Hong Kong’s Court of Final Appeal has, in a recent judgment, considered the applicable test for determining whether a Quistclose trust exists, highlighting the importance of paying attention to the expression or otherwise of any intention regarding the use of funds being held by a party.
A Quistclose trust, named after a House of Lords decision in the UK, is a type of trust that comes into existence when a person transfers money or property to another person by way of a loan or otherwise, with the intention that the money or property be used for a specific purpose and no other purpose.
It is often believed that Quistclose trusts are limited to loan transactions, but in fact they may arise in many different contexts such as joint ventures, mergers and acquisitions, real estate transactions, etc.
The court reiterated that the requisite intention for constituting a Quistclose trust is that the parties must have objectively intended for the transferred property to be used for a specific purpose and no other purpose, and that the property is not at the recipient’s free disposal.
It also held that there is no need to show that there was any express stipulation or intention on the payer’s part to retain some beneficial interest in the property transferred.
Quistclose trusts often arise in day-to-day commercial transactions. Examples include funds transferred by a lender to a borrower in a loan transaction, funds invested by a party in a joint venture, funds paid into an escrow account for a corporate acquisition, or a deposit paid by a purchaser in a real estate transaction.
One should pay close attention to the terms of their agreements, correspondence and other documentary records. In particular, both the transferor and the recipient should be cautious of the presence or absence of terms restricting the use of the relevant funds.
Thought should also be given as to where and how funds are kept, for example, whether there are segregated accounts and whether there is any mixing of funds.
In more detail
In a high-stakes legal saga, a complex dispute arose concerning bonds issued by special purpose vehicles (SPVs) affiliated with the China Energy Group. At the heart of the matter were two distinct bond series: HKD bonds issued by SPV1, set to mature in 2022, and USD bonds issued by SPV2, with a maturity date in 2018. These bonds were meant for financing the group’s operations, with cross-default provisions triggering interconnected financial repercussions.
The crux of the legal clash lay in the ownership and allocation of funds, notably focusing on a substantial sum of USD120 million under SPV1, which was equipped with separate HKD and USD accounts. SPV2, on the other hand, relied on SPV1’s USD account for transactions associated with the 2018 bonds.
As financial strains mounted and the 2018 bonds matured, China Energy Group faced a shortfall in meeting its obligations. A pivotal moment arrived when USD120 million was transferred from the group’s treasury account to SPV1’s USD account, with a specific ledger entry indicating that these funds were distinct from SPV1’s general assets.
Subsequent to failed refinancing efforts, the group defaulted on the 2018 bonds, consequently triggering cross-defaults across the bond series.
Bondholders of the 2022 bonds secured a judgment against SPV1, culminating in a garnishee order targeting the funds in SPV1’s account. In a parallel legal battle, bondholders of the 2018 bonds sought to challenge the garnishee order against SPV2, arguing the existence of a Quistclose trust that safeguarded the USD120 million for specific purposes.
The Court of Final Appeal ended this intricate legal entanglement by overturning preceding rulings and discharged the garnishee order. Emphasising an objective assessment of circumstances, the court determined that the USD120 million held in SPV1’s USD account was designated for the singular purpose of redeeming the 2018 bonds, thereby establishing that these funds were held in trust by SPV1 and were not available to settle the judgment debt owed by the SPV.
Business Law Digest is compiled with the assistance of Baker McKenzie. Readers should not act on this information without seeking professional legal advice. You can contact Baker McKenzie by e-mailing Howard Wu (Shanghai) at howard.wu@bakermckenzie.com
