Key takeaways
A Quistclose trust arises when A transfers property (usually money) to B to be applied for a specific purpose and no other. If the specific purpose cannot be achieved, the property is held on trust for A, meaning that it belongs to A and cannot be claimed by B’s creditors.
In the recent decision of China Life Trustees Limited v China Energy Reserve and Chemicals Group Overseas Company Limited [2024] HKCFA 15, the Hong Kong Court of Final Appeal (“HKCFA”) clarified that the touchstone for a Quistclose trust is that the parties have the objective intention that the transferred property is used only for a specific purpose and is not at the free disposal of the transferees. It is unnecessary to demonstrate that the parties intended the transferor to retain a beneficial interest in the property.
Background
The litigation arose in the context of a bond issuance and default. China Energy Reserve and Chemicals Group Company Limited (“ListCo”) was a listed company in Hong Kong. ListCo created and owned several special purpose vehicles (“SPVs”) for the sole purpose of issuing bonds in order to finance the operations of a corporate group headed by ListCo (“Group”). Funds raised from bond issuances by the SPVs would be transferred to a treasury subsidiary which further distributed them for the Group’s operation. When payments were due on a series of bonds, the treasury subsidiary would remit funds to the designated bank account for payment.
In April 2015, SPV1 issued bonds denominated in HKD, which were to mature in 2022 (“2022 HKD Bonds”). China Life Trustees Limited (“China Life”) was the sole bondholder. SPV1 opened an account (“Account”) with a bank as payment agent for the 2022 HKD Bonds. The Account included a USD sub-account for which SPV1 had no use.
In May 2015, SPV2 issued bonds denominated in USD, which were to mature in 2018 (“2018 USD Bonds”). The bondholders included several institutional investors, including those forming the Ad Hoc Committee. For convenience, SPV2 did not open a bank account. Rather, it would use the USD sub-account of the Account for transactions relating to the 2018 USD Bonds. SPV1 and SPV2 were authorised joint signatories for the USD sub-account.
In May 2018, the 2018 USD Bonds fell due in the principal sum of USD350 million plus interest. However, the Group only managed to raise USD120 million, which was deposited into the USD sub-account. Given the shortfall, SPV2 and the ListCo declared the 2018 USD Bonds in default. This triggered cross-defaults and accelerated payment obligations on other bonds, including the 2022 HKD Bonds. The USD120 million in SPV1’s USD sub-account remained unused.
Subsequently, China Life and the Ad Hoc Committee both obtained judgment against SPV1 and SPV2 on the respective bonds in default. China Life then apply for a court order to garnish the USD120 million remaining in SPV1’s USD sub-account (“Garnishee Order”). The Ad Hoc Committee sought to set aside the Garnishee Order, asserting that the amount was subject to a Quistclose trust such that it was not at the free disposal of SPV1 and therefore could not be claimed by China Life as SPV1’s creditor.
The Court of First Instance ruled in favour of China Life, granting a Garnishee Order absolute. The decision was upheld by the Court of Appeal. SPV1 and the Ad Hoc Committee appealed to the HKCFA.
Decision
The HKCFA unanimously allowed the appeal with Chief Justice Cheung, Ribeiro PJ and Gummow NPJ giving concurring judgments. In gist, the HKCFA held that:
- A Quistclose trust arises if the transferor has intended, with the transferee’s agreement or acquiescence, that the property transferred should be used only for that specific purpose and should not be at the transferee’s free disposal. Such restrictive intention is to be ascertained objectively from the circumstances (at [20]; [148]).
- It is unnecessary to show that the parties intended the transferor to retain a beneficial interest in the fund (at [57]-[58]).
- For a property which is subject to a Quistclose trust, the transferee must apply it for the specific purpose. If the specific purpose fails, the transferee has to restore the property to the transferor. As the transferee never has beneficial ownership of the property, such property is not available for distribution to the transferee’s creditors (at [21]; [148]).
The HKCFA reviewed the relevant authorities, particularly the recent Privy Council case of Prickly Bay Waterside Ltd v British American Insurance Company Ltd [2022] UKPC 8 (“Prickly Bay”), which was heavily relied on by the Court of Appeal in upholding the Garnishee Order. The HKCFA held that the Court of Appeal seemingly erred in interpreting Prickly Bay to mean that Quistclose trust required an intention for the transferor to retain a beneficial interest in the property.
The HKCFA found that the funds of USD120 million were paid into the USD sub-account specifically for meeting SPV2’s obligation under the 2018 USD Bonds in attempt to avoid cross-defaults. The funds were never intended to be at SPV1’s free disposal. It was therefore held that a Quistclose trust existed over the USD120 million in the Account in favour of the treasury subsidiary and/or the Group, such that when the specific purpose of meeting the obligations of the 2018 USD Bonds was not achieved, the funds were held by SPV1 on trust for the treasury subsidiary, rendering such funds unavailable to China Life as SPV1’s creditor and garnishee.
Commentary
The HKCFA’s decision provided helpful clarification as to the requirements of a Quistclose trust. It also serves as an example of how Quistclose trust may arise in the context of intra-group transfer. Given the prevalent use of special purpose vehicles in bond issuance by listed companies, it is expected that the Quistclose trust argument will frequently be raised between competing bondholders in corporate collapse cases.
With a properly drafted purpose clause, a lender may also make use of Quistclose trust to reduce its finance risk, as the amount lent would be ringfenced from other unsecured creditor if it is not applied for the purpose specified.