareholder or actual controller; only 2 cases sued directors, supervisors, or senior management. In the Wuyang Bond case, defendant Chen Mouchang was both the actual controller and chairman (thus, total cases suing controlling shareholders, actual controllers, or directors/supervisors were only 3).

Among the above 10 cases, only the Chaori Bond case and the Haiyin Convertible Bond case (both public offering bonds) sued the issuer, yet 8 cases sued intermediaries. Among these, as many as 7 cases sued underwriters (including financial advisors and managers in the ABS case); 5 cases each sued auditing institutions and law firms; 4 cases sued credit rating agencies.

It can be seen that, unlike stock misrepresentation cases which mainly pursue the issuer, bond misrepresentation cases more frequently seek compensation from intermediaries. This is likely because bond misrepresentation cases are often triggered by bond defaults, with many issuers having already entered bankruptcy proceedings before the lawsuit. Investors are often forced to act because the bond issuer has lost its solvency. Additionally, in practice, controlling shareholders, actual controllers, directors, supervisors, and senior management are rarely sued. On one hand, this may be because, before the new Securities Law took effect, the 2005 Securities Law stipulated that controlling shareholders and actual controllers bear fault-based liability rather than presumed fault liability. Most misrepresentations in existing cases occurred before the new Securities Law came into effect, and many controlling shareholders and actual controllers had not been subject to administrative penalties, making it difficult to establish their fault. On the other hand, controlling shareholders and actual controllers (who may also be issuer executives) often act as joint obligors when the enterprise raises funds or borrows, and they also lack solvency, often being listed as dishonest judgment debtors for failing to perform effective judgments. Some legal person shareholders have even been ordered by courts to merge bankruptcy with the issuer (e.g., Dalian Machine Tool case). For directors, supervisors, and senior management, even if not listed as dishonest judgment debtors, their solvency is often limited, and there may be obstacles in notification and service that affect litigation efficiency. After comprehensive consideration, most investors do not list the issuer’s controlling shareholders, actual controllers, or directors/supervisors/senior management as defendants.

Conversely, banks and securities firms, as bond underwriters, are often financially strong and occupy a primary position among intermediaries. Once misrepresentation occurs, they are the most likely targets for lawsuits. In addition, auditing, legal, and credit rating intermediaries are also prone to being sued. This fully demonstrates that in bond misrepresentation cases, because the issuer and the “primary wrongdoer” often lack solvency, investors turning to intermediaries, especially underwriters, is more common than in stock market misrepresentation cases.

(B) Liability of the Issuer and Its Controlling Shareholders, Actual Controllers, Directors, Supervisors, and Senior Management

Table 3: Lawsuits Against and Liability of Issuer, Controlling Shareholders, Actual Controllers, Directors, Supervisors, and Senior Management

As shown in Table 3, in a total of 6 cases, the issuer and/or its controlling shareholders, actual controllers, directors, supervisors, and senior management were sued. Among them, 5 cases sued the issuer, and the court in all cases ordered them to bear compensation liability (in the Jiliang Bond case and the Wuyang Bond case, because the issuer had entered bankruptcy proceedings, the court decided by confirming the plaintiff’s bankruptcy claims against them). In the 3 cases suing controlling shareholders, actual controllers, and senior management—including the controlling shareholder Jiliang Group in the Jiliang Bond case (involved in criminal proceedings), the actual controller Chen Mouchang in the Wuyang Bond case (administrative penalty), and the directors/supervisors/senior management in the Hongrun Bond case (not penalized)—all were held liable.

Regardless of the old or new Securities Law, the issuer, as the primary responsible party for information disclosure, bears no-fault liability. Therefore, when the court confirms that the issuer has committed misrepresentation and caused losses to the plaintiff, the issuer is the first to bear compensation liability. Thus, all five sued issuers were held liable (including confirmation of bankruptcy claims). The other 5 cases did not sue the issuer, mainly because the issuer had already entered bankruptcy proceedings and the plaintiff’s claims had been confirmed, making further suit unnecessary (see below). This does not mean that the issuer is not liable.

As mentioned, the 2005 Securities Law stipulates that controlling shareholders and actual controllers bear fault-based liability, requiring the plaintiff to prove their fault. Without related criminal judgments or administrative penalties, it is difficult for plaintiffs to prove fault in practice. Additionally, the solvency of controlling shareholders and actual controllers after bond default is often problematic. Therefore, in practice, few sue controlling shareholders or actual controllers. In the existing cases where controlling shareholders or actual controllers were sued and the plaintiffs prevailed, the defendants were either involved in criminal proceedings or had been penalized.

Regardless of the old or new Securities Law, directors, supervisors, and senior management of the issuer bear presumed fault-based joint and several liability. That is, as defendants, they must prove that they are not at fault; otherwise, they bear joint and several liability with the issuer. In the two existing cases (whether penalized or not), the directors, supervisors, and senior management were ultimately ordered to bear joint and several liability. Even though the law is relatively favorable to plaintiffs, as analyzed above, cases suing directors, supervisors, and senior management are very limited. Furthermore, based on the current trend of refined adjudication and with reference to recent stock misrepresentation cases such as Zhonganke and LeEco, the author predicts that in future bond misrepresentation cases involving directors, supervisors, and senior management, even if fault is found, the court is likely to apply proportional joint and several liability based on the degree of fault.

(C) Liability of Intermediaries

Table 4: Sued Intermediaries and Their Liability

As shown in Table 4, bond misrepresentation disputes primarily focus on the liability of intermediaries. Among the past 10 cases, except for the Chaori Bond case and the Haiyin Convertible Bond case (both exchange market public bonds where no intermediaries were sued), the other 8 cases all sued intermediaries. Among these, 7 cases sued underwriters (including financial advisors and managers in the first ABS case), 5 cases each sued auditing institutions and law firms, and 4 cases sued credit rating agencies.

Regarding the ultimate liability of each intermediary: Among the 7 cases where underwriters were sued (including financial advisors and managers in the first ABS case), all except the Kangde Bond case ordered the underwriter to bear joint and several liability. In terms of the proportion of liability, 5 cases ordered the underwriter to bear full joint and several liability, and only the Dalian Machine Tool case ordered the lead underwriter to bear 10% joint and several liability. Additionally, in the first ABS case, while one securities firm as financial advisor bore 100% joint and several liability, the manager, Hafutong Company, was found by the court to primarily act as a channel and was ordered to bear only 30% joint and several liability.

Among the 5 cases where auditing institutions were sued, all except the Kangde Bond case were ordered to bear compensation liability. Among these, except for the Dalian Machine Tool case where the auditing institution bore only 4% joint and several liability, the other three cases ordered the auditing institution to bear full joint and several liability.

Among the 5 cases where law firms were sued, only one (the Hongrun Bond case) was not held liable; the other four law firms bore joint and several liability of 5% (Wuyang Bond case), 6% (Dalian Machine Tool case), 5% (Shengtong Bond case), and 10% (ABS case) respectively.

Among the 4 cases where credit rating agencies were sued, except for the Dalian Machine Tool case where the rating agency was not held liable, the other three bore joint and several liability of 10% (Wuyang Bond case), 50% (Shengtong Bond case), and 10% (ABS case) respectively.

From the above cases, it is evident that lead underwriters are sued most frequently and often bear the highest proportion of joint and several liability. Although law firms are sued in the same number as auditing institutions, since the misrepresentations often involve financial fraud, auditing institutions typically bear a higher proportion of joint and several liability than law firms. Rating agencies are sued the least, but the proportion of liability is not low (three-quarters), and the Shengtong Bond case ordered the credit rating agency to bear as much as 50% joint and several liability, undoubtedly sounding an alarm for credit rating agencies.

Regarding the form of fault, both the old and new Securities Law stipulate that underwriters, sponsors, and securities service institutions such as legal, auditing, appraisal, and credit rating agencies bear presumed fault liability. The new Securities Law also adds directly responsible persons of underwriting and sponsoring institutions as liability subjects. Currently, there is no precedent in bond misrepresentation disputes for claiming against the responsible persons of underwriters. Furthermore, regarding the determination of fault and exemption, the Old Several Provisions did not provide detailed rules, simply stating “if there is evidence of no fault, exemption shall be granted.” The Bond Summary (Articles 29-31) and the New Several Provisions (Articles 17-19) contain more detailed provisions. From past cases, there are not many successful cases where intermediaries claimed exemption based on no fault. The reasons are twofold: first, intermediaries bear presumed fault liability, so their burden of proof is heavier; second, compared to stock issuance business, intermediaries charge much lower fees for bond projects, and they usually try to profit by investing less human and time resources. However, the legally required procedures and methods for due diligence have not significantly decreased, leading intermediaries to conduct due diligence superficially or cut corners, and due diligence working papers often fail to meet legal requirements. In the few cases where intermediaries were exempted, the credit rating agency in the Dalian Machine Tool case was exempted mainly because it only conducted an issuer credit rating and did not rate the specific bond. In the Kangde Bond case, the court held that the underwriting institution’s Due Diligence Report and working papers were sufficient to prove that it had performed reasonably adequate due diligence obligations for the bond issuance. However, from the retrial ruling, the applicant (a bank) pointed out multiple issues in the underwriter’s due diligence documents, but the court did not respond. In contrast, the Beijing Financial Court in the Dalian Machine Tool “Case No. 1” provided a detailed discussion on whether the lead underwriter fulfilled its due diligence obligations in accordance with regulations and whether it was at fault, based on the prospectus and the lead underwriter’s due diligence report. The author believes that compared to the Dalian Machine Tool case, the Kangde Bond case’s reasoning was insufficient, and its adjudication result is debatable.

Regarding the form of liability, both the old and new Securities Law stipulate that intermediaries shall bear joint and several liability. However, the 2007 Provisions of the Supreme People’s Court on Several Issues Concerning the Trial of Civil Compensation Cases Involving Accounting Firms in Audit Business Activities (hereinafter the “Audit Provisions”) differentiates between forms of fault to impose different types of liability: in short, intentional fault leads to joint and several liability, while negligence leads to supplementary liability. This provision conflicts with the Securities Law. The author believes that since the Securities Law stipulates that securities service institutions, including auditing institutions, bear joint and several liability, based on the basic legal principle that higher-level laws prevail over lower-level laws, the joint and several liability provision should naturally apply in securities misrepresentation cases. In the Kangde Bond case, the court’s determination that the auditing institution bore supplementary liability is debatable. Additionally, the second-instance final judgment in that case should have been rendered before the implementation of the New Several Provisions. The New Several Provisions clarify that where the Audit Provisions are inconsistent with them, the New Several Provisions shall prevail.

Furthermore, in recent years, the adjudication of securities misrepresentation disputes has become increasingly refined. The Bond Summary also emphasizes that when pursuing intermediary liability, liability should be combined with the degree of fault, ordering at-fault intermediaries to bear corresponding legal liability. Therefore, although the Securities Law stipulates that intermediaries bear joint and several liability, courts have creatively “interpreted the law” in securities cases, putting forward the concept of “proportional joint and several liability,” i.e., ordering relevant responsible parties to bear only a certain proportion of joint and several liability based on their degree of fault. The Hangzhou Intermediate People’s Court first applied proportional joint and several liability in the Wuyang Bond case, with relevant intermediaries bearing between 5% and 100% joint and several liability. However, it should be noted that even with the application of proportional joint and several liability, courts generally impose heavier liability on intermediaries that played a major role in the misrepresentation. Typically, securities firms and banks, as lead underwriters, draft major documents such as the Prospectus and lead the entire bond offering process, thus usually bearing heavier liability. Additionally, bond misrepresentation often manifests as financial fraud, so auditing institutions also bear heavier liability. In contrast, the liability of law firms, credit rating agencies, and other intermediaries is relatively lighter. This is reflected in practice: among the 6 underwriters held liable, 5 bore 100% joint and several liability; among the 4 auditing institutions held liable, 3 bore 100% joint and several liability. Meanwhile, the proportions for law firms and credit rating agencies ranged between 5%-10% and 10%-50%, respectively. Moreover, intermediaries with intentional fault often bear 100% joint and several liability. This includes the auditing institution in the Zhifu Bond case and the securities firm (financial advisor) in the Meijite ABS case, both of which were found by the court to have knowingly cooperated in the issuer’s financial fraud. In the Meijite ABS case, the Shanghai Financial Court further held that even if the plaintiff had some negligence, it could not mitigate the securities firm’s compensation liability.

It is worth mentioning that, except for the Kangde Bond case, the lightest liability proportion among the above cases was in the Dalian Machine Tool case, where each institution bore only 0-10% liability based on its degree of fault. However, an important reason was that the plaintiff itself had multiple faults, which greatly reduced the defendants’ compensation liability (see below). Moreover, the currently decided “Case No. 1” of the Beijing Financial Court is only one case in the Dalian Machine Tool misrepresentation series. In other subsequent cases, the liability proportions of each intermediary may differ due to different circumstances of the plaintiff’s own fault.

III. Calculation of Investor Losses

Since the publication of the Bond Summary, loss calculation has become a hot topic in bond misrepresentation cases. Especially after the implementation of the new judicial interpretation, whether the losses of investors who continue to hold bonds should be compensated based on “face value principal and interest” or calculated based on “investment difference” has become a focal point of contention. Particularly after the Jinan Intermediate People’s Court’s decision in the Shengtong Bond case to calculate investor losses based on the investment difference, the controversy and criticism surrounding Article 22, paragraph 2 of the Bond Summary have intensified.

The reasons for believing that investor losses should be calculated based on the investment difference/actual loss are mainly: (1) the new law prevails over the old one, and higher-level law prevails over lower-level law; (2) calculating losses based on “face value principal and interest” violates the principle of loss compensation and may encourage arbitrage in the secondary bond market; (3) Article 22, paragraph 2 of the Bond Summary violates the legal principle of “concurrence of claims”; (4) the Supreme People’s Court once adopted the relevant provisions of Article 22, paragraph 2 of the Bond Summary in the draft of the New Several Provisions for comment but deleted them in the final version, indicating that the Supreme Court has denied the method of determining bond investor losses based on “face value principal and interest”[11].

The reasons for believing that investor losses should continue to be calculated according to Article 22, paragraph 2 of the Bond Summary are mainly: (1) the Bond Summary has not been abolished and remains effective; (2) Article 27 of the New Several Provisions limits the calculation method of investment difference loss to the stock market with centralized bidding and does not apply to the bond market, which does not use centralized bidding; moreover, that article uses the term “stocks” rather than “securities” (unlike other articles that use “securities”); (3) the Bond Summary also explicitly states in Article 5 that in civil cases of bond fraudulent issuance and misrepresentation, the issuer’s compensation liability should be determined based on the actual losses of investors, which is no different from the “limited to actual losses” mentioned in the New Several Provisions; (4) the New Several Provisions do not contain specific rules for calculating bond misrepresentation losses, so the premise for the so-called “new higher-level law prevails over old lower-level law” does not exist; (5) simply interpreting the deletion of the relevant rules on bond loss determination from the draft to the final version of the New Several Provisions as the Supreme Court’s intention to unify the loss determination rules for stocks and bonds is also far-fetched[12].

Table 5: Methods of Calculating Investor Losses

As shown in Table 5, from past cases, except for the Kangde Bond case where the court did not support compensation for investor losses, the other 9 cases all ordered compensation. Among these 9 cases, before the Shengtong Bond case, only the Chaori Bond case and the Haiyin Convertible Bond case compensated based on investment difference loss (but these two cases occurred before the Bond Summary was issued, and the bonds involved were all publicly issued on stock exchanges and traded by centralized bidding, fully applicable to the calculation method for investor difference loss under the Old Several Provisions). The remaining cases all determined investor losses based on face value principal and interest (minus amounts already recovered). Among them, the Jiliang Bond case was decided before the Bond Summary was published; the Hongrun Bond, Zhifu Bond, and Wuyang Bond cases were decided after the Bond Summary was published but before the New Several Provisions took effect. After the implementation of the New Several Provisions, the Dalian Machine Tool case and the Meijite ABS case (where no transfer occurred in between) still calculated investor losses based on the basic principle of face value principal and interest. The Shengtong Bond case was the first and so far the only case after the implementation of the New Several Provisions to award compensation based on investment difference loss. Additionally, some cases also supported attorney fees (Wuyang Bond case) and preservation insurance fees (Hongrun Bond case).

It should be noted that in the cases supporting loss determination based on face value principal and interest, some plaintiff investors had subscribed at the issuance price at the time of issuance and did not have the issue of low-price acquisition, so it does not reflect and should not be taken as the presiding judge’s actual inclination toward the two different views. It can be anticipated that the controversy over loss calculation will continue to collide in judicial practice for several rounds.

IV. Impact of Plaintiff’s Own Fault on Defendant’s Compensation Liability

Among the past 10 cases, in 5 cases the defendant raised the defense that the plaintiff itself was at fault (the Shengtong Bond case has no judgment document available, so there may be an error), but only one case (Dalian Machine Tool case) was explicitly accepted by the court.

Table 6: Impact of Plaintiff’s Own Fault on Defendant’s Compensation Liability

As shown in Table 6, in the Jiliang Bond case and the Hongrun Bond case, the plaintiffs were securities firms acting as investment advisors for the bonds involved. In the Hongrun Bond case, the plaintiff’s received financial advisory fees were even higher than the defendant’s underwriting fees, yet the court did not find the plaintiff itself at fault.

The Dalian Machine Tool case was the first bond misrepresentation case where the court found the plaintiff itself at fault. The court held that the plaintiff had dual faults: first, at the time of purchasing the bonds, the bonds had been subject to consecutive risk notices about inability to pay, and other bonds of Dalian Machine Tool had already defaulted. Second, the plaintiff had actually engaged in marketing the bonds and received kickbacks from the issuer. After the bond default, part of the reason the plaintiff bought back the bonds was to fulfill its off-balance-sheet investment advisory management obligations, not necessarily solely for investment purposes. Based on these reasons, the court significantly reduced the defendants’ compensation liability, with the lead underwriter, bearing the heaviest liability, only bearing 10% joint and several liability.

Additionally, in the Meijite ABS case, although the court mentioned that the plaintiff, as a professional institutional investor, had a certain duty of care in investment decisions, it held that the original equity holder, Dengdu Company, fraudulently issued securities, and Huatai Securities Company knowingly acquiesced or even allowed it. Even if the plaintiff had some negligence, it was not enough to exempt or reduce the compensation liability of Dengdu Company and Huatai Securities Company. The court also stated: “In determining the proportion of joint and several liability of other intermediaries, this court has already considered the duty of care that the plaintiff, as a professional institutional investor, should bear, as well as its negligence in excessively relying on credit enhancement measures and failing to conduct effective on-site investigations, and has accordingly reduced the compensation liability of other infringing parties.”

V. Impact of Issuer Bankruptcy on Bond Misrepresentation Lawsuits

Among the 10 cases surveyed, 7 entered bankruptcy liquidation or reorganization proceedings, as shown in Table 7:

Table 7: Impact of Issuer Bankruptcy on Bond Misrepresentation Lawsuits

The first impact of issuer bankruptcy on investors is that if the plaintiff’s claim has been confirmed, its claim against the issuer should be resolved in the bankruptcy proceedings, and its lawsuit against the issuer should not be accepted according to law. This is because once bankruptcy proceedings begin, investors’ claims against the issuer must be uniformly handled under the bankruptcy law, confirmed as bankruptcy claims, and satisfied equally with similar claims (usually ordinary claims). After the plaintiff’s claim is confirmed, unless there is a dispute over the amount or nature of the claim, the investor may not separately sue the issuer. This is an important reason why only half of the issuers were sued in practice—not because of unwillingness, but because of inability. Among the past 10 cases, 7 cases involved the issuer entering bankruptcy proceedings, and in 4 of those, the issuer was not sued. Additionally, in the Wuyang Bond case, even though some plaintiffs had already sued the issuer, some plaintiffs’ claims had been confirmed earlier, and the court immediately dismissed those portions of the lawsuits against the issuer. Of course, this does not affect investors’ recourse against other joint and several obligors.

Furthermore, in practice, the portion already recovered in bankruptcy proceedings is usually deducted when determining the compensation liability of other responsible parties. If the amount recoverable by the plaintiff in bankruptcy proceedings has not yet been determined, in most cases this does not affect the court’s decision to hold intermediaries liable, as in the Wuyang Bond case and the Zhifu Bond case. Only in the Kangde Bond case did the court determine that the auditing institution bore supplementary liability and that the loss amount was not yet determined, so it temporarily did not need to bear compensation liability. In the Zhifu Bond case, the court’s judgment explicitly stated the compensation amount and the calculation method for interest and liquidated damages to be borne by the sued auditing institution, while also stating that the compensation amount should deduct amounts actually recovered through bankruptcy proceedings and other legal channels. As mentioned earlier, the Kangde Bond case’s view that the auditing institution only bore supplementary liability based on the Audit Provisions, ignoring the Securities Law’s provision on joint and several liability for intermediaries, is itself debatable. From existing securities misrepresentation cases, it is rare for courts to order defendants to bear supplementary liability in practice, and the uncertainty of bankruptcy recovery amounts generally does not affect the defendant’s compensation liability.

In addition to the above cases, if a plaintiff, as a creditor in bankruptcy reorganization, chooses non-cash settlement and subsequently seeks recourse against other responsible parties, it may be deemed that its claim has been satisfied in the bankruptcy proceedings, leading to a loss of the lawsuit. In bankruptcy reorganization proceedings, debt settlement plans can be divided into cash settlement and non-cash settlement. Non-cash settlement plans include settlement with shares, accounts receivable, or other assets or rights, with share settlement (commonly known as “debt-to-equity swap”) being the most common. However, the price for share settlement often involves a high premium. For example, in a listed company’s reorganization plan, the debt settlement plan used shares converted from the company’s capital reserves. Based on relevant calculations, the price of the settlement shares was set at RMB 10 per share, meaning that a creditor received one share of the listed company for every RMB 10 of debt. At that time, the actual stock price of the listed company in the secondary market was only RMB 2. Although the creditor actually received only RMB 2 (the actual stock price) for every RMB 10 of debt, it was still deemed that the RMB 10 debt had been 100% satisfied. The creditor could not then claim the difference (RMB 8) between the settlement price (RMB 10/share) and the market price (RMB 2/share) from other joint and several obligors.

There is a relevant case in reality. In the dispute involving CITIC Trust suing the issuer of “Yiyang Bond,” Yiyang Group, and underwriters Zhongshan Securities and Huatai Securities for misrepresentation, both the first and second instance courts dismissed the plaintiff’s claims. The court held that although CITIC Trust argued that “the actual equity value of Yiyang Group was far lower than the per-share price of the debt-to-equity swap,” even if that argument were valid, based on Article 92 of the Bankruptcy Law and the reorganization plan’s provision that “the debt-to-equity swap stipulated in the reorganization plan is a method of debt settlement. Upon completion of the industrial and commercial registration of the shares, the corresponding debts shall be deemed fully settled, and Yiyang Group and the guarantors shall no longer bear the obligation to pay. The rights of creditors against third parties other than Yiyang Group and its guarantors shall not be affected by the reorganization plan,” the court determined that the debt of over RMB 23.53 million claimed by CITIC Trust had been fully settled in accordance with the reorganization plan. Therefore, Yiyang Group no longer bore the obligation to pay, and Zhongshan Securities and Huatai Securities also no longer bore joint and several liability[13].

Conclusion

The history of bond market misrepresentation lawsuits in China is relatively short, and adjudication precedents are relatively few. However, through research, it can be seen that within just a few years, judicial adjudication of bond misrepresentation in China has become increasingly specialized and refined. For example, from initially ordering intermediaries to bear full joint and several liability, to after the Wuyang Bond case, ordering different proportions of joint and several liability based on the different degrees of fault of each intermediary. Another example is the impact of the plaintiff’s own fault on the defendant’s compensation liability, from a relatively simple determination in the Jiliang Bond and Hongrun Bond cases that the plaintiff itself was not at fault, to the Dalian Machine Tool case and the first ABS fraudulent issuance case, where detailed reasoning was used to argue whether the plaintiff itself was at fault or the degree to which such fault could reduce the defendant’s compensation liability. At the same time, some highly controversial issues remain to be resolved, such as the calculation of losses for investors who acquired bonds at a low price, which awaits further observation.

Notes:

[1] Lai Guanneng, Senior Partner at Beijing Long’an (Shenzhen) Law Firm, Director of the Securities Law Professional Committee of the Shenzhen Lawyers Association.

[2] Because the judgment is not publicly available, the author was unable to find the specific bond type involved. The same applies to the Shengtong Bond case.

[3] This article includes the first ABS fraudulent issuance case in its scope of review mainly for the following reasons: 1. The central bank includes asset-backed securities in the statistical scope of corporate credit bonds, and relevant policy documents explicitly include asset-backed securities in the bond market for regulation. 2. The judgment in this case held that the asset-backed plan at issue had the characteristics of bonds that repay principal and interest at a fixed income, and paying interest at the expected rate of return was consistent with the mutual agreement and expectations of the investment and financing parties.

[4] Case numbers: (2020) Jing 03 Min Chu No. 688 and (2021) Jing 74 Min Chu No. 1.

[5] Case number: (2020) Hu 74 Min Chu No. 1801.

[6] See the Supreme People’s Court’s Civil Ruling (2020) Zui Gao Fa Min Xia Zhong No. 23.

[7] See Xing Huiqiang: “Legal Application of Civil Liability Disputes for Misrepresentation in the Interbank Bond Market,” published in Research on Multi-level Capital Markets, Issue 2, 2022.

[8] See the Beijing High People’s Court’s Civil Ruling (2023) Jing Min Shen No. 287.

[9] The new Securities Law also includes directly responsible persons of sponsor-underwriting institutions.

[10] This article lists the original equity holder, Meijite Dengdu Company, as the issuer primarily because the court held that the original equity holder actually played the role of the issuer. Additionally, Article 78 of the National Court Financial Trial Work Conference Minutes (Draft for Comments) also uses whether the actor actually obtained the raised funds through the securities issuance activity as the criterion for determining the issuer. In this case, Hafutong Asset Management Company paid the purchase price for the initial underlying assets (including the amount paid by Dengdu Company to its related parties), so this article lists Meijite Dengdu Company as the issuer.

[11] See Wang Zekun and Wu Peng: “Discussion on the Calculation Method of Damages for Bond Misrepresentation Tort Liability,” published on the public account “Compliant Soldier,” March 24, 2022; Li A’min and Sheng Weirong: “Series Interpretation of the New Judicial Interpretation on Securities Misrepresentation, Part Three: Loss Calculation Issues in Bond Misrepresentation Dispute Cases,” published on the public account “Commerce & Trade Law Firm,” April 20, 2022.

[12] See Li Panshen: “The Misunderstood Half-Life of Article 22, Paragraph 2 of the Bond Symposium Summary,” published on the public account “Tiantong Litigation Circle,” July 17, 2023.

[13] See the Heilongjiang High People’s Court’s Civil Judgment (2021) Hei Min Zhong No. 2062.