On 1 February 2024, the Hong Kong High Court in Hip Hing Construction Company v Hong Kong Airlines Ltd [2024] HKCFI 370 considered whether, and to what extent, segregation of funds is a necessary condition for the creation of a trust in respect of such funds.

In the Honourable Madam Justice Mimmie Chan’s judgment, her ladyship held that while segregation is normally an indicator of a trust, the mingling of funds is not fatal to the creation of a trust, and the Court should look at all the circumstances as there may be other indicators of the trust ([46]).

Background

The Plaintiff (Hip Hing Construction Company) sought  a declaration that the Defendant (Hong Kong Airlines) held HK$56,321,000 as retention monies on trust for the Defendant, pursuant to the standard form building contract (i.e. Clause 32.5 of the General Conditions of the Standard Form of Building Contract (2005 Private Edition)) entered into between them. As a winding-up petition had been presented against the Defendant in 2022 and a subsequent scheme of arrangement and restructuring plan became effective in 2023 ([8]), the declaration of a trust over the retention monies would mean that the retention monies would need not to be shared in the general pool of the Defendant’s assets with other creditors ([9]) and the Plaintiff could claim them in their entirety.

Has a trust over the retention monies  been created?

For the creation of a trust, there must be certainty of intention, certainty of subject matter, and certainty of object. While there is no dispute that the sum of HK$56,321,000 had never (prior to this action) been paid into any segregated bank account of the Defendant nor segregated from the rest of the Defendant’s receipts and funds held ([6]), the question before the Court was whether the lack of segregation would mean that the trust failed for lack of certainty of the subject matter.

The problem of the lack of certainty of subject matter often arises with fungible property (such as shares, monies). If the transferor is free to select the relevant property from any source, then the transferee cannot possibly acquire an ownership interest in any particular bulk, as the situation would be one of an intended transfer of property which is completely unidentified until the transferor makes the necessary choice. Until such identification, it would be impossible for the transferee to obtain a property interest at all ([61]).

Having considered two of conflicting lines of authority[1], the Court concluded that the lack of segregation is not an absolute bar to the creation of a trust, and each case must be decided on its particular facts, taking into account the nature of the asset which is claimed to be the subject matter of the trust, and whether and how it can be identified with certainty ([14]). Madam Justice Mimmie Chan noted  that although in the following cases segregation was lacking, there were other factors present which were sufficient to identify the subject matter with certainty:

• In Re CA Pacific Finance Ltd [1999] 2 HKLRD 1, relating to the collapse of a securities brokerage, although there were no numbered certificates issued and no earmarking of relevant scrip by number or otherwise, there were strict requirements at each level of the CCASS clearing system to show what securities were held for whom and the quantities of each type of securities held for the account of each client was recorded by the broker ([17]);
• In Re Gatecoin Ltd [2023] 2 HKLRD 1079, relating to the insolvency of a cryptocurrency exchange platform, the internal ledgers clearly recorded the contributions of cryptocurrency by each account holder and the proportionate share of the undivided bulk to which each account holder was entitled could be identified with certainty ([29]);
• In Re Hsin Chong Construction Co [2021] 5 HKLRD 212, relating to the insolvency of a contractor, the employer had a “stringent” project accounting system and the retention money could be easily ascertained. For example, there was evidence on how payment was made by the employer, how the retention money had been set aside as capital commitment in the bank account since the commencement of the project[2], how the retention money was maintained throughout, and that the retention money of each nominated subcontractor could be identified clearly at any time ([43]).

Coming back to the present case, as the Plaintiff could only identify the retention monies as all the money in any and all bank accounts of the Defendant, and there was no other evidence before the Court , to show that the location of the retention monies could be identified with more particularity, (for example in one specific bank account, or several bank named accounts, there could not be any certain or identifiable subject matter to be impressed with the trust ([48]).

Implications

Parties are advised to be vigilant in safeguarding their interests in ensuring that trust property is preserved in face of any insolvency risk of the counterparty. Especially for fungible property, proactive measures are encouraged, whether by means of contracting (to insert an express obligation to produce proof of segregation) or applying to the court (as the case maybe) at an early stage.

See full judgment here.

[1] The conflict is between segregation being a necessary requirement for the existence of a valid trust versus segregation being only an indicator of the creation of a trust and the absence of which is not fatal ([13]).

[2] Conventionally retention monies are to be kept in a completely separate trust fund for the benefit of another if they are to be impressed with a trust (MacJordan Construction Ltd v Brookmount Erostin Ltd [1994] CLC 581, 586).

On 29 January 2024, the Honourable Madam Justice Linda Chan made a winding-up order against China Evergrande Group (the “Company“).

The Company is the ultimate investment holding company of a group of companies known as Evergrande Real Estate Group, which is engaged in property development business mainly in Mainland China. In August 2021, funding constraints and overdue payments caused the halt of construction of housing projects across Mainland China, and by the end of 2021, it was clear that the Company was severely in debt.

In the proceedings in Hong Kong, one of the Company’s creditors, Top Shine Global Limited, filed a petition to wind up the Company on 24 June 2022. The winding up proceedings were protracted, with several adjournments and the hearing on 29 January 2024 was ultimately the sixth hearing of the petition.

For the purposes of the winding up proceedings, there was no dispute that the 3 core requirements for the court to exercise its jurisdiction over the Company were satisfied:

1. The Company is listed in Hong Kong, has a principal place of business in Hong Kong, and some of its senior management are based in Hong Kong.
2. The Company has substantial assets within the jurisdiction, mainly in the form of subsidiaries incorporated in Hong Kong, and receivables owed by these subsidiaries.
3. There are many creditors within the jurisdiction, or who have submitted to the jurisdiction, including the petitioner and the ad hoc group of creditors (who filed notices of intention to appear in the Petition).

However, the Company opposed the petition on the ground that it intended to put forward a comprehensive restructuring scheme in respect of its offshore debts, which, if implemented, would restore the solvency of the Company. The Company made attempts to draft schemes for discussion with creditors, which were the reasons for the adjournments of the first three hearings. However, the Company failed to secure approval from creditors, and the relevant scheme meetings were adjourned and eventually cancelled, and the proceedings in respect of the schemes were dismissed.

On 30 October 2023 (the fourth hearing), the Court stated that if the Company failed to come up with a fully formulated restructuring proposal by the next hearing, it was likely that the Court would make a winding-up order against the Company.

The fifth hearing was on 4 December 2023, where the Company provided an update to the Court which fell “far short” of a fully formulated restructuring proposal. However, at the hearing, the petitioner informed the Court that they would not seek an immediate winding-up order against the Company and would not oppose the adjournment sought by the Company.

At the sixth hearing, the Company did not provide any further proposal nor did they file an affirmation to update the court on their restructuring efforts. The petitioner wrote to the Court, stating that they were “prepared not to push for a winding-up order“, and invited parties to substitute as a petitioner. Treasure Glory Global Ltd (“TG“) then made an application to substitute for the petitioner.

The Court stated that allowing TG to be substituted as creditor or allowing an adjournment for substantive arguments would only result in further delay in the determination of the petition, and it would be better for the Court to instead determine whether there is a proper basis to exercise its discretion to grant a further adjournment of the petition.  In this regard, the Court stated that even if all the parties to the petition agreed to have the petition dismissed, the Court still had discretion to order the Company to be wound up, if circumstances warranted (Re Shop Clothing Ltd (t/a Theme) [1999] 2 HKLRD 280).

As the Company had not laid out any restructuring proposal, the Court was of the view that the creditors’ interests would be better protected if the Company was wound up, so that liquidators can take over, secure and preserve the Company’s assets, and review and formulate a restructuring proposal if they consider that such course is appropriate. The Court remarked that is not uncommon for a Company to put forward and implement a scheme of arrangement after it is wound up by the Court.

Please see here for the full decision.

Introduction – On 26 January 2017, the Securities and Futures Commission (“SFC“) commenced legal proceedings in the Court of First Instance (“Court“) to seek disqualification and compensation orders under section 214 of the Securities and Futures Ordinance (“SFO“) against Mr. Tse On Kin (“Mr. Tse“), former chairman and executive director of Kong Sun Holdings Limited (“Kong Sun“) and China Sandi Holdings Limited (“China Sandi“) (previous name was China Grand Forestry Green Resources Group Limited), for fraudulently obtaining a secret profit out of the companies’ share placements in 2009.

The wrongful actions – The SFC’s investigation revealed that Mr. Tse orchestrated a fraudulent scheme to use a nominee company (falsely declaring its independence) to apply for 100 million and 19 million shares placed by Kong Sun in or around June 2009 and China Sandi in or around November 2009 respectively, at a discounted price, with the intent of making a secret personal profit out of the share placements.

To this end, he procured and permitted the nominee company to make false and misleading representations to the placing agent to secure the share allotment. He also procured and permitted Kong Sun and China Sandi to make false and misleading representations (a) to the Stock Exchange of Hong Kong Limited (“Exchange“) to induce the latter to grant listing approvals with respect to the placing shares; and (b) in the public announcements of these companies.

Mr. Tse made a profit of about HK$2 million with respect to the Kong Sun shares, and a loss of about HK$200,000 with respect to the China Sandi shares.

Factors affecting disqualification period – As a starting point the Court considered the following brackets for reference:

• > 10 years for particularly serious cases;
• 6 – 10 years for cases in between; and
• ≤ 5 years for relatively less serious cases.

The Court also took into account a wide range of factors, including (a) the age; (b) state of health and character of the offender; (c) the nature of the breaches; (d) the honesty and competence of the offender; (e) the length of time he has been in jeopardy; (f) any admission of liability; (g) his general conduct before and after the offence; (h) the periods of disqualification of his co-directors that may have been ordered by other courts; and (i) the interests of shareholders, creditors and employees.

Reasoning – The Court agreed with the SFC’s submission that Mr. Tse’s conduct fell on the borderline between the top bracket and the middle bracket for the following reasons:

(a) Tse’s conduct was fraudulent and dishonest. This brought the case near the top bracket;

(b) Tse carried out the fraudulent scheme not only once but twice with two different companies in which he held important positions;

(c) the fraudulent misrepresentations were not only made to the placing agent, Kong Sun and China Sandi, but also to the Exchange;

(d) Tse obtained a secret personal profit out of the share placement;

(e) on the other hand, Kong Sun and China Sandi did not suffer any financial loss.

Consequence – A disqualification order was made against Mr. Tse, disqualifying him for 10 years from being, or continuing to be, a director, liquidator, receiver or manager of any corporation in Hong Kong, and taking part in the management of any corporation in Hong Kong. He was also ordered to pay a compensation of $2,185,784.1 to Kong Sun, being the profit that he made in breach of his fiduciary duty owed to Kong Sun, and the SFC’s costs in the proceedings.

Please access SFC’s press release and the judgement for more details.

The Securities and Futures Commission (the “SFC“) has recently suspended the licence of a former account executive (the “Former Account Executive“) of a licensed corporation (the “Licensed Corporation“) for 15 months in relation to (i) failure to obtain written authorization prior to allowing a third party to operate a client’s securities account and (ii) carrying out his personal trades in the client’s securities account.

The background is that a client opened a securities account (the “Account“) with the Licensed Corporation in 2009, at which time the client verbally authorized a third party (the “Third Party“) to place orders and make investment decisions on his behalf and to communicate with the Former Account Executive directly as regards matters concerning the Account. However, written authorization of such was never procured by the Former Account Executive or the Licensed Corporation.

Further, the Former Account Executive permitted the Third Party to place his personal trades in the Account for convenience, holding the belief that the Third Party and the account holder would agree among themselves on the apportionment.

Besides, the Former Account Executive carried out more than 260 pairs of cross trades (the “Cross Trades“) in an attempt to delay settlement of his personal trades, involving approximately $3 million, and to generate client transactions when business was slow. This was achieved by selling on the T+1 day the shares bought on the T day to the client and buying them back on the same day immediately, such that he would only have to settle difference between the purchase price and the sale price on the T+2 day, and settlement of the purchase price could wait until the T+3 day. By repeatedly doing so, the Former Account Executive could roll over payment of the purchase price of the subsequent Cross Trades with the effect of delaying settlement of his trades. Eventually the Cross Trades materialised in loss-making transactions of around $70,000, which was borne by the Former Account Executive himself without causing any financial impact on the client.

By way of the above, the Former Account Executive violated paragraph 7.1(a) of the Code of Conduct and constituted a breach of General Principle 2 of the Code of Conduct.

This case serves as a reminder of the risks relating to “unauthorised trades”. Licensed corporations are required to have internal controls in place to reduce the risk of unauthorised trading, such as blatant conduct by an account executive who conducts his personal trades through his clients’ accounts without the clients’ knowledge. There were also many cases and disputes relating to alleged verbal authorisations, and the lack of a written authorisation is a red flag, which points to misconduct by licensed persons.

On 27 December 2023, the Financial Services and the Treasury Bureau (the “FSTB”) and the Hong Kong Monetary Authority (the “HKMA“) published the Consultation Paper on the Legislative Proposal to Implement the Regulatory Regime for Stablecoin Issuers in Hong Kong (the “Consultation Paper“).  Prior to this consultation, the HKMA issued a Discussion Paper on Crypto-assets and Stablecoins in January 2022 (the “2022 Discussion Paper“), with its Conclusion issued in January 2023, whereby respondents generally supported the HKMA’s proposal of bringing stablecoins into the regulatory perimeter and the HKMA indicated its expected key regulatory scope and requirements.

What are stablecoins and what prompted the regulatory concern?

Stablecoins are a sub-set of crypto-assets (or known as virtual assets, which are digital representations of value that are cryptographically secured, typically through the use of distributed ledger technology (DLT), like blockchain) that aims to maintain a stable value with reference to certain asset(s), typically fiat currencies like the U.S. or Hong Kong dollar. They have been gaining popularity in the wider market for several reasons, including their commitment to minimize price volatility, enabling faster and more cost-effective cross-border payments, and increasing financial inclusivity by providing access to digital payments for the unbanked population.

The collapse of TerraUSD in 2022 highlighted the urgency to introduce a regulatory regime of stablecoins in Hong Kong, with fiat-referenced stablecoins (“FRS“) being a priority for regulation and legislative guidance as they are more likely to be used in day-to-day payments and have linkages with the traditional financial system, thereby creating more direct and imminent monetary and financial stability risks than other types of stablecoins or other crypto-assets.

Proposed new licensing regime for fiat-referenced stablecoins (FRS) issuers

Against the above background, and taking into account the market conditions and needs in Hong Kong, the FSTB and the HKMA propose to introduce a new piece of legislation to implement a licensing regime for FRS issuers with the following key features:

(1)  requiring all FRS issuers who (a) issue an FRS in Hong Kong; (b) issue a Hong Kong dollar-referenced stablecoin; or (c) actively market their issuance of FRS to the public of Hong Kong, to be licensed by the HKMA;

(2)  requiring that FRS can only be offered by specified licensed entities, including licensed FRS issuers[1], authorised institutions[2], licensed corporations[3] and licensed virtual asset trading platforms (“VATP“), and for FRS not licensed by the HKMA, they can only be offered by specified licensed entities to professional investors;

(3)  prohibiting the advertising of:

(a) a person’s issuance of FRS unless the person is licensed by the HKMA; or

(b) a person’s offering of FRS unless the person is a specified licensed entity;

(4)  providing the necessary supervisory and investigation powers for the authorities to adjust the parameters of in-scope stablecoins and activities having regard to the rapid virtual assets market development;

(5)  subjecting regulated activities without a licence to criminal and civil offence and sanction provisions, and setting up of an appeal tribunal mechanism to ensure there are checks and balances to the HKMA’s powers; and

(6)  providing a transitional arrangement to facilitate the implementation of the regulatory regime.

Respondents to the earlier 2022 Discussion Paper expressed concerns about potential overlap between the proposed regime and other financial regulatory regimes in Hong Kong, including the licensing regime for VATP operators, administered by the Securities and Futures Commission (the “SFC“) under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615). More information on this regime can be found in our prior news updates dated 25 April 2023 and 16 August 2023.

To address these concerns and prevent regulatory arbitrage, the FSTB and the HKMA will collaborate with the SFC and other stakeholders to formulate the specific details of the stablecoin regime.

The proposed regime aims to strike a good balance between safeguarding financial stability and embracing innovation. The public is encouraged to provide feedback on the proposals by 29 February 2024.

Access the full Consultation Paper here for more details.

[1] A licensed FRS issuer can only offer FRS it issues.

[2] An authorized institution means a licensed bank, a restricted licence bank or a deposit-taking company under the Banking Ordinance (Cap. 155).

[3] A licensed corporation means a corporation (that is not an authorized institution) which is granted a licence to carry on one or more regulated activities under sections 116 and 117 of the Securities and Futures Ordinance (Cap. 571). When offering FRS, licensed corporations must hold a licence for Type 1 regulated activity (dealing in securities) and be permitted by the SFC to carry out dealing in virtual assets.