By Xiaosu Zhu (Watson & Band) and Anna Chan (OLN) 

In a landmark decision by the Hong Kong Court of First Instance in Re Joint and Several Liquidators of CEFC Shanghai International Group Ltd (the “CEFC Case”), the Hong Kong Courts extended recognition and assistance to liquidators in Mainland China, which is a huge step towards Hong Kong-PRC coordination in cross-border liquidations. 

Previously, there has also been precedents whereby Hong Kong Court urged for multi-jurisdictional cooperation in cross-border liquidation cases. In Re Da Yu Financial Holdings Limited, the Court sanctioned a scheme of arrangement proposed by a Cayman-incorporated company listed in Hong Kong and commented that the full blown parallel schemes, instead of a simple recognition of foreign scheme, are an outmoded way of conducting cross-border restructuring. The CEFC Case now marks the first time that Hong Kong Courts has recognized and provided assistance to liquidators from the Mainland China, a non-common law jurisdiction. 

Background 

CEFC Shanghai International Group Limited (“CEFC”) is a PRC-incorporated company undergoing insolvent liquidation in the Mainland China. CEFC’s assets included a claim against its Hong Kong subsidiary, Shanghai Huaxin Group (Hong Kong) Limited, amounting to around HK$7.2 billion (the “Receivable”). Given the Subsidiary was in liquidation in Hong Kong, CEFC had submitted a proof of debt in respect of the Receivable. 

Subsequently, CEFC’s liquidators (known as “administrators” in PRC) discovered that, before the liquidation, a creditor of CEFC had obtained default judgment against CEFC in Hong Kong for a sum of around EUR 29 million, and a Garnishee Order nisi in respect of the Receivable. 

If CEFC was only asserting itself as the creditor of the Hong Kong subsidiary, it would only rank pari passu with the judgment creditor, therefore running the risk that it would be too late to enforce upon the Receivable if the judgment creditor obtained Garnishee Order absolute.   

To mitigate such risk, the PRC liquidators sought recognition of the PRC insolvency proceedings, and assistance for a stay of the Garnishee proceedings. The Hong Kong Court granted such recognition and assistance, and allowed the stay of the creditor’s Garnishee proceedings.  

Criteria for application to the Hong Kong Court 

Mr. Justice Harris summarized the now well-established principles and procedures governing applications to the Courts of Hong Kong for recognition and assistance. Provided that:- 

1. the foreign insolvency proceedings are collective insolvency proceedings; and
2. the foreign insolvency proceedings are opened in the company’s country of incorporation,

the Court may recognize insolvency proceedings in a civil law jurisdiction. Upon recognition, the Court will then grant assistance to the foreign liquidators by applying Hong Kong insolvency law. The above 2 criteria were ruled to be satisfied in the present case. 

However, in the judgment the Court said that it will not grant the foreign liquidators all powers as are available to a liquidator appointed pursuant to the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32 of the Laws of Hong Kong)(“CWUMPO”). Powers of assistance granted to foreign liquidators are limited to:- 

1. enabling the foreign liquidators to do something which they could do under the law by which  they are appointed;
2. only when it is necessary for the performance for the foreign liquidators’ function; and
3. where it is consistent with the substantive law and public policy of the assisting court.

Mr. Justice Harris opined that the case satisfied all of the above requirements, and observed that there were considerable similarities in the insolvency laws of Hong Kong and the PRC, such as the powers and duties of liquidators and pari passu distribution of debtor’s assets. 

His Lordship also held that, if a creditor commences Garnishee proceedings in Hong Kong after liquidation has commenced, the Garnishee proceedings should be terminated. Even if an order nisi has been obtained before the foreign insolvency proceedings, the Court has discretion to make the order absolute. In coming to the conclusion, the English case Galbraith v Grimshaw was held to be incompatible with modern insolvency laws (and indeed the case has been subject to much judicial and academic criticism) and therefore no longer applicable. 

Significance 

This case is the first ever in time that Mainland Chinese liquidators have applied for and been granted recognition from the Hong Kong Court. Although the Court cautioned that assistance granted to PRC liquidators should be on a case by case basis, this case certainly lends support to future PRC liquidators in seeking Hong Kong Court’s recognition and assistance (provided that they pass the thresholds). Immediately following this case, on 4^th June 2020 in Re Shenzhen Everich Supply Chain Co Ltd, Mr. Justice Harris made another ruling recognizing the Shenzhen bankruptcy proceedings and the appointment of the liquidator by Shenzhen intermediate Court, empowering the liquidator to exercise its powers in Hong Kong. 

In light of the growing trend for PRC-incorporated companies to hold assets in Hong Kong, it is expected that where such companies enter liquidation, liquidators will seek Hong Kong Court’s recognition relying on this landmark judgment. If the mainland Chinese authorities are agreeable to promoting a unitary approach to trans-national insolvencies like Hong Kong, it is likely that this case will become highly persuasive in favour of Hong Kong Courts granting recognition and assistance to mainland liquidators.  

This result can also be contrasted with past cases where the Hong Kong Courts refused assistance to trustees of a foreign-incorporated company governed by foreign jurisdictions, such as in the case of China Fishery Group Ltd where it was held that the companies involved did not have a connection with the US. In that case, the companies involved were found to have been acting in bad faith by filing the Chapter 11 proceedings in the US and appointing the trustee thereunder, in an attempt to defeat the creditor’s enforcement action under the Hong Kong jurisdiction. As such, the Courts declined to allow the companies to reap from their egregious conduct. 

It appears to suggest that, provided that companies have acted in good faith in the proceedings, Hong Kong Courts are prepared to offer recognition and assistance to liquidators. This would be in the interest of expediting cross-border insolvency and restructuring in future. 

The position by the PRC Courts remains to be tested. According to the PRC Enterprise Bankruptcy Law, if a legally effective foreign ruling on a bankruptcy case involves the property of a debtor within the territory of Mainland China, and an application for the recognition and execution thereof is filed with the Mainland Court, the Mainland Court shall, according to international treaties or the principle of reciprocity, review the ruling, and decide whether to recognize or execute such ruling having regard to factors such as whether such recognition or execution would violate the fundamental principles of the law of Mainland China, impair state sovereignty, security and social public interests, or impair the legitimate rights and interests of the debtors within Mainland China. However, in practice, so far there is no precedent in which Mainland Courts recognize the effectiveness of foreign bankruptcy proceedings. 

Now that Hong Kong Courts have made this breakthrough, it is expected to lead to positive influence on Mainland Courts. Whether Mainland and Hong Kong will further recognize and cooperate in cross-border insolvency and restructuring in the future will largely depend on whether Mainland Courts, like the Hong Kong Courts, will adopt a unified approach. In fact, mutual recognition by the Mainland and Hong Kong Courts is believed to be a two-way street and the Supreme People’s Court in China has begun to explore and establish institutional arrangements for judicial assistance in insolvency cases with relevant parties in Hong Kong. This case definitely provides reference and practical experience in this area and will have a great impact on foreign application for recognition in the Mainland in the future. 

Other points to note in cross-border insolvency

1. Application of pari passu principle

It is commonly the case that in cross-border insolvency, a company in one jurisdiction holds assets situated in a foreign jurisdiction. It has been held in Re Guangdong International Trust & Investment Corporation Hong Kong (Holdings) Ltd that it is possible to apply the principle of pari passu distribution to distribute the insolvent estate’s assets both in Hong Kong and abroad.In that instance, the liquidators of the company were tasked with distributing the company’s cash in a PRC bank account, and its Hong Kong assets, to the creditors. Given the mainland regulations on currency transfer, the cash in the PRC bank account could only be transferred to other PRC bank accounts. The Court allowed the proposed mechanism of distribution of the PRC account balance to creditors who had a PRC account, and distribution of Hong Kong assets to those who did not receive the PRC account balance, both on a pari passu basis. Despite this mechanism not involving a pooling of all assets of the company before pari passu distribution, it was held that the principle was concerned with achieving a substantive result but not the procedural mechanisms. This is a welcoming flexibility that would no doubt assist future liquidators in proposing methods of distribution of assets, where there might be procedural difficulty in adhering to the traditional understanding of pari passu principle.

2. Bankruptcy proceedings vs. garnishee proceedings

Notably, if the parent company undergoing liquidation were a Hong Kong company instead of a Shanghai entity, it would still result in the way as in the CEFC Case (that the Garnishee proceedings could not continue against the company’s receivables). This is by virtue of section 186, CWUMPO, which provides that when a winding-up order has been made, or a provisional liquidator has been appointed, no proceeding shall be proceeded with or commenced against the liquidating company (except by leave of the Court). It is a well-settled principle that the Court has inherent jurisdiction to stay proceedings (e.g. Garnishee proceedings) or stay execution against a company in liquidation, with good policy reasons behind. It would be “unfair or more likely an abuse” if, in liquidation where pari passu distribution of a judgment debtor’s asset is in place or imminent, the judgment creditor gains an unfair advantage over other creditors by enforcing the judgment. In the CEFC Case, the stay of Garnishee proceedings was precisely because the Court wished to achieve the same result as it would in local winding-ups under section 186 CWUMPO, so that it may oversee creditor action to promote an orderly liquidation. 

Comparison of the insolvency regimes in Hong Kong and Shanghai/PRC 

Extrapolating on the Court’s ending remark on unitary approach by the two jurisdictions, this part sets out differences in winding-up proceedings in Hong Kong and Shanghai in order to explore the possibility of future similar treatment of Hong Kong liquidators by the PRC authorities.   

	Hong Kong	Shanghai/ PRC
Primary legislation	CWUMPO; andCompanies Ordinance (Cap. 622).	Enterprise Bankruptcy Law; andthe relevant Judicial Interpretations on Enterprise Bankruptcy Law by the Supreme People’s Court
Corporate rescue/ restructuring regime	No rescue regimes, but restructuring by scheme of arrangement is possible.	There are special chapters under the Enterprise Bankruptcy Law about corporate rescue and restricting, namely Chapter 8 about reorganization and Chapter 9 about reconciliation.
Insolvency test	Company is unable to pay its debts and if:- A creditor serves on the company at its registered office a Statutory Demand and the company neglects to pay the sum within 3 weeks of service; Execution or other process issued on a judgment or court order in favor of the creditor is returned unsatisfied; or After considering the contingent and prospective liabilities of the company, it is proved to the court that the company cannot pay its debts. The usual test relied upon is the cash flow test but the balance sheet test is also applicable, and is applied as the Court considers appropriate.	An enterprise is unable to pay its debts due and if: Its assets are not sufficient to pay all its debts (namely, the balance sheet test); or Such enterprise obviously lacks solvency (to some extent like the cash flow test). If the assets of a debtor exceed the liabilities on the balance sheet, the Court will hold that it obviously lacks solvency if: it is unable to pay its debts due to such reasons as the serious insufficiency of funds or the failure to realize property; or it is unable to pay its debts because the whereabouts of its legal representative is unknown and there is no other person responsible for managing its property; or it is unable to pay its debts upon enforcement of the Court; orit is unable to pay its debts because it has made a loss for a long time and it is difficult for it to turn losses into profits; or in any other circumstances which result in the loss of solvency of the debtor. As for reorganization, the threshold could be even lower; as long as the enterprise has apparently forfeited the ability to pay its debts, it may undergo reorganization according to the provisions of the Law.
Applicants	Winding up proceedings: Creditors, directors, shareholders Scheme of arrangement: Creditors, liquidators, shareholders	Bankruptcy Liquidation (winding ups): Creditors,  debtor Reorganization:   Creditors, debtor, shareholders who hold more than one-tenth of the debtor’s registered capital  Reconciliation:   Debtor
Secured creditors’ position	Secured creditors can enforce its security.	Secured creditors can enforce its security.
Transactions subject to challenge	Unfair preferences: If the company previously entered into any transaction influenced by the desire to prefer a particular creditor over creditors, the liquidator may apply to the Court to have the transaction set aside. Such transaction must have occurred:In the 6 months before liquidation has commenced; orIn the 2 years before liquidation has commenced if transaction is with an associate of the company, its director or shadow director. Dispositions in compulsory liquidation: All dispositions of property, transfer of shares, or alteration of shareholders’ status after commencement of winding up will be void. Extortionate credit transactions: A liquidator may apply to the Court for various orders regarding a transaction, which requires grossly exorbitant payments or is otherwise grossly against fair dealing principles, entered into within 3 years before commencement of the winding up.  Transaction at undervalue: Transactions at undervalue entered into within 5 years before liquidation has commenced may be voidable. This refers to transactions by the company where the company receives consideration significantly less than that provided by the company, or receives no consideration. Floating charges: A floating charge may be invalid if it was created:Within 2 years before the liquidation has commenced, if created in favor of an associate of the company, its director or shadow director; orWithin 1 year before the liquidation has commenced, if created in favor of other persons.	Within 6 months before the Court accepts the application for bankruptcy, if the debtor meets the bankruptcy test but still pays debts to specific creditors, the liquidator is entitled to request the Court to rescind the payoff unless the debtor’s property benefits from such payoff.After the Court accepts the application for bankruptcy, it shall be invalid for the debtor to pay off debts to a particular creditor.The following activities concerning the property of the debtor shall be invalid and the liquidator is entitled to recover the property:Hiding or transferring property for avoidance of debts;Fabricating debts or recognizing unreal debts.Within 1 year before the Court accepts the application for bankruptcy, the liquidator is entitled to request the Court to rescind the following activities concerning the debtor’s property:Transferring property free of charge; orTransferring property at obviously unreasonable low prices; orProviding property security for the debts that originally have no property security; orPaying in advance the debt undue; orWaiving creditsThe liquidator is entitled to recover the unusual income that the directors, supervisors and senior executives of the debtor have obtained by taking advantages of their authority of office and recover the enterprise property that they appropriate in the same manner.

 If you have any question regarding the topic discussed above, please contact our partners for further assistance. 

Anna Chan
Partner of Oldham, Li & Nie

anna.chan@oln-law.com

Xiaosu Zhu
Partner of Watson & Band

xiaosu.zhu@watsonband.com 

Oldham, Li & Nie Solicitors and Watson & Band have entered into formal association in 2020. The new Association will strengthen OLN’s China Legal Service Network and Watson & Band’s international practice, allowing the Association strategic and direct access to lawyers in different jurisdictions. With a deeper understanding of clients’ needs and behaviour, it will complement the ambitious growth of OLN and Watson & Band to provide high-quality legal services on a global scale. 

Disclaimer: This article is for reference only. Nothing herein shall be construed as Hong Kong or PRC legal advice or any legal advice for that matter to any person. Neither Oldham, Li & Nie nor Watson & Band shall be held liable for any loss and/or damage incurred by any person acting as a result of the materials contained in this article. Shall you be interested to download this article as a brochure, please click on the following link:  Legal Update: Hong Kong Court Recognizes Application by Shanghai Liquidators

Dynasty trust, is an increasingly popular tool to pass on family wealth to the next generation. As its name suggests, trust assets are intended to live through dynasties across generations within the family. Contrary to an outright gift to your kids, a dynasty trust allows you to control (even after your passing) how and when the kids can receive, enjoy and use the family assets. It can also ensure that certain core assets are retained within the family generation after generation. If the same thoughts have crossed your mind, a dynasty trust may be for you.

Despite the fancy label of a “dynasty” trust, it still shares most features of, serve mostly the same purposes with, and requires almost the same pre-set up considerations as normal trusts.

What are the advantages of setting up a trust?

In general, trust is a useful tool, if structured properly, in achieving multiple purposes, including succession planning, tax planning, protection of assets in case of matrimonial disputes, and protection from creditors’ claims.

1. Fast-tracking “inheritance”

A trust can help bypassing the otherwise cumbersome and time-consuming process of getting a Grant of Probate. As an illustration, if there is no trust in place, the process of the probate of the 1^st Generation can take anywhere from months for simple estate matter, to years for complicated estate matter (which is not uncommon for high-networth individuals). Worse still, in certain jurisdictions such as the US, the deceased’s assets would be frozen until a Grant of Probate is obtained. Assuming it takes month to complete the process and consequently a huge amount of cash sat in the estate’s account frozen, the cash would not then be available for injection into the family business.  This might pose problem if the family business requires urgent cash flow or interim liquidity.

2. Succession planning

A trust is useful in minimizing the risk of families mired in ugly spats over succession and control of business units, when there are assets and/or family business to be managed following the death of a family member. With a trust in place, a settlor can transfer property during his lifetime into the trust, setting out in clear terms as to how his properties and any family business shall be managed in a letter of wishes, and entrusting a reliable trustee to manage the trust assets. When he passes away, the trustees can still hold the reigns over the family properties in the trust in a timely manner, and provide for beneficiaries according to the settlor’s wishes.

3. Tax planning

Trusts are recognized instruments for tax planning especially when a beneficiary is resident of a high tax regime where world-wide income or assets might be subject to heavy taxes. With the setting up of a trust, the trust can be carefully designed such that taxes are only imposed when there is trust distribution to beneficiaries, and can be tailor-made based on needs of the settlor and the beneficiaries.

A significant advantage to beneficiaries is that, beneficiaries can manage when trust distribution and hence taxable income is required to be paid. The beneficiaries’ income tax obligation is “deferred” in that sense. That being said, settlors still need to beware of any “throwback tax” and penalizing interest charge that may be imposed for distribution of any accumulated net income (“UNI”) of a trust in some jurisdictions, for example, distributions of UNI to beneficiaries in the United States under a foreign non-grantor trust.

For certain jurisdictions, recognized trust structures might assist beneficiaries to save enormous sum of tax. If you are interested to find out more, please go to:-

• https://oln-law.com/tax-emigration-from-hong-kong-the-importance-of-pre-migration-tax-planning
• https://oln-law.com/emigration-from-hong-kong-to-australia-the-importance-of-pre-migration-tax-planning-2
• https://oln-law.com/emigration-from-hong-kong-the-importance-of-pre-migration-tax-planning-3
• https://oln-law.com/emigration-from-hong-kong-the-importance-of-pre-migration-tax-planning-4-236

4. Trust treatment in divorce

If you are going through a rough patch in your marriage, you might be concerned whether your assets will have to be divided with your estranged spouse, leaving your children with less financial provision than they would need. Some may therefore have their assets settled into a trust to avoid being pooled into the matrimonial pool when it comes to division of assets in a matrimonial proceeding. A trust with sophisticated set-up and carefully drafted trust deed may well serve such purpose and protect the trust assets from the attack of ancillary relief claims.

However, in certain circumstances, the court might declare the settlement of the relevant trust void, if the trust documents are not carved carefully enough by professionals. In the case of Kan Lai Kwan v Otto Poon, [2014] 6 HKC 111, the trust fund was held to be included in the marital pot to be divided between spouses, because the drafting of the trust documents showed that the supposed beneficiary (the daughter) actually did not have fixed beneficial interest in the trust fund: the trustee was generally deferential to the settlor, such that the trustee has insufficient managerial role over the assets. Precedents have set out various landmines in making a trust “façade” like what happened in the Otto Poon case, which settlors and their legal advisor shall be aware of.

5. Protection from creditors’ claim

Setting up of trusts is also an effective way to protect assets from hostile claims. On the presumption that a trust is properly set up, the trust assets would remain intact from the reach of creditors even if a settlor becomes bankrupt.

However, one shall note that any disposition (including settlement of trust assets) may be subject to the claw back rules under the relevant local insolvency rules. For example in HK, the Bankruptcy Ordinance (Cap. 6), and the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32), and the Conveyancing and Property Ordinance (Cap. 219) set out circumstances where liquidators have power to claw back certain non-arm’s length transactions, for example, if such disposition happens within a certain timeframe before the commencement of the bankruptcy or liquidation proceedings.  

When should I set up a trust?

It is a good idea to set up a trust and segregate certain assets for the benefit of your next/future generations when you are formulating your estate planning.  

It is also a popular option nowadays in Hong Kong for people to migrate to other jurisdictions. If your destination country has in place a high-tax regime, you may consider setting up trusts to manage your tax affairs. For example, in Canada, one of the most popular destinations where Hong Kong people are keen to migrate to, their aggressive tax avoidance laws have substantially restricted the room for tax structuring. However, if an offshore trust is set up properly, its worldwide income may not be taxable under Canadian tax regime. For details, you may refer to our article series on “Emigration from Hong Kong: The Importance of Pre-Migration Tax Planning”.   

• Emigration from Hong Kong: The Importance of Pre-Migration Tax Planning (1)
• Emigration from Hong Kong to Australia: The Importance of Pre-Migration Tax Planning (2)
• Emigration from Hong Kong: The Importance of Pre-Migration Tax Planning (3)
• Emigration from Hong Kong: The Importance of Pre-Migration Tax Planning (4)

Who should be acting as trustee?

Choosing trustees is an important decision which should not be taken lightly. Trustees shoulder responsibilities, and their duties are often statute-regulated, as is the case in Hong Kong. Below are the some of the common choices of trustees for settlors:-

1. Friends and families: Most people like to consider friends and families as trustees, but might have failed to consider whether or not they are qualified to make financial decisions in the management of trust estate and their limited lifespan.
2. Professional trustees: This may be a more appropriate option compared to friend and families for the sake of prudence. In Hong Kong, professional trustees have to be licensed under a new licensing regime for trust and company service provides, under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615 of the laws of Hong Kong) and be statutorily regulated to ensure that professional trustees are well qualified to manage assets.
3. Offshore trustee companies: This may be the case if offshore trusts are set up, for example in Cayman Islands or the British Virgin Island. However, the costs of engaging offshore trustee companies can be significant compared to onshore ones. The relatively higher set up cost and annual maintenance fee might be a concern for cost-sensitive individuals.
4. Banks: Many banks also offer trustee services. However, banks can be particularly critical in accepting trust assets when compared to trustee companies, and may only take wealth management products issued by themselves, or fixed deposit or real estate properties as trust assets. In particular, banks are generally reluctant to take shares in private company as trust assets, partly attributed to the increasingly stringent due diligence requirements imposed on banks these days in accepting funds or new clients, for anti-money laundering purposes. Therefore, banks are less preferred by businessmen who wish to settle their family business into trust structure.
5. Other professionals: Solicitors and accountants who have worked with your business may also serve as trustees. Since they know the businesses in depth, they are likely to provide a bespoke service to your businesses and tailor-made the necessary trust documents. It is another plus if you prefer trustees with more flexibility than institutional trustees. 

What should a settlor take into account before deciding on the jurisdiction of a dynasty trust?

You might have heard of trusts in Jersey, the BVI, Guernsey and other offshore jurisdictions but how a settlor shall choose among the many jurisdictions? There are indeed various factors you would have to take into account:-

1. Settlor’s reservation of powers

A valid trust requires the alienation of the trust property by the settlor. However, in many cases settlors would wish to retain powers to manage the trust, so as to ensure proper maintenance and growth of trust assets. Accordingly, a settlor may need to consider the statutes of the relevant jurisdiction to ensure that reservation of power by him is allowed in that particular jurisdiction, if he intends to reserve any power. So far as the statute in Hong Kong is concerned, the Trustee Ordinance (Cap. 29) specifically allows for reservation of powers by the settlors, which usually includes power of investment and asset management. However, it is important to note that any provision in the trust documents regarding reservation of powers by the settlor shall be carefully drafted, so as to avoid a trust being declared “façade” in light of the principals as set out in the Otto Poon case.

2. Rule against perpetuities

An old common law principle, the “rule against perpetuities,”[1] prohibits trusts that could potentially last forever. The principle provides for trusts to be valid only for certain number of years, depending on the rules of different jurisdictions. To preserve wealth for generations and allow for long-term and strategic wealth planning, settlors who wish to set up dynasty trusts should take note of the legal position of different jurisdictions on the rule against perpetuities, and may need to avoid those jurisdictions which still uphold the common law rule. For example, in Hong Kong, the Perpetuities and Accumulations Ordinance (Cap. 257) abolished the rule against perpetuity and excessive accumulations for trusts created on or after 1 December 2013. This should prove an attraction to settlors who wish to create a high value dynastic trust lasting many generations.

3. Trustee’s statutory duty

Trustees owe a duty of care that originates from common law. Precedent cases have also prescribed boundaries of trustees’ fiduciary duties owed to beneficiaries. In some jurisdictions, this duty has been codified into statutory laws to better protect trust assets and beneficiaries, such as by way of limiting certain exclusion of trustee liabilities to the advantage of beneficiaries, which is preferred by settlors.

In Hong Kong, trustees’ duties and powers are codified into the Trustee Ordinance (Cap. 29). The Trustee Ordinance requires a trustee to exercise reasonable care and skill, having regard to any special knowledge or experience that the trustee has or holds himself out as having, and (if he is a professional trustee) to any special knowledge or experience reasonably expected. This statutory duty has shed light on the ambit of trustee’s duty and provided clearer guidance on the standard expected, thus safeguard the interest of settlors and beneficiaries.

4. Beneficiaries’ right to remove trustees

Beneficiaries’ right to remove trustees is a crucial check and balance against the trustees’ power. Where this is codified into statutes, it can become a nuclear weapon for beneficiaries who are dissatisfied with the trust administration to remove the trustee. Statutes may provide for a simplified, hassle-free procedure for the removal, which can often save time and cost compared to instigating court proceedings to effect such removals.

In Hong Kong, the Trustee Ordinance confers on beneficiaries the right to remove trustees from the administration of the trust by giving a written direction for the trustee to retire[2], subject to certain criteria. Such mechanism offers a degree of flexibility and eliminates dependence on the court’s discretion, which are not available in some other jurisdictions. For example, in Singapore there is no such statutory provision allowing beneficiaries to remove trustees by direction, thus beneficiaries have to apply to the court for a court order to substitute trustees instead.

5. Trustee’s power to delegate

Under common law, trustees have a duty to act personally and cannot delegate their functions unless authorized to do so. However, some trustees may wish to appoint agents to provide professional assistance in trust asset management.  

In the past, one of the least satisfactory aspects of Hong Kong trust law was the difficulty in trustees appointing discretionary fund managers to manage the trust portfolio. Now, the position in Hong Kong has conferred broader discretion on trustees, which allows trustees to delegate some aspects of their duties for a maximum of 12 months under a power of attorney. That being said, some core duties of a trustee including distributions to beneficiaries, the decision whether a payment should be made out of capital or income, appointment of new trustees, and any further delegation by agents still cannot be sub-delegated.

6. Dispute resolution

This factor is often neglected by settlor during peaceful time. Jurisdiction for dispute resolution could become problematic when there are disputes arising from the trust such as whether a piece of document is discoverable. For offshore trusts, even if all beneficiaries and trustees are physically in HK, the dispute might still have to be fought over on the other side of the world.  It is equally important to choose a jurisdiction with predictable and reliable judicial system in place. Taking Hong Kong as an example, Hong Kong has a well-established judicial system which follows the common law regime and doctrines of equity.  In addition, trusts in Hong Kong are governed by statutes including the Trustee Ordinance and the Perpetuities and Accumulations Ordinance. With its robust regulatory environment and mature legal system, disputes arising from trusts established in Hong Kong can be properly resolved under settled principles of law. 

7. Administration fees, tax and double tax agreements (“DTA”)

The initial set up costs, as well as annual maintenance fees will add to the expense of the trust. It is also essential to consider whether a jurisdiction has a favourable tax system so that the trust can enjoy low tax rates on dividend, interest and royalty etc. arising from the businesses of the trust. Exemptions offered by DTA will help the trust to avoid international double taxation of income and property, and will save cost/expense for the trust.     

Hong Kong is world renown for having in place a favorable tax regime. Dividend income, bank deposit income, certain types of non-bank interest and bond interest are tax-exempt in Hong Kong. Rent and gains from foreign real estate, capital gains and foreign-sourced profits are also non-taxable. A resident Hong Kong trust which owns foreign assets can remit income and profits from such assets to the trust without incurring any taxes in Hong Kong. In addition, Hong Kong has an extensive network of DTAs with other jurisdictions. Trust income will not be taxed twice in the source jurisdiction and residence jurisdiction (known as source-residence conflict), if those jurisdictions have in place a DTAs with Hong Kong. This helps break down the tax barriers that obstruct cross-border flow of investment by trusts, and trusts in Hong Kong may claim relief from taxes paid overseas under DTAs.    

What are the ways a dynasty trust can be challenged, and how to avoid them?

As can be seen from the Otto Poon case, there can be instances where the trust assets in a dynasty trust might be considered necessary financial income for a spouse, hence be included in the matrimonial pot. This shall be considered in light of section 17 of the Matrimonial Proceedings and Property Ordinance (Cap. 192) in Hong Kong, which provides that where a disposition took place less than 3 years before the date of application of the spouse to set aside the same, the Court may presume that such disposition is done with the intention of defeating the applicant’s claim for financial provision.

Another possible challenge faced by dynasty trusts is when a trust estate as originally constituted had come to an end and has subsequently been “resettled” into a new trust i.e. new trusts are declared over the trust property with the result that its use or application is modified.

Therefore, to avoid a dynasty trust being challenged, the settlor is advised to carefully carve the terms of distribution in the trust deed, give due consideration to the timing of setting up a dynasty trust and avoid some the legal landmines which may make a trust “façade”. It would also be advisable to provide clearly as to trustee’s power in administration and management of trust assets so as to minimize disputes relating to such management, which can sometimes result in resettlement of a trust.

  Conclusion

Given the sound judicial system and favorable tax treatments, Hong Kong could be one’s ideal jurisdiction for the establishment and operation of a dynasty trust. Considerable rights, powers and protections are conferred on settlors, trustees and beneficiaries to enable better management of the dynasty trust. As long as trusts are structured properly to avoid challenges, family wealth can be preserved for generations to come. 

If you have any question regarding the topic discussed above, please contact our partner Anna Chan at anna.chan@oln-law.com or associate Barbara Kwong at barbara.kwong@oln-law.com for further assistance.

Disclaimer: This article is for reference only. Nothing herein shall be construed as Hong Kong legal advice or any legal advice for that matter to any person. Oldham, Li & Nie shall not be held liable for any loss and/or damage incurred by any person acting as a result of the materials contained in this article.

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[1] It requires that future trust interests (i.e. interests that do not take effect immediately), must be certain to vest within a defined period of time known as the perpetuity period.

[2] Section 40A, the Trustee Ordinance.