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Hong Kong – Breakdown Of Trust.

5 August, 2014

 


Important Court Of Final Appeal Divorce Ruling Reaffirms The Court’s Power To Consider Assets Held In Trust As Part Of The Matrimonial Estate And The Presumption Of The Equal Division Of Assets.

 

The case of Poon Lok Otto v Kan Lai Kwan Kay and HSBC International Trustee Ltd. arose out of the high-profile divorce of a wealthy couple and the ramifications for the family business, Analogue Group (“Analogue”), an increasingly common occurrence in Hong Kong and further afield. The Court of Final Appeal (“CFA”) judgment found overwhelmingly in favour of the wife and, as a result, maintained its close association with the position in England as being one of the friendliest jurisdictions for the less financially well-off spouse. The case also highlights the difficulties of using a trust structure to protect assets from a spouse.

 

The CFA judgment dealt with three important issues:

 

  1. The test the court should apply when deciding whether trust assets constitute a ‘matrimonial asset’ (i.e. part of the pool of assets which may be divided);
  2. Whether the courts, in their quasi-inquisitorial role in divorce cases, can override an estoppel which would otherwise prevent one party from being unable to change a story they had previously relied upon; and
  3. Equal division of assets: to what extent should the less financially well off spouse benefit from any increase in the value of Analogue after separation.

 

Facts

 

The Husband (“H”) set up a discretionary trust for the benefit of his family and he transferred to the trustee a single asset: an 84.63% shareholding in Analogue. At the time of the divorce (after a marriage lasting over 40 years), there were 3 potential beneficiaries of the trust which had a value of approx. HKD 1.5bn: H, his wife (“W”) and his daughter (“K”).

 

The Proper Approach To Discretionary Trusts

 

H argued that the discretionary trust over the shares was necessarily divided into 3 parts (one for each beneficiary) and so only two thirds of the trust was a ‘matrimonial asset’, the other one third belonging to K.

 

W contended that H’s very high level of influence over access to the funds in the trust meant that in fact the whole amount was a matrimonial asset for the purposes of the divorce.

 

The CFA stated that the relevant test was:

 

“If H asked the trustee to advance to H the whole part of the capital and/or income of the trust the trustee would, having regard to all the relevant circumstances, be likely to do so.”

 

The CFA considered the following range of factors in coming to its decision:

 

  • H’s position as settlor, protector and potential beneficiary;
  • H’s history of dealing with the trustee, and the trustee’s history of acting rapidly in accordance with H’s instructions; in particular, several company dividends were planned and rapidly paid out of the trust upon receipt; and
  • H’s power to replace the trustee (the CFA considered this fact, in particular, was highly indicative of the strength of his control over the trust).

 

As a result, the CFA held that the property in the discretionary trust was a matrimonial asset.

 

The Operation Of Estoppel In Divorce Cases

 

One of the key issues that arose was the timing of the separation. This was important because, during this period the family company had rapidly increased in profitability (and thus value) and one of the key decisions the CFA had to make was the extent to which this increase in value should be part of the matrimonial estate. From 2000 to 2010 the Analogue’s profit increased by a factor of ten, reaching HKD 293min 2010. In 2001, the parties agreed that their marriage was “unhappy and unfulfilling”, H contended there was only “a shell of a marriage” while W argued that this was “still a marriage”. The parties remained living together until 2008 and attended/hosted numerous functions, and frequently travelled together. W also continued to take an active role in taking care of H’s home (cooking, cleaning etc.).

 

H alleged the separation of H and W occurred in 2001 and so W was not entitled to the increase in Analogue’s value after 2001.The divorce proceedings themselves were based on H’s action alleging 2 years separation as of February 2009, and both parties affirmed that separation took place in February 2001 as part of the proceedings. The first instance judge considered that W was estopped from denying that separation had occurred in 2001. The Court of Appeal considered that W was merely estopped from denying that separation had occurred any later than February 2007 (i.e. two years prior to H’s action).

 

The CFA ruled that the technical problem could be sidestepped by following the approach of Lord Denning in Thompson v Thompson[1957] P. 19. The court stated, “The parties are bound by the estoppel but, where the circumstances demand the Court’s intervention, it is free to override that estoppel in exercising its statutory jurisdiction and to act upon evidence which is material to its determination.” In coming to this decision, the CFA stressed that the Thompson v Thompson approach accorded with the recognized quasi-inquisitorial role of the judge in a matrimonial case. The CFA citied Thorpe LJ in Parra v Parra [2003] 1 FLR 942 with approval:

 

“The quasi-inquisitorial role of the judge in ancillary relief litigation obliges him to investigate issues which he considers relevant to outcome even if not advanced by either party. Equally he is not bound to adopt a conclusion upon which the parties have agreed.”

 

Utilising such a quasi-inquisitorial role, the CFA relied on find that the separation occurred only in mid-2008.

 

Equal Division Of Assets

 

The CFA acknowledged that the default position was to divide the assets equally as they stood at the date of separation. However, the court noted that between separation in mid-2008 and 2010 (when the case came to court) the profits of Analogue had increased from approx. HKD 78m to approx. HKD 293m. The court stated that in some cases it was fair that the non-providing spouse should not share equally in post separation benefits. However, the court held that in the instant case,

 

“The increased Analogue Group profits do not provide a ground for departure from the equal sharing principle in the present case. The parties married in January 1968 and separated in mid-2008, over 40 years later. The period of separation prior to the hearing date was relatively insignificant. The profits accruing to the Analogue Group during the post-separation period arose out of the business which had been built up in the course of the marriage, in respect of which W can legitimately assert an unascertained share.”

 

W was awarded 50% of the total pool of matrimonial assets (less those assets already owned).

 

Key Points

 

  1. This case reinforces previous decisions which – while not suggesting the trust is a sham – determine that the settlor’s control over the trustee means that the assets in the trust are “matrimonial assets”. It is common, particularly in Asia, for settlors of discretionary trusts to wish to exert control over its operations. However, this case demonstrates that the asset protection benefits can fall away if the settlor has too much influence over the trust and/or the trustee.
  2. A settlor of a discretionary trust who is also in the class of possible beneficiaries/objects under that trust is subject to a test of whether or not he had ‘access’ to the funds (not necessarily control of the funds) to determine whether or not these will be a part of his matrimonial assets in a divorce case. The extent of the powers reserved to the settlor are also relevant in this context.
  3. Where a party adduces evidence as to a date of factual separation, in normal circumstances that party is estopped from denying that fact later in the proceedings. However, if the Court, having regard to all the circumstances of the case feels it is necessary to intervene to achieve a fair and just outcome, it may override that estoppel.
  4. The Principle of Equality in the division of assets following a divorce can be applied to assets accrued after the date of factual separation where fairness requires this. This will be particularly relevant where years of hard work and input from both parties begin to produce increased profits in the last years of the marriage.

 

herbert smith Freehills

 

For further information, please contact:

 

Gareth Thomas, Partner, Herbert Smith Freehills

gareth.thomas@hsf.com

 

Robert Hunter, Partner, Herbert Smith Freehills

robert.hunter@hsf.com

 

Richard Norridge, Herbert Smith Freehills

richard.norridge@hsf.com

 

Herbert Smith Freehills Dispute Resolution Practice Profile in Hong Kong

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