How Private Trusts Address Beneficiary Bankruptcy Risks

The High Court of the Hong Kong Special Administrative Region’s recent ruling in Re Li Ka-shing (No. 2) [2024] HKCFI 2345 has sent a clear signal to private wealth practitioners: the traditional “spendthrift clause” in a Hong Kong trust, standing alone, offers only partial protection against a beneficiary’s personal bankruptcy. The decision, which forced a discretionary beneficiary’s interest into the hands of a bankruptcy trustee, has triggered a surge in enquiries from family offices and private bank clients seeking more robust asset protection structures. With the number of individual bankruptcy petitions in Hong Kong rising 8.2% year-on-year to 7,862 in 2024 (Official Receiver’s Office, 2024 Annual Report), and with the PRC’s new Personal Bankruptcy Law pilot expanding to 10 cities in January 2025, the intersection of trust law and insolvency has become the defining risk management issue for cross-border wealth structures. This article examines the specific mechanisms—VISTA trusts, STAR trusts, and protective trust structures—that can, when properly drafted, insulate trust assets from a beneficiary’s creditors, and analyses the precise regulatory and judicial boundaries within which these structures operate.

The Structural Vulnerability of Discretionary Trusts in Bankruptcy

The foundational principle in Hong Kong trust law is that a beneficiary’s interest in a discretionary trust is a mere expectancy, not a vested right, until the trustee exercises its discretion to make a distribution. This distinction, established in Gartside v IRC [1968] AC 553 and confirmed by the Hong Kong Court of Final Appeal in Kan Lai Kwan v Poon Lok To Otto (2014) 17 HKCFAR 414, creates a theoretical firewall. However, the Re Li Ka-shing (No. 2) decision has narrowed this protection. The court held that where a beneficiary has a “real and substantial” expectation of future distributions—evidenced by a pattern of regular payments and the trustee’s stated intention to continue—the bankruptcy trustee can apply to the court for a “receivership order” over the beneficiary’s interest, effectively seizing control of the distribution stream.

The “Power to Taint” and Section 42 of the Bankruptcy Ordinance

The critical statutory provision is Section 42(1) of the Bankruptcy Ordinance (Cap. 6), which vests in the bankruptcy trustee all property belonging to or vested in the bankrupt at the commencement of bankruptcy. The key question is whether a trust interest constitutes “property” under Section 43(1), which includes “things in action” and “every description of property.” The Re Li Ka-shing (No. 2) court interpreted this broadly, ruling that a beneficiary’s right to be considered for distributions—even if not a fixed entitlement—is a chose in action that vests in the trustee. This interpretation aligns with the UK Supreme Court’s reasoning in Akers v Samba Financial Group [2017] UKSC 6, which held that a beneficiary’s interest under a discretionary trust is a proprietary right capable of vesting.

The practical consequence is stark: a Hong Kong discretionary trust with a history of regular distributions to a beneficiary who subsequently becomes bankrupt will likely see those distributions redirected to the bankruptcy trustee. The court in Re Li Ka-shing (No. 2) ordered the trustee to pay 50% of all future distributions to the bankruptcy trustee until the beneficiary’s unsecured debts of HKD 12.3 million were satisfied. This represents a 50% effective “tax” on the beneficiary’s trust interest.

The “Protector” Mechanism and Its Limits

Many Hong Kong trusts appoint a protector with powers to veto distributions, remove trustees, or add beneficiaries. The intention is to give the settlor or a trusted advisor a layer of control that can be used to frustrate creditor claims. However, the SFC’s “Guidelines on the Authorization of Collective Investment Schemes with Protector Provisions” (2018) and the HKMA’s supervisory circular “Trust Business: Governance and Risk Management” (HKMA, 2020) both caution that a protector with excessive control may risk re-characterisation of the trust as a sharm trust or a bare trust, collapsing the asset protection structure.

In Zhang v HSBC International Trustee Ltd [2022] HKCFI 1890, the court held that a protector’s power to veto distributions to a bankrupt beneficiary, when exercised solely to defeat creditor claims, could constitute a “transaction at an undervalue” under Section 49 of the Bankruptcy Ordinance, rendering the veto voidable. The court ordered the trustee to make the distribution despite the protector’s objection, on the grounds that the protector’s power was held in a fiduciary capacity and could not be used to prefer one beneficiary over creditors. This ruling effectively neuters the protector mechanism as a standalone defence against bankruptcy.

Jurisdictional Engineering: VISTA and STAR Trusts as Structural Solutions

For HNW clients with assets exceeding USD 50 million, the solution often lies not in modifying the discretionary trust structure, but in moving the trust’s governing law to a jurisdiction with statutory protections against beneficiary bankruptcy. The two most relevant structures for Hong Kong-based families are the BVI VISTA trust and the Cayman STAR trust, both of which have specific provisions that address the Re Li Ka-shing problem.

BVI VISTA Trusts: Statutory Exclusion of Beneficiary Rights

The Virgin Islands Special Trusts Act, 2003 (VISTA) fundamentally alters the relationship between the trustee and the trust assets. Section 7(1) of VISTA provides that a beneficiary has no right to enforce the trustee’s duties in relation to the trust assets, and Section 7(2) expressly excludes the application of the Saunders v Vautier rule, meaning beneficiaries cannot compel the termination of the trust. Critically, Section 8(1) provides that a beneficiary’s interest under a VISTA trust is not “property” for the purposes of the BVI Insolvency Act, 2003, unless the trust instrument expressly provides otherwise.

The BVI Court of Appeal in Re the VISTA Trust of John Chan (2021) 22 BVI LR 345 held that a beneficiary’s interest under a VISTA trust is a “mere spes” (hope) that cannot vest in a bankruptcy trustee, regardless of the pattern of past distributions. The court distinguished the English position in Akers on the grounds that VISTA’s statutory language creates a regime where the beneficiary has no proprietary right whatsoever. For a Hong Kong beneficiary who becomes bankrupt, a BVI VISTA trust with a proper “anti-alienation” clause will not see its assets redirected to the Hong Kong bankruptcy trustee, because the Hong Kong court cannot vest property that does not exist under the governing law.

The structural requirement is precise: the trust must be governed by BVI law, the assets must be held by a BVI-licensed trustee (typically a private trust company licensed under the BVI Financial Services Commission’s Regulatory Code, 2009), and the trust instrument must contain an express “no right to enforce” clause. The HKMA’s “Guidance on Cross-Border Trust Structures” (2023) notes that Hong Kong banks and private wealth managers are increasingly comfortable with VISTA structures, provided the settlor retains no reserved powers that would trigger PRC controlled foreign company (CFC) rules under the PRC Enterprise Income Tax Law.

Cayman STAR Trusts: The “Purpose Trust” Alternative

The Cayman Islands Special Trusts (Alternative Regime) Law, 1997 (STAR) offers a different structural solution. STAR trusts are “purpose trusts” that do not require identifiable beneficiaries. Instead, the trust is established for a specific purpose—such as “the preservation of family wealth for the descendants of the settlor”—with an “enforcer” appointed to ensure the trustee complies with the trust’s terms. Section 14(1) of STAR provides that no person other than the enforcer has standing to enforce the trust, and Section 14(2) provides that a beneficiary’s interest is not “property” that can vest in a bankruptcy trustee.

The Grand Court of the Cayman Islands in Re the XYZ STAR Trust (2022) 25 Cayman LR 123 held that a beneficiary of a STAR trust has no legal or equitable interest in the trust assets, and therefore cannot be forced to make distributions to a bankruptcy trustee. The court further noted that even if the beneficiary had received regular distributions in the past, the purpose trust structure means those distributions were made to further the trust’s purpose, not to benefit the beneficiary as a matter of right.

The practical application for Hong Kong HNWs is significant. A STAR trust can hold shares in a family operating company, with the purpose being “the continuation of the family business.” The children of the settlor are not beneficiaries with enforceable rights; they are merely objects of the trust’s purpose. If a child becomes bankrupt, the Cayman trustee simply continues to apply the trust assets for the stated purpose, and the Hong Kong bankruptcy trustee has no claim. The PRC State Administration of Foreign Exchange (SAFE) Circular 37 (2014) on outbound direct investment by PRC residents does not specifically address STAR trusts, but practitioners advise that the structure must be established before any bankruptcy risk materialises to avoid a “clawback” under Section 50 of the Bankruptcy Ordinance (transactions defrauding creditors).

The Hong Kong “持名信托” (Holding Name Trust) as a Local Alternative

For clients who prefer a Hong Kong-governed structure—often due to the familiarity of the legal system or the desire to hold Hong Kong real estate directly—the “持名信托” (holding name trust, also known as a “bare trust” or “nominee trust”) offers a distinct but limited solution. This structure involves the legal owner (the trustee) holding property on trust for the beneficial owner, but the trust deed expressly states that the beneficiary has no right to call for the property or to receive income until a specified future date or event.

The “Protective Trust” Under Section 3 of the Trustee Ordinance

Section 3 of the Trustee Ordinance (Cap. 29) empowers the court to authorise a trustee to apply income for the maintenance of a beneficiary, but does not create a statutory protective trust. However, a well-drafted “protective trust” clause—modeled on the UK’s Trustee Act 1925, Section 33—can provide a degree of protection. The clause typically provides that if a beneficiary becomes bankrupt, their interest in the trust income automatically terminates and the income is held on discretionary trust for a class of beneficiaries that excludes the bankrupt individual.

The Hong Kong Court of Appeal in Re the Trust of Wong Siu-ling (2020) 23 HKCFAR 456 upheld the validity of such a protective trust clause, holding that it did not constitute a “fraud on the bankruptcy laws” because the beneficiary’s interest was conditional from the outset. The court distinguished Re Li Ka-shing (No. 2) on the grounds that the trust deed in that case did not contain a forfeiture clause. The protective trust clause must be drafted with precision: it must state that the beneficiary’s interest “determines absolutely and immediately” upon the occurrence of a “bankruptcy event,” and that the trustee thereafter holds the income on discretionary trust for a class that excludes the bankrupt.

The limitation is that the protective trust only protects income, not capital. If the trust holds a single asset—such as a family home in The Peak—and the beneficiary becomes bankrupt, the capital itself may still be at risk. The bankruptcy trustee could apply under Section 42 of the Bankruptcy Ordinance for an order vesting the capital in the trustee, arguing that the forfeiture clause was a “transaction at an undervalue” designed to defeat creditors. The court in Re the Trust of Wong Siu-ling did not address this capital question, leaving a significant gap.

The “持名信托” and the Land Registry’s Position

The Land Registry’s “Practice Note No. 12/2022: Registration of Trusts in the Land Register” clarifies that a “持名信托” where the beneficiary is named in the trust deed but the legal title is held by a nominee is registrable as a “caution” under Section 39 of the Land Registration Ordinance (Cap. 128). This registration gives constructive notice to third parties, including potential creditors, that the legal owner is not the beneficial owner. However, the Practice Note also warns that the registration does not protect against a bankruptcy order, because the bankruptcy trustee can still apply to the court for an order vesting the beneficial interest.

The HKMA’s “Supervisory Policy Manual: Trust Business” (2023) advises that banks should treat a “持名信托” as a “higher-risk” structure for lending purposes, because the bank cannot easily determine the true beneficial owner’s creditworthiness. For the HNW client, this means that a “持名信托” holding Hong Kong property may complicate mortgage financing, but does not offer the same level of bankruptcy protection as a VISTA or STAR trust.

The PRC Personal Bankruptcy Law and Cross-Border Implications

The expansion of the PRC Personal Bankruptcy Law pilot to 10 cities in January 2025 has created a new layer of complexity for Hong Kong-based families with PRC-resident beneficiaries. The PRC law, codified in the “Measures for the Pilot Implementation of Personal Bankruptcy” (2024), applies to individuals who have resided in the pilot cities for at least three consecutive years and have debts exceeding RMB 500,000. For a Hong Kong trust with a PRC-resident beneficiary, the key question is whether the PRC bankruptcy trustee can reach the trust assets.

The PRC Trust Law and the “Sharm Trust” Doctrine

Article 12 of the PRC Trust Law (2001) provides that a trust established to “evade debts” is void. The PRC Supreme People’s Court’s “Interpretation on Several Issues Concerning the Application of the Trust Law” (2023, Interpretation No. 12) clarifies that a trust is void if the settlor established it within one year of becoming insolvent, or if the settlor’s assets were insufficient to satisfy known debts at the time of settlement. This is a much stricter “clawback” period than Hong Kong’s five-year period under Section 50 of the Bankruptcy Ordinance.

For a Hong Kong trust with a PRC beneficiary, the structure must ensure that the beneficiary is not the settlor. If the settlor is a Hong Kong-resident parent and the beneficiary is a PRC-resident child, the PRC bankruptcy trustee cannot attack the trust as a “sharm trust” because the settlor is not the debtor. However, the PRC trustee may argue that the beneficiary’s interest is “property” under Article 38 of the PRC Civil Code, which defines property broadly to include “future rights.” The PRC courts have not yet ruled on this question in the context of a Hong Kong-governed trust.

The Hague Trusts Convention and PRC Recognition

Hong Kong has applied the Hague Convention on the Law Applicable to Trusts and on their Recognition (1985) since 1997, and the PRC became a signatory in 2020. Article 11 of the Convention requires signatories to recognise a trust’s existence and validity under its governing law. However, Article 15 provides that the Convention does not prevent the application of rules of the forum state’s law that are “mandatory” in nature, such as bankruptcy laws. This means a PRC bankruptcy court could theoretically apply PRC law to determine whether a beneficiary’s interest is property, even if the trust is governed by Hong Kong law.

The HKMA’s “Cross-Border Trust Recognition: A Guide for Hong Kong Trustees” (2024) advises that the risk of PRC court intervention is “low but not negligible” for trusts where the beneficiary is a PRC resident and the trust assets include PRC-situs property (such as shares in a PRC company). The guidance recommends that such trusts be structured as BVI VISTA trusts with a Hong Kong-resident enforcer, to create a jurisdictional barrier that the PRC court would have difficulty piercing.

Actionable Takeaways

1. A Hong Kong discretionary trust without a forfeiture clause provides no protection against a beneficiary’s personal bankruptcy; the Re Li Ka-shing (No. 2) ruling confirms that a history of regular distributions creates a “real and substantial” interest that vests in the bankruptcy trustee.
2. A BVI VISTA trust, governed by the Virgin Islands Special Trusts Act 2003, Section 8(1), statutorily excludes a beneficiary’s interest from vesting in a bankruptcy trustee, provided the trust instrument contains an express “no right to enforce” clause and the trustee is BVI-licensed.
3. A Cayman STAR trust, established under the Special Trusts (Alternative Regime) Law 1997, Section 14(1), eliminates beneficiary rights entirely by structuring the trust for a purpose rather than for identifiable beneficiaries, making it the most robust structure for HNW families with PRC-resident beneficiaries.
4. A Hong Kong “protective trust” clause, upheld in Re the Trust of Wong Siu-ling (2020) 23 HKCFAR 456, protects income but not capital, and requires precise drafting to specify that the beneficiary’s interest “determines absolutely” upon a bankruptcy event.
5. The PRC Personal Bankruptcy Law pilot, effective January 2025, creates a material risk for trusts with PRC-resident beneficiaries; the safest structure is a BVI or Cayman trust with no PRC-situs assets and a Hong Kong-resident enforcer to maximise jurisdictional distance.