Hong Kong Court tackles Beddoe applications and Bartlett clauses

The case of Highmax Overseas Ltd v Chau Kar Hon Quinton considers the interaction of two issues very relevant to trustees (particularly trustees of trust funds including company shares): Beddoe applications and Bartlett clauses. Reported Court decisions on both issues are thin on the ground, so this case provides helpful insight.

When trustees feel the need to consider whether to pursue or defend litigation, the Beddoe procedure allows them to seek the Court's directions. This will, crucially, ordinarily protect the trustees against claims from beneficiaries and also allow them to take legal fees from the trust fund.

On the other hand, Bartlett clauses are commonly included in modern trust deeds to give protection in particular to trustees who hold shares in underlying companies. The case of Bartlett v Barclays Bank Trust Co Ltd requires the trustee to supervise ventures of underlying companies. This arises from the duty to conduct the business of the trust with the same care that an ordinary prudent man would conduct a business of his own. Accordingly, trust deeds often contain clauses seeking to restrict this duty.

Background

The Highmax case concerned an irrevocable discretionary trust set up in order to benefit the settlor, Mr Chau, and his issue. Mr Chau transferred four Hong Kong properties into four separate BVI companies, and then transferred the shares in these companies (by way of gift) to the trustee. Shortly after, litigation was commenced against Mr Chau and Mareva injunctions obtained against him, freezing his assets.

The litigation eventually resulted in his bankruptcy and his trustees in bankruptcy brought proceedings against him, and against the BVI companies, seeking to avoid the transfer of the properties to the BVI companies on the basis that the assignments were:

i.  a sham;
ii. made at a time when Mr. Chau was insolvent and for the purpose of putting the properties beyond the reach of his creditors; or
iii. at an undervalue and therefore void under the Bankruptcy Ordinance.

The trustee proceeded to bring a Beddoe application seeking guidance from the Court as to how it should conduct itself in these proceedings. Deputy High Court Judge Simon Leung, at first instance, gave directions for the companies (under the control of the trustee) to remain neutral in the proceedings and freeing certain funds from the Mareva injunction to pay legal costs. This order was appealed to the Court of Appeal, with the respondents contending that the judge should have directed the trustee to defend the proceedings rather than take a neutral stance.

Decision

The Court of Appeal set aside the judge's order, but refused to grant an order in the terms requested in the appeal.

The Court held that, whilst a trustee can apply to the Court for directions in respect of the administration of trust, the Court has no power to direct how the property holding companies, who are not trustees of the relevant trust, act in response to the proceedings. The Court considered that it was for the relevant company directors to decide how they should act in the context of the interests of their respective shareholders and creditors as a whole.

The Court considered the following: if trustees are faced with a dispute involving the underlying property of the trust (as opposed to direct trust property, which is just the shares in the underlying company), how they should deal with it, and to what extent they should exercise their shareholder powers to direct the companies to take a particular action.

The Court of Appeal did not consider that the Bartlett duty could warrant a trustee seeking directions in relation to assets not directly held by the trust without regard to the interposition of the corporate structure. Even if the trustee has full control over the shares, the Court considered that much depends on the views of the directors upon whom the primary responsibility to manage the company is vested. As a matter of company law, the Court will not normally interfere with managerial decisions of the board. The Court also considered that this applied all the more strongly given the extensive Bartlett clause in the trust deed which provided in detail how the trustee was not bound to interfere in business of the company in which it is interested.

The distinction between who should take a decision: the trustees or the directors, is not simply a legal technicality. Whereas the trustees owe their duties to the beneficiaries, the directors' duties are potentially broader as they can include duties not only to the shareholders (i.e. the trustees), but also to creditors if the company is in or on the verge of insolvency.

Comment

The case represents a useful Court of Appeal judgment giving insight into the limitations of a Beddoe application. It also may provide some comfort for trustees as it seemingly limits the imposition of the high duty on a trustee as to when it should use its shareholder rights to intervene in a company (particularly when it benefits from a detailed Bartlett clause). The case suggests that a trustee should find out what the director's decision is first, and then only interfere if the director has not made a reasonable decision. Particularly when they can rely on a Bartlett clause, the Court suggested that it should not intervene in relation to decisions of company directors upon whom the trustees are entitled to rely. Future trustees holding primarily shares in companies, would be well advised to seek the views of company directors prior to seeking directions from the Court, as following this decision, the Court is unlikely to intervene unless the directors propose to take an unreasonable decision.

If you wish to discuss, please contact Gareth Thomas or Richard Norridge of our Private Wealth and Trusts team.