Recent legal developments in Mainland China and Hong Kong have introduced new challenges to Mainland Chinese high-net-worth individuals (HNWIs) in protecting their assets from creditors' claims.

This Legal Update aims to provide an overview of these changes from an asset protection perspective and their potential impact on HNWIs, along with a brief introduction on using life insurance products and discretionary trust structures as effective asset protection strategies.

New Company Law of the People's Republic of China (PRC)

PRC’s new Company Law, which took effect from 1 July 2024, introduces and expands some areas of personal liability for directors, supervisors and senior managers (Senior Company Officers), shareholders and de facto controllers of PRC companies. These persons may face legal consequences if they violate the rules on capital contributions, profit distribution, capital reduction, financial aids, liquidation, debt evasion, etc., particularly when and where they act with intention, wilfulness or gross negligence:

• Senior Company Officers have a general duty of care and diligence, and to act in the best interests of the PRC company. If they cause harm to other parties while discharging their duties, though the PRC company itself will assume vicarious liabilities, the Senior Company Officers themselves may also have to bear personal liabilities by paying compensation if they act with intention, wilfulness or gross negligence.
• Senior Company Officers also have to check the capital contribution of shareholders and keep in check any unlawful withdrawal, reduction of capital, distribution of profits or implementation of financial aids that may harm the PRC company. If the Senior Company Officers fail to do so, or are involved in, connived with or acquiesce to the unlawful conduct or abuse of power by a shareholder or others, they may be liable to pay compensation to the PRC company as well.
• If the PRC company is to be liquidated, the directors are in charge of the liquidation process and may be held liable for neglect or dereliction of their duties and causing loss to the PRC company or its creditors.
• Controlling shareholders and de facto controllers, despite not being directors themselves, may also be considered as de facto or shadow directors who shall assume and discharge directors’ duties accordingly, including but not limited to acting with loyalty and diligence towards the PRC company, and refraining from damaging its interests. Such controlling shareholders and de facto controllers may be held jointly liable with the Senior Company Officers if the latter commit any wrongdoing and cause harm to the PRC company or its shareholder under their instruction or direction.

NEW HONG KONG-MAINLAND CHINA RECIPROCAL ENFORCEMENT OF JUDGMENTS REGIME

Under the new Mainland Judgments in Civil and Commercial Matters (Reciprocal Enforcement) Ordinance (Cap. 645) which came into force on 29 January 2024, the scope of Mainland China judgments enforceable in Hong Kong has been broadened. The following are three of the key changes:

• Expanded scope of judgments – The new regime (subject to a list of exclusions) covers both monetary and non-monetary judgments that are civil and commercial in nature, and also extends to orders for compensation and damages arising from criminal proceedings. This includes also orders made with respect to the offences under the newly amended PRC Criminal Law (which took effect from 1 March 2024) that are applicable to Senior Company Officers, employees of state-owned enterprises and their counterparts in the private sector.
• Broader range of courts – Insofar as the first-instance judgments made by the Primary People’s Courts are concerned, a legally effective judgment of the first instance from literally all Primary People's Courts may now be enforceable in Hong Kong.
• Removal of the exclusive jurisdiction requirement – Under the old regime, the Mainland China judgment creditor had to show that the parties had agreed, in their underlying contract, to submit to the exclusive jurisdiction of the courts in Mainland China. Under the new regime, Mainland China judgment creditors can satisfy the jurisdiction requirement simply by showing the Hong Kong court how the original PRC court proceedings had sufficient connection with Mainland China.

Unsatisfied Mainland China judgment creditors can make a registration application to the Hong Kong courts. Once accepted, the registered judgment can be enforced as if it were a Hong Kong court judgment, with various enforcement remedies, e.g., an asset freezing order (Mareva injunction) to prevent asset dissipation, a charging order against securities or landed properties, a garnishee order against bank balances, etc.

ASSET PROTECTION ALTERNATIVES

CASH AND NON-CASH ASSETS: DISCRETIONARY TRUSTS

Discretionary trusts could potentially be used to shield cash and non-cash assets (e.g., real estate properties, company shares, etc.) from creditors’ claims, as compared against holding assets by the relevant HNWI personally.

What are discretionary trusts? Under a discretionary trust:

• the trustee, after taking into account all relevant circumstances, has the discretion to decide on the distribution of the trust fund and such discretion shall be exercised in accordance with the terms of the trust deed and in the best interests of the beneficiaries. While the trustee is entitled to take into account the settlor’s wishes and the beneficiaries’ wishes, such wishes are not binding on the trustee; and
• a beneficiary has no vested interest in the trust assets until the trustee has determined to make a distribution to the beneficiary.

Key features of a discretionary trust designed for asset protection purposes include:

• it shall be irrevocable;
• the HNWI cannot be a beneficiary of the trust;
• the HNWI shall not retain any control or influence over the trust; and
• when the HNWI transfers assets into the trust:
  1. he does not have any intent to defraud creditors; and
  2. he should be solvent and have sufficient assets outside the trust structure to pay his foreseeable debts.

Important considerations for HNWIs to take into account when setting up a discretionary trust include:

• HNWI has to give up control over his assets – The trustee, not the HNWI, shall have the power to control the management and distribution of the trust assets.
• Tax and reporting implications – HNWIs should consider the tax and reporting implications on the transfer of assets into the trust and in the event of distribution to beneficiaries, in particular when the beneficiaries reside in high tax jurisdictions.
• Succession planning objectives – While a discretionary trust offers more flexibility in adjusting the distribution, the trustee may deviate from the HNWI’s wishes as set out in a letter of wishes. In contrast, by making a will, an HNWI can decide how to divide his estate among his heirs, which is binding on the executor.
• Choice of trustee – If an HNWI appoints close family members or close friends as trustees, they may be considered to be under the influence and control of the HNWI. The HNWI may wish to consider the appointment of a professional and independent trustee instead.
• Setting up and maintenance costs – The trustee’s fees, legal fees, and other costs in setting up the trust, transferring assets into the trust and maintaining the trust should be considered.

CASH ASSETS: INSURANCE

Life insurance policies are important tools for asset protection and wealth and legacy planning. HNWIs can also use discretionary trusts to purchase life insurance, which means the trust pays and owns the life insurance and is protected from creditors during the HNWI’s lifetime.

Insurance proceeds are not subject to probate process and are protected from creditors, which means upon the death of the life insured, the death benefit can be paid immediately to the HNWI’s designated beneficiaries.

Life insurance products can be used as financial assets as they can also provide savings and investment in addition to insurance protection.

The life insurance policy can also be used as security to obtain loans for financing the premium to buy the policy.

CONCLUSION

PRC’s new Company Law has expanded the scope of potential liability for Senior Management Officers, shareholders and ultimate controllers of PRC companies. Coupled with the new regime on Hong Kong-Mainland China reciprocal enforcement of judgments in civil and commercial matters, it may be an opportune time to critically consider asset protection solutions.

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