Family Law: LCYP v JEK [2019] HKCFI 1588, finally clarifying the law on pre-and postnuptial agreements in Hong Kong. Responsible Family Asset Protection: will the Hong Kong Monetary Authority’s proposed Code provide much-needed regulation and supervision?

1.   LCYP v JEK [2019] HKCFI 1588: Finally Clarifying the meaning of ‘Real Need’ in the Enforcement of Pre- and Postnuptial Agreements (PNAS) 

Anthony Chan J in his groundbreaking judgment in LCYP v JEK of 8 July 2019 cited at paragraph 127, the following key passage from the UK Supreme Court decision in Granatino v Radmacher [2011] 1 AC 534, ‘The court should give effect to a nuptial agreement that is freely entered into by each party with a full appreciation of its implications unless in the circumstances prevailing it would not be fair to hold the parties to their agreement.' The emphasis was his.

The main question therefore is how do you ensure that you have the greatest chance of a court giving effect to a PNA? The answer is that there are two, key, interconnected stages to focus on in the preparation and negotiation of a PNA. Stage 1 is to create an unvitiated PNA. If Stage 1 has been successfully effected, then Stage 2 is to ensure that the terms of the PNA are ‘fair’.

The law in Hong Kong in connection with Stage 1 - with the identification of the standard vitiating factors - has been clear for some time (although the essential, practical and meticulous safeguards that need to be put in place are not so well understood: as presaged in 1.1 below). 

What constitutes ‘fairness’ in Stage 2 was disputed in Hong Kong until the LCYP v JEK judgment. Our Family Asset Protection/Divorce and Trusts team at BCLP LLP (Marcus Dearle, Ruben Sinha, Rebecca Alexander and Veronica Lee) represented the successful American husband - JEK (H) - from New Jersey in the United States.

1.1   Stage 1: the creation of an unvitiated PNA - Attention to Detail

PNAs are highly complex documents. PNAs in high and ultra-high-net-worth cases should never be drafted on the cheap or handled by inexperienced junior associates on their own with minimal partner supervision. Underquoting on costs forces practitioners to cut corners. It is vital to devote considerable time to such cases. In terms of managing expectations effectively, the task of negotiating PNAs is a potential quagmire, fraught with numerous pitfalls and challenges. Many of the pitfalls and the pressures which must be dealt are not so well understood or are ignored. Often, insufficient care and attention is given to the paper or electronic communication trail needed to evince that the PNA is unvitiated. An unvitiated PNA is one where there is no concern about the fairness of the circumstances surrounding the creation of the PNA: that there was no fraud, misrepresentation or undue pressure at that time, and that it was entered into ‘freely’. 

Failing to spot and deal with a message from a financially weaker party which has been deliberately planted to sabotage the agreement, indicating that he or she is actually not happy to sign when this contradicts the more positive position being officially communicated through the lawyers is a danger signal - and could cost millions if it is not handled swiftly and effectively. Very occasionally, this might even involve advice for the marriage itself to be postponed.

Financially stronger parties also need to avoid at all costs a situation where the PNA is immediately cancelled by the parties as it was in the case of TCWF v LKKS [2014] HKEC 1593 where the post-nuptial agreement was terminated on the same day that it was signed. Marcus Dearle acted for the wife who benefited significantly from the cancellation of the agreement, and consequently, when advising the financially stronger party, we often include ‘think carefully’ clauses in PNAs as an extra level of protection - requiring the financially stronger party to obtain independent legal advice whenever the PNA is varied in any way or to be terminated: see Marcus Dearle’s article, ‘Responsible family asset protection: lessons from Asia’s HK$1.2 billion divorce award: when aggressive strategies can backfire’ (April [2018] Fam Law 420).

1.2   Stage 2: Once you have an unvitiated PNA, what is ‘fair’ financial provision? LCYP v JEK has provided key guidance.

LCYP v JEK is one of the most important family law decisions to be handed down in Hong Kong in the 9 years since the Court of Final Appeal’s landmark decision in LKW v DD in 2010 which brought in the ‘equal sharing’ principle. It has clarified the law and provided for the first time much-needed guidance about the standard at which the financially weaker party’s needs are to be assessed in the context of an unvitiated PNA. It has clarified the meaning of ‘real need’ (when the Court of Final Appeal case of SPH v SA [2014] 3 HKLRD 497 had not done so) in the context of determining whether financial terms of a PNA are to be treated as ‘fair’. 

There was a sharp divergence in the case on one important principle: the calibration of needs in the context of an unvitiated nuptial agreement, where, for the avoidance of doubt, there is no challenge to the fairness of the circumstances surrounding the creation of the agreement. The judge stated that the parties: ‘differ strongly on the standard which the Husband has to meet in order to provide for the Wife’.

The wife’s (W) case was that the court must make provision for her needs generously interpreted. We disagreed with that submission and submitted that this misstated the law. We relied upon a number of English post-Radmacher authorities including N v F [2011] 2 FLR 533, Luckwell v Limata [2014] 2 FLR 168, Hopkins v Hopkins [2015] EWHC 812 (Fam) and WW v HW [2016] 2 FLR 299. We submitted that when it comes to spouses (as opposed to children), it is normally sufficient for the court to make provision that would alleviate a predicament of real need which is likely to be at a materially lower level than the needs generously interpreted level.

Indeed, the judge’s final award for W was significantly below a needs generously interpreted level, and the ruling confirms that in certain circumstances, in line with English case law, the court will order that some capital should be returned to the financially stronger party at a future date: the court agreed with us that a significant proportion of the financial capital award for W should be returned to him or his estate upon the occurrence of certain future triggering events - when W was against any capital being returned at all. Such a clawback arrangement has never before been imposed by a court in Hong Kong in any reported case involving a PNA:

  1. The judge held: “Mr Nagpal [counsel for H] submitted that there is a consistent theme in the outcome of various English authorities, including and since [the UK Supreme Court case of] Radmacher, of the payee having to return capital to the payer. There is an obvious fairness of the payee having to return capital when it is not needed if that party has been provided capital to meet his or her needs in circumstances where that capital is in excess of what was agreed in an unvitiated nuptial agreement.“ [Our emphasis]. “On balance I agree with Mr Nagpal that there is nothing in the facts of this case which militates in favour of the Wife receiving capital outright over and above that which she is entitled to, in circumstances where it was agreed that she would not have claim to such capital. I therefore agree with the chargeback in favour of the Husband.”
  2. The chargeback amounts to 21.24 percent of W's award.
  3. It powerfully demonstrates the impact on and the material financial consequences for a financially weaker spouse on divorce when parties sign up to an unvitiated PNA - while still achieving fairness: the fact that an agreement does not meet an applicant’s generously interpreted needs does not in and of itself make it unfair.
  4. It should act as a deterrent against forum shopping in future.

2.   The Hong Kong Monetary Authority’s (HKMA) Consultation Paper of 10 July 2020: Will this Impose much-needed Mandatory Regulation and Supervision of Trust Business in Hong Kong in Family Asset Protection/Divorce and Trust Cases?

The HKMA intends to regulate and supervise trust business via a mandatory Code of Practice for Trust Business (the Code) - ‘especially [for business] conducted by banks for wealth management purposes’ - which will apply to authorised institutions (AIs) and subsidiaries of locally incorporated AIs that conduct trust business in Hong Kong. Other trustees and trust companies are encouraged to adopt the proposed Code to the extent applicable. 

The Code could have a major beneficial impact on the setting up and running of trust structures in a divorce context. The Family Law Committee of the IBA fully supports the introduction of a mandatory HKMA Code and will be responding to the consultation paper.

2.1.  The key provisions in the Code that will likely impact the setting up and running of trust structures in a divorce context are:

‘Principle 1: Fairness, honesty and integrity’ - ‘A trustee should act honestly, fairly and with integrity in conducting its business, including…..making adequate and accurate disclosure of information to customers.’

‘Principle 2: Due skill, care and diligence’ - ‘A trustee should (among other things): possess and maintain sufficient skills, knowledge and expertise to conduct its trust business, and ensure that its staff are and remain fit and proper for their roles and responsibilities.’

‘Principle 5: Compliance with legal and regulatory requirements and standards.’

These provisions, if made mandatory, should mean that all AIs and their employees will be likely to be required to have a thorough understanding of the landmark Hong Kong Court of Final Appeal (CFA) decision in Kan Lai Kwan v Poon Lok To Otto [2014] HKFLR 329 (the Otto Poon case), and the indisputable fact that assets held in a discretionary trust are often at risk of being treated by the court as a potential financial resource in divorce proceedings if either or both of the parties are beneficiaries of the trust.

It should also mean that attention will be given to ensuring that AIs do not deliberately, or unwittingly, become involved in the setting up of trusts in circumstances which would be likely to be treated by the Hong Kong court as forming ‘part of [a] fraudulent scheme to defeat the Wife's claims’: see our comments on the English Akhmedova v Akhmedov case as presaged in 2.3 below.

2.2.  Accurately applying the Otto Poon case

Marcus Dearle led the team acting for the trustee in the Otto Poon case, HSBC International Trustee Limited. The case remains the leading divorce and trust case in Hong Kong and is regularly misapplied. The discretionary trust in the case was not improperly drafted, as is mistakenly assumed by some in Hong Kong. It was a standard discretionary trust, drafted in a similar way to most other discretionary trusts. 

The CFA’s decision did not impact on the more robust asset protection approach afforded by genuinely dynastic trusts, where the settlor is not a beneficiary. It is to these dynastic trusts that individuals wishing to ring-fence assets responsibly, ideally in tandem with PNAs, should continue to be directed. The paradox is, however, that substantially wealthy clients in Asia, who can easily afford to put a significant part of their wealth aside into dynastic trust structures, are usually not prepared to settle a trust without being a beneficiary. Thus, a discretionary trust is chosen, despite its asset protection vulnerabilities in a divorce context, as shown in the Otto Poon case.

It is essential that, when discretionary trusts are set up, advice given to the client is accurate and carefully noted to guard against the risk that a client might later assert that those vulnerabilities were not explained sufficiently, or at all, at the outset, and that they were lulled into a false sense of security. Sometimes it transpires that there is truth in these complaints particularly where a trust was set up through an intermediary more interested in the money in the portfolio account than the suitability of the wrapper the asset was held in. AIs under the ‘accurate disclosure of information’ heading in Principal 1 should be expected fully to advise the client (a) about the difference between a discretionary trust (with its vulnerabilities) and dynastic trusts, and (b), if they are concerned about potential divorce risks, that the client might be better off entering into a PNA. 

There were also significant divorce and trust aspects to the LCYP v JEK case. This was the first reported Hong Kong divorce case involving USA discretionary trusts. The trusts were situated in Delaware, New York, Florida and New Jersey. Applying the ‘likelihood test’, Anthony Chan J held that the assets of the main high value Delaware discretionary trust ‘are the [financial] resources of the Husband’. 

The requirement to make adequate and accurate disclosure of information to customers under Principal 1 also dovetails into Principal 2 which highlights the need for ‘due skill, care and diligence’. AIs under Principle 2 should be expected to be skilled in the application of the Otto Poon ‘likelihood test’.

In the Hong Kong Court of Appeal case of WYSL v FHCBA [2019] HKCA 814 (judgment 26 July 2019), the court was critical of both the trustee and the solicitors for the divorcing husband/beneficiary. Essentially, the court was concerned about their handling of the likelihood test: for example, the trustee responded to the husband’s solicitors that the ‘question of when [the husband’s] entitlement will be for distribution was “not applicable”’. In the first place, asking about ‘entitlement’ was the wrong question to be asking. The court also stated, ‘the stonewalling replies of the trust relationship officer were most unhelpful…...’

2.3.  Lawyers in the cross-hairs in trust and divorce cases: when the marriage is over, to advise that there should be no trust structuring/trust restructuring is usually the best strategy - don’t be a ‘yes adviser’

Although it is proposed that law firms will be exempted from the Code, to avoid regulatory overlap because law firms are already subject to their own professional codes, solicitors are already in the spotlight. Solicitors (and barristers for that matter) should take care not to advise on, or take part in, any trust scheme or arrangement which is, or is likely to be treated by the court to be, a fraudulent attempt by one spouse to defeat the other spouse’s ancillary relief or financial remedy claims: the recent English judgment of Knowles J in Akhmedova v Akhmedov [2019] EWHC 3140 (Fam) of 22 November 2019 requires careful consideration - in particular paragraphs 40, 41 and 42 - where Her Ladyship found that emails from the husband’s solicitor (which had been produced by a whistleblower),show that they form part of the fraudulent scheme to defeat the Wife's claims, including both by moving assets to jurisdictions in which enforcement would be impossible …….”. Our emphasis. 

She also stated: ‘This conduct began in March 2015 (when assets were settled into a Bermudan discretionary trust) through the months leading up to the trial in December 2016 (when all of the assets, including those previously held by the Bermudan trust, were transferred into Liechtenstein structures) and continuing after judgment was obtained (including the further transfer of the vessel to Straight).’ It’s important to note that all this trust structuring was completed after the marriage had broken down: W’s divorce petition was filed in October 2013.

And the husband’s solicitor in Akhmedova could not rely on privilege - even when, the documents, which were referred to as ‘reviewable documents’, had been provided by a whistleblower. Knowles J held, ‘For the avoidance of doubt, I am satisfied that the Reviewable Documents are not confidential (or that no relief should be granted to protect any confidentiality) and that the 'fraud' exception to privilege applies. There is no reason therefore to order that the Wife should return or make no use of the Reviewable Documents.’

In LCYP v JEK, H responsibly made no alteration whatsoever to any of the trust structures, all of which were in place well before W’s divorce petition was filed. 

 

Jurisdictions: 

Senior Vice Chair, IBA Family Law Committee

Fellow, IAFL

Marcus Dearle is Senior Vice Chair of the IBA Family Law Committee and a fellow of IAFL. He is a Partner and Global Head of Bryan Cave Leighton Paisner LLP’s Family Law team based in Hong Kong and London, and is one of the leading family, and trust and divorce, lawyers in Hong Kong. Marcus has led the teams acting in a number of the highest profile cases in Hong Kong, including for the wife in TCWF v LKKS [2014] HKEC 1593, for the trustee, HSBC International Trustee Limited, in the landmark Court of Final Appeal trust and divorce case of Otto Poon, and for the husband in LCYP v JEK.

Associate, Family Law team,

Bryan Cave Leighton Paisner LLP

Veronica Lee is an associate in the Family Law team at Bryan Cave Leighton Paisner LLP and acted in LCYP v JEK. She trained with King & Wood Mallesons in Hong Kong. She focuses on advising HNW and UHNW individuals and families and trustees on all family law matters, including divorce proceedings, pre-and post-nuptial agreements, and children related issues. The team practises in the London magic circle family law firm manner, with multiple fee-earners as necessary working on financial cases and full-time partner supervision: in LCYP v JEK, 1 partner, 3 associates and 1 trainee simultaneously worked on the case.