The judgment of the Court of Appeal in China Life Trustees Limited v China Energy Reserve and Chemicals Group Overseas Company Limited [2023] HKCA 966 contains a review of the law on Quistclose trusts and provides guidance as to when such trusts may arise in the context of intra-group transfers.

The case was concerned with an application by a bondholder for a garnishee order absolute against the bond issuer after the latter defaulted on repayment of principal and interest. The group of companies of which the bond issuer formed part claimed that the bank balance which the bondholder sought to garnish was subject to, amongst other things, a Quistclose trust in favour of the group’s treasury company. That argument was dismissed at first instance by Au-Yeung J.

After reviewing the case law on Quistclose trusts, including the recent Privy Council decision of Prickly Bay Waterside Ltd v British American Insurance Company Ltd [2022] UKPC 8, the Court of Appeal held that in determining whether or not the funds or assets alleged to form the subject of the trust is subject to the free disposal of the recipient, the Court should focus on the parties’ objective intentions, and that their subjective intention is not relevant. The minimum requirement is that the payer should retain some beneficial interest in the funds, or in other words, that there is sufficient indication that the payer did not intend to dispose of the entire beneficial interest in the funds. In deciding whether this requirement is satisfied, proper account needs to be taken of the structure of the arrangements and the contractual mechanisms involved.

On the facts, the Court of Appeal held that whilst the evidence suggested that the relevant funds were transferred to the bond issuer for a specific purpose (namely repaying the bondholders of a different set of bonds), it was unrealistic to suggest that there was objective intention to create a trust to limit the bond issuer’s freedom to deal with the funds. The Court of Appeal noted that any desired control could be effected through the corporate chain of command, as the bond issuer and the treasury company were sister companies held by a common ultimate parent. The Court of Appeal also analysed the evidence concerning the accounting treatment of the funds, but found that such evidence only showed that the payments to the bond issuer were treated as inter-company transfers giving rise to credits and debits reflecting inter-company payables and receivables, which were consistent with the funds being beneficially owned by the bond issuer.

View the full judgment here.