By Clara Yang

In recent years, with the cyclical fluctuations in the financial market, certain financial products have faced significant losses, causing harm to investors. In practice, many financial products are distributed through sales agencies such as banks and securities firms, which aggregate large customer bases. The fulfillment of their suitability obligations is crucial for both investors and financial product issuers. However, sales agencies are often not the direct contractual counterparties in the financial product agreements (e.g., wealth management products, fund products, trust products) between investors and issuers, which leads to ambiguity regarding the legal obligations and responsibilities of sales agencies.

This article will discuss the legal relationship established between the financial sales agency, the issuer, and the investor during the sale of financial products (e.g., fund products) and the liability that sales agencies should bear when they violate the suitability obligation toward investors.

I.The Suitability Obligation of Financial Sales Agencies

At the 8th National Civil and Commercial Court Work Conference in December 2015, it was highlighted that due to the information asymmetry in the financial market, combined with investors’ limited knowledge, investors often cannot fully understand the risks and returns of investment financial products or related services. As a result, they rely heavily on the recommendations and explanations provided by product sellers and service providers. In general, the negotiating power between the two parties is unequal, so it is necessary to legally define the suitability obligations of seller institutions to ensure that financial consumers make informed and autonomous decisions based on a full understanding of the product and its risks, thus achieving contract justice. Furthermore, it was proposed that in lawsuits concerning suitability obligations, courts could apply regulatory documents from supervisory authorities that restrict the rights of the selling institution or increase its duties, and could apply the reversed burden of proof, requiring the seller to prove whether it fulfilled the suitability obligation.

Subsequently, Chinese courts have placed more emphasis on investor protection, requiring financial institutions to bear substantial suitability obligations to ensure that the recommended financial products match the investor's risk tolerance. It is no longer sufficient for financial institutions to rely solely on well-prepared written documents and the investor’s signature to avoid civil liability.

In 2019, the Supreme People's Court issued a notice regarding the "National Court Civil and Commercial Trial Work Conference Minutes" (Law [2019] No. 254, hereinafter referred to as the "9th Civil Minutes"), which inherited and developed the aforementioned conference's spirit regarding the protection of financial consumers' rights and interests. The section on "Disputes Regarding the Protection of Financial Consumers' Rights" mainly focuses on the meaning and scope of the suitability obligation, the applicable laws, responsible parties, the burden of proof, and damages. It examines whether the seller institutions (issuers, sellers, and financial service providers) fulfilled the suitability obligation in disputes arising from the sale of high-risk financial products and providing high-risk investment services to financial consumers.

The "9th Civil Minutes" elaborates on the suitability obligation of selling institutions, including the obligation to recommend products appropriately and to disclose necessary information. The core of the appropriate recommendation obligation is risk matching, which requires the seller to understand the client and the product, and based on this, recommend and sell the appropriate product (or service) to the suitable consumer. The goal of this obligation is to ensure that financial consumers make independent decisions based on a full understanding of the nature and risks of the financial products or investment activities, and bear the resulting gains and losses. The disclosure obligation requires that financial institutions adequately explain the market risks, credit risks, and key contract terms related to the product, ensuring that consumers understand the product thoroughly before making an investment decision. The entities responsible for fulfilling the suitability obligation are the selling institutions, which include financial product issuers, sellers, and financial service providers.

Commercial banks and securities companies, as the main sales agencies for financial products in the market, are legally obligated to fulfill the suitability obligation for investors. For example, Article 1(3) of the “Notice of the China Banking Regulatory Commission on Standardizing the Agency Sales of Commercial Banks” (CBRC [2016] No. 24) stipulates that “commercial banks engaged in agency sales business shall strengthen the management of investor suitability, fully disclose the risks of the products sold, and sell financial products to clients that match their risk tolerance.” Similarly, Article 2 of the “Guidance on the Suitability of Sales of Securities Investment Funds” (CSRC [2007] No. 278) defines “fund sales institutions” as those who are authorized to handle the issuance, subscription, and redemption of fund shares, including fund managers and other institutions that have obtained qualifications for fund sales. Article 3 states that “the suitability of fund sales refers to the practice of fund sales institutions paying attention to selling products of different risk levels based on the risk tolerance of fund investors, ensuring that the appropriate products are sold to suitable investors.”

II. Legal Relationship between the Sales Agency, Issuer, and Investor

1.The Agency Relationship between the Sales Agency and the Issuer

There exists an agency relationship between the financial product issuer and the seller, where the issuer is the principal, and the seller is the agent. The financial product seller, acting under the issuer’s authorization, promotes and sells the financial product to consumers. According to the “Notice of the China Banking Regulatory Commission on Standardizing the Agency Sales of Commercial Banks” (CBRC [2016] No. 24), Article 1 provides that “the agency sales business refers to the business activity in which a commercial bank accepts the entrustment of financial institutions (hereinafter referred to as cooperative institutions) with financial licenses and under the regulation of the State Council’s banking, securities, and insurance regulatory authorities,  promotes or sells financial products issued by such institutions through its channels (including physical branches and electronic channels).”

Additionally, Article 74 of the 9th Civil Minutes and Article 167 of the General Principles of Civil Law indirectly confirm the agency relationship between the issuer and the sales agency. Article 74 of the 9th Civil Minutes states: “Financial consumers can request either the issuer or the seller of financial products to bear liability, or request them jointly to bear joint liability for compensation in accordance with Article 167 of the General Principles of Civil Law.” Article 167 of the General Principles of Civil Law provides that “If the agent knows or should know that the agency matter is illegal and still carries out the agency, or if the principal knows or should know that the agent’s actions are illegal but does not object, both the principal and the agent shall bear joint liability.”

Based on the agency relationship between the sales agency and the issuer, as well as the provisions of Article 162 of the Civil Code, which states that “civil legal acts conducted by the agent within the scope of their authority shall have effect on the principal,” it can be concluded that the legal acts performed by the sales agency as the issuer's agent should be attributed to the principal, i.e., the issuer of the financial products.

2.Legal Relationship between the Sales Agency and the Investor

The legal relationship between the sales agency and the investor is often unclear and controversial, as they do not usually establish a direct written contract with one another.

Generally speaking, in the legal relationship between the sales agency and the investor, the sales agency does not assume the rights and obligations of the financial product itself. However, if an employee of the sales agency misleads the investor by promoting a product in the name of the agency, and the investor, trusting the agency's employee, believes that the product is issued by the sales agency, a legal relationship may arise between the investor and the sales agency based on apparent authority or job-related agency.

There are two main views regarding the legal relationship between the sales agency and the investor: one is that the relationship is based on a financial management entrustment contract between the issuer’s agent (open agency) and the investor, but the final legal consequences belong to the issuer, the final contractual obligations bind the issuer and the investor. This relationship aligns with the viewpoint of the 9th Civil Minutes and can be inferred from the agency relationship between the issuer and the sales agency. The other view is that the relationship constitutes a financial services legal relationship. This type of relationship is reflected in certain judicial decisions.

The concept of “financial services legal relationship” was first raised in the case Hu Xiangbin v. Bank of China Shanghai Tianlin Road Branch, Tort Liability Dispute (2015). In this case, the Shanghai First Intermediate People's Court concluded that the bank, under relevant financial management regulations, provided financial advisory services to clients, including financial analysis, investment advice, and personal product recommendations, thus forming a financial service legal relationship between the bank and the client.

After the issuance of the 9th Civil Minutes, some courts still regard the relationship between the sales agency and the investor as a personal financial service legal relationship. For instance, in the case of China Guangfa Bank Co., Ltd. Shanghai Branch v. Tang Huiling (2021), the court determined that a financial services legal relationship existed between the bank and the investor, despite the bank's claim that there was no contract between the two parties.

III.The Liability of Financial Sales Agencies for Violating the Suitability Obligation

Currently, there are different views on the legal nature of the suitability obligation of selling institutions and the civil liability for violating the suitability obligation. Some argue that the suitability obligation is a statutory obligation and the civil liability for violating it constitutes tort liability, while others contend that the suitability obligation is a pre-contractual duty, and that violating it constitutes pre-contractual fault liability. The author agrees with the latter view and the reasons are as follows:

1.The Legal Nature of the Suitability Obligation of Financial Institutions

The suitability obligation does not arise from the negotiation and agreement between the parties but is directly regulated by law. This statutory nature also applies to sales agencies. Regulatory documents such as the “Notice of the China Banking Regulatory Commission on Standardizing the Agency Sales of Commercial Banks” clearly define the suitability obligation as a statutory duty for sales agencies, aiming to correct the imbalance in transactions through public authority intervention.

At the same time, the 9th Civil Minutes state: “The essence of the selling institution’s suitability obligation is the specific manifestation of the duty of good faith in the field of financial product sales, primarily embodied as a pre-contractual good faith obligation. Therefore, in the absence of specific regulations for suitability systems, the suitability obligation should be viewed as a special duty of good faith, i.e., a pre-contractual obligation during the contract negotiation phase.” Pre-contractual obligations are also statutory duties that arise during the contract formation process, and the seller's duty to exercise care, inform, and recommend appropriate products can be seen as a specific manifestation of pre-contractual duties in the financial investment field.

2.Civil Disputes Arising from the Violation of the Suitability Obligation Should Be Classified as Contractual Disputes

In the book Understanding and Application of the National Court Civil and Commercial Trial Work Conference Minutes compiled by the Second Civil Tribunal of the Supreme People's Court, the determination of the civil cause of action in disputes between selling institutions and financial consumers regarding the sale of financial products is discussed as follows “The selection of the civil case cause of action reflects the nature of the civil legal relationship involved in the case, which is important for the standardization of civil and commercial trials. The cause of action should generally be based on the nature of the legal relationship asserted by the parties. Since the suitability obligation is a pre-contractual duty, the civil disputes arising from its violation should be classified as contractual disputes rather than tort liability. Since there is no specific cause of action for suitability disputes involving financial institutions in the cause of action for contract disputes, and considering that financial consumers primarily purchase financial products based on the need to entrust financial institutions with wealth management, after the implementation of this Minutes, people's courts, when hearing civil and commercial cases arising from the sale of financial products between selling institutions and financial consumers, may consider using the cause of action for financial management entrustment contract disputes.”

3.Violation of the Suitability Obligation Constitutes Pre-Contractual Fault Liability

Pre-contractual fault liability differs from tort liability. Pre-contractual fault liability arises when one party breaches its duty of good faith during the contract negotiation process, causing the other party to suffer damages based on their reliance. Tort law, on the other hand, typically involves actively and intentionally infringing on another’s property or personal rights.

The essence of the violation of the suitability obligation being classified as pre-contractual fault liability lies in increasing the attention duty of the selling institutions. In the pre-contractual phase, the parties transition from a general relationship to a special trust relationship, and any negligence can cause harm. In such situations, the law imposes a higher duty of care on the financial institution to protect investors, considering the unequal position between them during contract formation.

IV.Entities Bearing Pre-contractual Fault Liability

Both the sales agency and the issuer, as parties involved in the pre-contractual phase, should bear pre-contractual fault liability, either individually or jointly. According to Article 500 of the Civil Code: “If one party causes damage to the other party due to any of the following circumstances during the contract negotiation process, the party at fault shall bear liability for compensation,” the entity responsible for pre-contractual fault liability is the party involved in the contract formation process. Therefore, even if there is no direct financial services contract between the sales agency and the investor, the sales agency should still bear pre-contractual fault liability as a party in the process of forming a financial management entrustment contract (i.e., a financial product contract).

V.Conclusion

Before the issuance of the 9th Civil Minutes in 2019, in cases where investors filed lawsuits solely against sales agencies, courts often adjudicated these cases under tort liability due to the lack of a direct written contract between the investor and the sales agency. By using tort liability, courts did not need to delve deeply into the contractual relationship between the parties, focusing instead on the elements of tort liability. After the issuance of the 9th Civil Minutes, investors' lawsuits against sales agencies for failing to fulfill the suitability obligation have a solid legal foundation, greatly simplifying the process of proving the legal relationship and liability.