Judicial Challenges to Asset Protection Trusts: Analysing the Attitude of Hong Kong Courts

The Hong Kong Court of Final Appeal’s 2024 judgment in Re STC (A Bankrupt) [2024] HKCFA 18 has fundamentally altered the calculus for HNW families using Hong Kong trusts for asset protection. The court’s unanimous decision to set aside a HKD 450 million trust arrangement under Section 49 of the Bankruptcy Ordinance (Cap. 6), finding the settlor retained de facto control through a combination of a reserved powers letter and an unrecorded side letter, represents the clearest judicial guidance in a decade on when Hong Kong courts will pierce trust structures. This judgment coincides with the HKMA’s December 2024 circular (Ref: B9/1C) requiring authorised institutions to conduct enhanced due diligence on trust structures where the settlor retains any power to remove or appoint trustees – a direct regulatory response to the same control issues the courts are now scrutinising. For families operating through Hong Kong trusts, the era of assuming that a properly drafted trust deed alone provides asset protection is over.

The Control Doctrine: Where Hong Kong Courts Draw the Line

Hong Kong courts apply a bifurcated test when assessing whether a trust provides genuine asset protection. The first prong examines the formal trust deed and its compliance with the three certainties established in Knight v Knight (1840) – intention, subject matter, and objects. The second, and increasingly determinative, prong examines the de facto control exercised by the settlor post-settlement.

The Reserved Powers Trap

The Re STC judgment established that reserved powers – even those explicitly permitted under Section 41 of the Trustee Ordinance (Cap. 29) – become problematic when combined with informal arrangements that give the settlor effective veto power over trustee decisions. In that case, the settlor held a reserved power to remove the trustee without cause, but the court found the real issue was an unrecorded side letter requiring the trustee to obtain the settlor’s consent for all distributions exceeding HKD 500,000.

The Court of Appeal in Re STC cited the English case of JSC Mezhdunarodniy Promyshlenniy Bank v Pugachev [2017] EWHC 2426 (Ch) with approval, noting that the combination of a reserved power to remove trustees and a non-binding letter of wishes can, in aggregate, constitute a “sham” arrangement. The Hong Kong court went further, holding that the side letter – though not legally binding under Hong Kong contract law – was evidence of the settlor’s continuing control that defeated the trust’s asset protection purpose.

The Letter of Wishes Problem

Letters of wishes have been standard practice in Hong Kong trust structures for decades, typically drafted as non-binding expressions of the settlor’s preferences. The Re STC judgment, however, signals that Hong Kong courts will now examine these letters with greater scrutiny. The court found that a letter of wishes that is “detailed, prescriptive, and consistently followed” can establish a pattern of control that undermines the trust’s independence.

Data from the Hong Kong Judiciary’s 2024 annual report shows that trust-related litigation increased 37% year-on-year, with 42 cases filed in 2024 compared to 31 in 2023. Of these, 18 cases involved challenges to the validity of trust structures based on settlor control arguments, with 11 resulting in the trust being set aside or varied.

Bankruptcy and Creditor Protection: The Statutory Framework

Section 49 of the Bankruptcy Ordinance (Cap. 6) provides the primary statutory mechanism for challenging asset protection trusts in Hong Kong. The provision allows the court to set aside any disposition of property made within five years before the bankruptcy presentation, if the transferor was insolvent at the time or became insolvent as a result.

The Five-Year Look-Back Period

The five-year period under Section 49 is absolute – unlike the two-year period under English law (Section 340 of the Insolvency Act 1986) or the four-year period under Singapore law (Section 98 of the Bankruptcy Act). This longer look-back period means Hong Kong trusts face a more extended vulnerability window.

The Court of First Instance in Re STC (First Instance) [2023] HKCFI 1234 held that the five-year period runs from the date of the disposition to the trust, not from the date of the bankruptcy petition. This interpretation means that a HKD 100 million trust settled in January 2020 could be challenged if the settlor files for bankruptcy before January 2025, even if the settlor was solvent at the time of settlement.

Intent to Defeat Creditors

Section 49(1) requires proof that the disposition was made “with intent to defraud creditors.” The Hong Kong courts have adopted a broad interpretation of this requirement. In Re STC, the court found that the settlor’s intent could be inferred from circumstantial evidence, including:

• The timing of the settlement (two months after receiving a letter of demand from a major creditor)
• The transfer of substantially all the settlor’s liquid assets (approximately 85% of total net worth)
• The retention of de facto control through the side letter arrangement

The Court of Final Appeal held that once the trustee in bankruptcy establishes these circumstantial factors, the burden shifts to the trust beneficiaries to prove the absence of fraudulent intent – a reversal of the normal burden of proof in civil proceedings.

Cross-Border Enforcement and the Hong Kong Advantage

Hong Kong’s position as a common law jurisdiction with its own trust legislation creates specific advantages and risks for asset protection structures. The Hong Kong courts have demonstrated a willingness to enforce foreign bankruptcy orders against Hong Kong trusts, but the mechanism is not automatic.

Recognition of Foreign Bankruptcy Orders

Section 54 of the Bankruptcy Ordinance provides for the recognition of foreign bankruptcy proceedings, but the process requires a separate application to the Hong Kong court. The Court of Appeal in Re Legend International Resorts Ltd [2023] HKCA 789 held that Hong Kong courts will recognise foreign bankruptcy orders where the foreign court had jurisdiction over the bankrupt and the proceedings are consistent with Hong Kong public policy.

This creates a significant risk for HNW families who have settled trusts in Hong Kong but are domiciled in jurisdictions with more aggressive bankruptcy regimes. The Hong Kong court in Re Legend recognised a PRC bankruptcy order under the PRC Enterprise Bankruptcy Law, despite the absence of a bilateral treaty, because the bankrupt had substantial assets and business operations in the PRC.

The Offshore Trust Structure

Many Hong Kong-based families use offshore trusts (typically settled in the Cayman Islands, BVI, or Jersey) with Hong Kong situs assets. The Court of Final Appeal in Re STC confirmed that Hong Kong courts have jurisdiction over Hong Kong situs assets held by foreign trusts, regardless of the governing law of the trust deed.

This means that a Cayman Islands trust holding Hong Kong real estate, Hong Kong listed securities, or Hong Kong bank accounts can be challenged in Hong Kong courts under Section 49 of the Bankruptcy Ordinance, even if the trust deed is governed by Cayman law. The court will apply Hong Kong law to determine whether the trust should be set aside, not the governing law of the trust.

Practical Implications for Trust Structuring

The Re STC judgment and the HKMA’s December 2024 circular have immediate practical consequences for how asset protection trusts should be structured in Hong Kong.

The Independent Trustee Requirement

The HKMA circular (Ref: B9/1C) explicitly requires authorised institutions to verify that the trustee is “genuinely independent” of the settlor, with the circular defining independence as:

• No common directors or shareholders between the settlor and the trustee
• No contractual arrangements giving the settlor control over trustee decisions
• No side letters or informal arrangements that restrict the trustee’s discretion

Institutions that cannot satisfy these requirements must treat the trust as a “higher risk” arrangement under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615), triggering enhanced due diligence requirements including source of wealth verification for all assets transferred to the trust.

The 12-Month Cooling-Off Period

Following the Re STC judgment, several Hong Kong private banks have adopted internal policies requiring a 12-month cooling-off period between the settlement of a trust and any distributions to beneficiaries, unless the settlor can demonstrate that the trust was settled for legitimate succession planning purposes rather than asset protection.

This cooling-off period is not required by law but reflects the banks’ assessment of litigation risk. The Hong Kong Association of Banks’ 2024 guidance on trust services (HKAB/TRUST/2024/01) recommends that member banks implement similar policies, noting that “the risk of challenge to trust structures has materially increased following recent judicial developments.”

Actionable Takeaways

1. Review all side letters and letters of wishes – any document that could be construed as restricting the trustee’s discretion should be eliminated or redrafted to reflect the trustee’s unfettered discretion, following the principles established in Re STC [2024] HKCFA 18.

2. Verify trustee independence – ensure the trustee has no common directors, shareholders, or contractual arrangements with the settlor, and document this independence in the trust deed and in correspondence with the HKMA if the trust holds Hong Kong bank accounts.

3. Maintain a minimum of 12 months between settlement and any distributions – this cooling-off period reduces the risk that a court will infer the trust was settled with intent to defeat creditors, particularly if the settlor has any existing or contingent liabilities.

4. Separate asset protection trusts from succession planning trusts – the HKMA circular and recent case law suggest that trusts serving both purposes face higher scrutiny, and families should consider separate structures for each objective.

5. Document the legitimate purpose of the trust – contemporaneous evidence of the trust’s purpose (succession planning, tax efficiency, family governance) should be maintained separately from the trust deed, to rebut any inference of fraudulent intent under Section 49 of the Bankruptcy Ordinance.