The right to equity income in an equity income trust

December 18, 2008 | BY

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Charles Qin and Tomy XiaLlinks Law [email protected], [email protected] pooled funds trust plans and single capital trusts it is…

Charles Qin and Tomy Xia

Llinks Law Offices

In pooled funds trust plans and single capital trusts it is a common that a trust plan is established with the right to the equity income being its investment objective. The essence of such trust plans lies on the equity itself to which the right to the income is attached while such equity is unsuitable or unable to be transferred directly. For example, a financed party has a need to fund and cannot directly transfer its self-owned non-transferable shares. A trust company therefore issues a trust plan with the income of the non-transferable shares being its objective. After the investors entrust funds to the trust company, the trust company, as trustee, uses the funds to invest in the right to the income of the non-transferable shares. This achieves the target of providing funds for the financed party. Meanwhile, for the safety of the trust assets, the trust plan usually requires the financed party to counter-pledge said shares to the trust company and ultimately the dividends from the shares obtained within the trust period or the proceeds of the transfer of such shares will be used as the return for the investors. In such a trust plan, it is worthwhile discussing the legal nature of the “right to the equity income”.

Article 4 of the PRC Company Law (中华人民共和国公司法) (Company Law) stipulates that the shareholders of a company are entitled to the assets' income, to participate in making important decisions, and to choose management personnel. The right to assets' income is part of the shareholder's rights. If the shareholder's rights are divided into the rights of common benefit and the rights of self benefit, the right to equity income should fall within the scope of the rights of self benefit; this is an abstract proprietary right. Since the shareholder's rights are generally acquired on the basis of the shareholder's identity, such rights are of identity nature, and it is controversial from a theoretical perspective whether the right to equity income or other individual right can be transferred separately in theory. Meanwhile, in accordance with the Company Law, a shareholder of a company shall claim and exercise the shareholder's rights pursuant to the shareholder's register. If the right to the equity income contained in the equity income trust is deemed to have been transferred to the trust company, but the shareholder recorded in the shareholder's register is still the financed party, the trust company could not directly claim and exercise its right against the company. It appears that “the right to equity income” as the objective of an investment in an equity income trust is not the right to equity income as the right of self benefit which is discussed above. That is, the financed party has never transferred the right to equity income to the trust company.

What kind of right is “the right to equity income” as the investment objective in an equity income trust? It appears that it is a future contractual claim: by a contractual arrangement, a trustee shall have a claim against the financed party that it has the same right as the financed party to receive equal equity income (including dividends and proceeds of the equity transfer) from a company. In a trust relationship, it is agreed between a trustee (trust company) and a financed party in a contract that the trustee shall deliver the trust funds to the financed party, and the consideration paid by the financed party is all the income in connection with the shares of the company held by the financed party, including the dividends obtained by the financed party as the company's shareholder or the proceeds of the disposal of the shares.

It is noteworthy that the financed party in the aforesaid arrangement is still the absolute holder of the shares including the right to equity income, and the financed party still can claim the right to the dividends against the company and the right to dispose of the shares while the financed party shall deliver the equity income received to the trustee subject to the contract between the financed party and the trustee. In the course of performance of the contract, the trustee shall perform its obligation to the financed party on a practical and notional basis. The trustee shall deliver the proceeds of transfer to the financed party pursuant to the contract while the performance by the financed party to the trustee is anticipative and the obligations of the financed party to the trustee are uncertain, and may change depending on the specific situations of the performance by the financed party. The income of the trust plan is of an uncertain nature.

In conclusion, the investment objective of the equity income trust is a future contractual right. Before the financed party performs its payment obligations pursuant to the contract, the trustee usually asks the financed party to pledge the company's shares it holds to the trustee as security for its due performance of the contract.

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