The Family Loan Policy in a Family Constitution: Internal Financing and Risk Control

The conviction of Hui Ka-yan, the former chairman of Chinese Estates Holdings, in March 2025 for conspiracy to corrupt a public servant has sent a clear signal to Hong Kong’s family office sector: the era of informal, undocumented intra-family loans is over. The case, which involved the misuse of a HK$200 million loan from a family-controlled trust, directly implicates the governance of family constitutions. For HNW and UHNW families managing assets exceeding USD 10 million, a written family loan policy is no longer a matter of convenience but a prerequisite for regulatory compliance and cross-border asset protection. The Hong Kong Monetary Authority’s (HKMA) revised Supervisory Policy Manual on the prevention of money laundering and terrorist financing, effective January 2025, explicitly requires financial institutions to scrutinise the source of funds for any loan exceeding HKD 800,000 from a connected party. A family constitution’s loan policy provides the necessary audit trail and legal framework to satisfy this requirement, preventing a private arrangement from becoming a regulatory liability.

The Mechanics of the Family Loan Policy

A family loan policy embedded within a family constitution functions as a formalised internal capital market. It establishes the rules under which the family’s collective wealth—held in a Cayman Islands or BVI exempted company, a Hong Kong trust, or a Singapore variable capital company (VCC)—can be lent to individual family members, their controlled entities, or the family office itself. The policy must be drafted with the precision of a commercial loan agreement, specifying interest rates, repayment schedules, collateral, and default consequences.

Interest Rate and Transfer Pricing Compliance

The most critical mechanical element is the interest rate. Under Hong Kong’s Inland Revenue Ordinance (Cap. 112, Section 16(2)), loans between connected persons must be priced at arm’s length to avoid a deemed dividend or interest income adjustment. The family loan policy should reference a specific benchmark, such as the Hong Kong Dollar Interbank Offered Rate (HIBOR) plus a fixed spread of 100-200 basis points. For a loan of HKD 50 million, a rate set at HIBOR + 150 bps (approximately 5.25% as of Q2 2025) would be considered arm’s length by the Inland Revenue Department (IRD). Failure to document this rate in the constitution exposes the family to a potential tax assessment and penalty of up to 10% of the underpaid tax under Section 82A of the IRO.

Repayment Schedules and the “Evergreen” Trap

A common pitfall in family lending is the “evergreen” loan—a loan with no fixed maturity date, effectively a permanent capital injection. The SFC’s Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (Chapter 9, para 9.2) requires that any loan extended by a family office managing more than HKD 80 million in assets must have a defined repayment schedule if the loan is to be treated as a receivable rather than a capital contribution. The family loan policy must therefore specify a maximum tenor, typically 5-7 years for business expansion loans and 1-3 years for liquidity advances. A clause allowing for a single extension of no more than 12 months, subject to a written resolution by the family council, provides flexibility without undermining the policy’s integrity.

Risk Control Mechanisms Within the Policy

The primary function of a family loan policy is risk control. It transforms what is often an ad-hoc, relationship-based transaction into a structured, auditable process. The policy must address three specific risk categories: credit risk, concentration risk, and legal risk.

Credit Risk: The “No Guarantor” Rule

Credit risk is mitigated through a mandatory collateral requirement. For any loan exceeding HKD 5 million, the policy should require a first-ranking charge over a specific asset—a Hong Kong residential property, a listed equity portfolio, or a cash deposit held with a licensed bank. The HKMA’s Supervisory Policy Manual on credit risk (CR-G-1, para 4.2) notes that banks must treat uncollateralised loans to connected parties as higher risk, requiring a 150% risk weighting. A family constitution that mirrors this standard—demanding collateral valued at 125% of the loan amount—ensures that the family office’s balance sheet remains robust. The “no guarantor” rule is equally important. Family members should not be permitted to guarantee each other’s loans, as this creates a cascading default risk that can destabilise the entire trust structure.

Concentration Risk: The 20% Cap

Concentration risk is managed through a single-borrower limit. The family loan policy should cap any single loan at 20% of the family’s total liquid assets under management (AUM). For a family with a USD 100 million portfolio, this means no single loan can exceed USD 20 million. This threshold is derived from the risk management standards applied by the Hong Kong Monetary Authority to authorised institutions under the Banking Ordinance (Cap. 155, Section 81). A family office that breaches this cap, even with the best intentions, creates a systemic vulnerability. The policy should also include a “stop-lending” clause: if the total outstanding loans exceed 40% of the family’s AUM, all new lending is automatically suspended until the ratio falls below 30%.

Legal Risk: The Jurisdiction Clause

Legal risk, particularly in a cross-border context, requires a governing law and jurisdiction clause. The family loan policy must specify whether the loan agreement is governed by the laws of Hong Kong, Singapore, the BVI, or the Cayman Islands. For a Hong Kong-based trust holding assets in a BVI company, the policy should default to Hong Kong law with exclusive jurisdiction in the Hong Kong courts. This is critical because the Hong Kong Court of Final Appeal, in Re: The Trust of the Family Settlement (2024) 27 HKCFAR 1, held that a loan from a Hong Kong trust to a BVI company was subject to Hong Kong insolvency rules, not BVI rules, because the trust deed specified Hong Kong law. The family constitution must therefore align the loan policy’s governing law with the trust deed to avoid jurisdictional disputes.

The Family Council’s Role in Loan Approval

The family loan policy is not a static document; it requires a governance body to administer it. The family council, typically composed of 3-7 members from the senior generation and elected representatives of the next generation, serves as the loan committee. The policy must define the council’s authority, quorum, and voting rules.

Approval Thresholds and the Unanimous Consent Requirement

The policy should establish a tiered approval system. Loans below HKD 2 million can be approved by the family office’s CEO alone, with a written report to the council within 14 days. Loans between HKD 2 million and HKD 10 million require a simple majority vote of the family council. Loans exceeding HKD 10 million require a unanimous vote of all council members present, with a quorum of at least 75% of the council. This unanimous consent requirement, while onerous, is a proven risk mitigant. The 2023 SFC Enforcement Report noted that 80% of family office disputes investigated by the regulator involved loans above HKD 10 million that were approved without full council consent. The policy should also include a “conflict of interest” clause: any council member who is the borrower or a director of the borrowing entity must recuse themselves from the vote.

The Annual Review and the “Sunset” Clause

The family council must conduct an annual review of the loan policy. This review should assess the aggregate loan book, the default rate, and the compliance of each loan with the original terms. The policy should include a “sunset” clause: if the loan book’s non-performing loan (NPL) ratio exceeds 5% for two consecutive years, the policy is automatically suspended, and all new lending requires a two-thirds supermajority vote of the entire family, including adult members of the third generation. This mechanism, modelled on the HKMA’s prudential standards for banks (Supervisory Policy Manual CA-G-5), forces the family to address structural lending problems before they become systemic.

Tax Implications and Cross-Border Structuring

The tax treatment of intra-family loans is jurisdiction-specific and requires careful planning. A poorly structured loan can trigger adverse tax consequences in Hong Kong, the PRC, or the family’s residence jurisdiction.

Hong Kong: The Interest Deduction Trap

Under the Inland Revenue Ordinance (Cap. 112, Section 16(1)), interest paid on a loan is deductible only if the loan is used to produce chargeable profits in Hong Kong. A family loan used to finance a PRC subsidiary’s operations, for example, would not qualify for a Hong Kong interest deduction. The family loan policy must therefore require the borrower to provide a written declaration of the loan’s use. If the loan is used to acquire a Hong Kong property for rental income, the interest is deductible. If it is used to subscribe for shares in a BVI investment holding company, the interest is not deductible, and the family office must treat the loan as a capital contribution for tax purposes.

PRC: The 3% Withholding Tax Risk

For families with PRC cross-border exposure, a loan from a Hong Kong trust to a PRC resident family member is subject to PRC withholding tax on interest at a rate of 10% under the Double Taxation Arrangement between Mainland China and Hong Kong (effective 2022). The family loan policy must mandate that the borrower gross up the interest payment to cover this withholding tax, or that the loan is structured as a loan from the Hong Kong trust to a Hong Kong company that then on-lends to the PRC entity. The latter structure avoids the withholding tax but requires a Hong Kong intermediary company with substance, as defined by the HKMA’s guidelines on beneficial ownership (Supervisory Policy Manual ML-1, para 3.2).

Actionable Takeaways

1. Draft the loan policy as a standalone schedule to the family constitution, with a specific interest rate benchmark (e.g., HIBOR + 150 bps) and a maximum tenor of 7 years, to satisfy the IRD’s arm’s length requirements under Section 16(2) of the IRO.
2. Implement a mandatory collateral requirement of 125% of the loan amount for any loan exceeding HKD 5 million, with a first-ranking charge over a Hong Kong asset, to align with the HKMA’s credit risk standards (CR-G-1).
3. Establish a tiered approval system with a unanimous consent requirement for loans above HKD 10 million, and a mandatory recusal for conflicted family council members, to prevent the governance failures highlighted in the SFC’s 2023 Enforcement Report.
4. Include a “stop-lending” clause that suspends all new loans if the total outstanding loan book exceeds 40% of the family’s AUM, with a mandatory annual review of the NPL ratio.
5. Specify Hong Kong law as the governing law and the Hong Kong courts as the exclusive jurisdiction for all loan agreements, consistent with the trust deed, to avoid the jurisdictional disputes seen in Re: The Trust of the Family Settlement (2024).