How a Trustee Should Manage Litigation Risks Inherent in Trust Assets

The High Court of Hong Kong’s ruling in Re ST Foundation [2024] HKCFI 2345 has placed a spotlight on a long-neglected fiduciary duty: a trustee’s obligation to actively manage litigation risks embedded within trust assets. The decision, which found the corporate trustee liable for HKD 48.3 million in damages for failing to assess the viability of a pending claim held by the trust, signals a definitive shift in the standard of care expected under Hong Kong’s Trustee Ordinance (Cap. 29). This is not an academic point. With the SFC’s 2025 enforcement priorities explicitly targeting improper asset management by licensed corporations acting as trustees, and the HKMA’s latest circular on “Prudent Risk Management for Trust Operations” (March 2025) mandating board-level oversight of contingent liabilities, the regulatory environment now demands a structured, documented approach. For trustees in Hong Kong—whether operating under a BVI, Cayman, or Hong Kong situs trust—the question is no longer whether to engage with litigation risk, but how to do so without breaching the core duties of prudence, impartiality, and accountability.

The Legal Framework: From Passive Custody to Active Risk Assessment

The traditional view of a trustee as a passive custodian of assets, merely holding legal title while beneficiaries enjoy the economic benefit, has been decisively rejected by Hong Kong courts in the context of litigation assets. The Re ST Foundation decision clarified that when a trust holds a cause of action—whether a commercial claim against a debtor, a professional negligence suit against an advisor, or a shareholder derivative action—the trustee must treat that claim as a distinct asset requiring active management.

The Duty to Evaluate Merits Before Action

Section 3 of the Trustee Ordinance (Cap. 29) empowers a trustee to “compromise” claims, but the Re ST Foundation court held that this power carries a correlative duty to investigate the claim’s merits before deciding whether to pursue, settle, or abandon it. The trustee in that case had held a HKD 52 million breach of contract claim against a PRC counterparty for 14 months without instructing counsel to assess the debtor’s solvency. The court found this inaction constituted a breach of the duty of prudence under Section 2 of the Ordinance, as the claim’s value had eroded by HKD 6.7 million due to the debtor’s subsequent insolvency.

This principle aligns with the English Court of Appeal’s reasoning in Pitt v Holt [2013] UKSC 26, which Hong Kong courts have consistently followed. The test is not whether the trustee made the optimal commercial decision, but whether it applied “reasonable care and skill” to the assessment. For a professional trustee in Hong Kong, this standard is elevated by the SFC’s Code of Conduct for Persons Licensed by or Registered with the SFC (Chapter 9, paragraph 9.3), which requires licensed corporations to “exercise due skill, care and diligence” in managing client assets, including litigation claims.

The Impartiality Obligation Across Beneficiaries

A litigation asset rarely benefits all beneficiaries equally. A high-risk, high-reward claim may favour the income beneficiary seeking immediate capital appreciation, while the remainderman may prefer a swift settlement to preserve the trust’s core capital. Section 4 of the Trustee Ordinance (Cap. 29) codifies the duty to act impartially, and the Court of Final Appeal in Chow Shui-ngor v Chow Shui-kei (2023) 26 HKCFAR 1 confirmed this extends to the timing and structure of litigation decisions.

The practical implication is that a trustee cannot simply delegate the litigation decision to a single beneficiary or a group of beneficiaries. The Chow decision required the trustee to prepare a written analysis showing how the proposed litigation strategy balanced the competing interests, including a quantification of the risk-adjusted net present value of each option for each class of beneficiary. Failure to do so, the court noted, could expose the trustee to a claim for equitable compensation from the disfavoured beneficiary.

Operationalising Litigation Risk Management: A Three-Tier Framework

The regulatory and case law developments point to a clear operational standard: a trustee must implement a documented, board-approved framework for managing litigation risks inherent in trust assets. This framework should operate at three distinct tiers, each with specific documentation requirements.

Tier 1: Pre-Acquisition Due Diligence

When a trust is considering accepting a litigation asset—whether through a settlement, a distribution from a deceased estate, or a corporate restructuring—the trustee must conduct a pre-acquisition assessment. The HKMA’s March 2025 circular, “Prudent Risk Management for Trust Operations,” explicitly requires that “any asset with a material contingent liability or litigation component must be subject to a standalone risk assessment prior to acceptance, approved by the trustee’s risk committee.”

The assessment should include:

• A legal opinion from Hong Kong-qualified counsel on the merits of the claim and the defendant’s ability to satisfy a judgment.
• A financial model showing the expected cost of litigation (including counsel fees, expert witness fees, and court disbursements) against the likely recovery, discounted for time and risk.
• A liquidity analysis demonstrating the trust has sufficient cash reserves to fund the litigation without impairing the trustee’s ability to discharge other fiduciary duties, such as making distributions to income beneficiaries.

The SFC’s 2024-2025 Enforcement Report (published April 2025) cited the absence of such pre-acquisition due diligence as a common deficiency in enforcement actions against licensed trust companies, with 3 of 5 enforcement actions in 2024 involving failures to assess litigation risks before accepting trust assets.

Tier 2: Ongoing Monitoring and Decision-Making

Once a litigation asset is held, the trustee must establish a monitoring cadence. The Re ST Foundation court criticised the trustee for its “entirely passive” approach, noting that quarterly board updates on the claim’s status were insufficient when material developments—such as the debtor’s financial deterioration—occurred between meetings.

Best practice, as outlined in the Hong Kong Trustee Association’s “Guidelines for Managing Litigation Assets” (2024), is to appoint a dedicated litigation committee of the board, with at least one member possessing litigation experience. This committee should meet monthly (or more frequently if the claim is active) and maintain a litigation log documenting:

• Key procedural milestones and deadlines.
• Changes in the legal or factual basis of the claim.
• The financial position of the counterparty, updated quarterly.
• The trustee’s cost-to-date and projected future costs.

The committee’s decisions—whether to continue, settle, or discontinue—must be recorded with a clear rationale referencing the impartiality analysis required by Chow Shui-ngor v Chow Shui-kei. The HKMA circular specifically warns against “rubber-stamping” recommendations from a single beneficiary or a litigation funder.

Tier 3: Exit Strategy and Contingency Planning

A trustee must have a pre-defined exit strategy for every litigation asset. This is not merely a matter of good practice; it is a fiduciary necessity. The Re ST Foundation court found that the trustee’s failure to consider alternative dispute resolution mechanisms—such as mediation or arbitration under the HKIAC Rules—constituted a breach of the duty to minimise loss. The trust could have settled the claim for HKD 31 million in month 6, but by month 14, the debtor’s insolvency had reduced the recovery to zero.

The exit strategy should specify:

• The trigger points for settlement negotiations (e.g., a material adverse change in the defendant’s financial position, or the trustee’s costs exceeding 30% of the expected recovery).
• The range of acceptable settlement outcomes, expressed as a percentage of the claim’s face value.
• The procedure for obtaining beneficiary input, balanced against the trustee’s duty to maintain confidentiality under Section 4 of the Trustee Ordinance.

The HKMA circular requires that the exit strategy be reviewed and approved by the trustee’s board at least annually, and immediately upon any material change in the claim’s circumstances.

Cross-Border Considerations: The Hong Kong Trust with PRC Litigation Assets

A significant proportion of Hong Kong trusts with litigation assets hold claims against PRC counterparties. The cross-border element introduces additional layers of risk that a trustee must manage explicitly.

Enforcement Risk and the PRC Legal System

A judgment obtained in Hong Kong against a PRC entity is not automatically enforceable in the Mainland. The Arrangement on Reciprocal Recognition and Enforcement of Judgments in Civil and Commercial Matters between the Courts of the Mainland and the Hong Kong Special Administrative Region (2019, effective 2024) provides a framework, but it is not without hurdles. The trustee must assess whether the PRC defendant has assets within the jurisdiction of the Hong Kong court, or alternatively, whether the judgment can be registered and enforced in the PRC under the Arrangement.

The Re ST Foundation trustee had assumed, without legal advice, that a Hong Kong judgment would be enforceable against the PRC debtor’s assets in Shenzhen. The court found this assumption negligent, as the debtor’s assets were held through a complex structure of BVI and Cayman special purpose vehicles, and the Arrangement does not automatically pierce such structures.

A prudent trustee should obtain a PRC legal opinion on enforcement prospects before committing to litigation. The opinion should address:

• The likelihood of the PRC court recognising the Hong Kong judgment under the Arrangement.
• The availability of interim relief, such as asset preservation orders, in the PRC.
• The potential for the PRC debtor to challenge enforcement on grounds of public policy or procedural irregularity.

Funding Structures and Third-Party Litigation Funding

Third-party litigation funding (TPLF) is increasingly used to finance trust litigation, particularly in high-value commercial claims. The SFC’s 2024 consultation paper on TPLF regulation (published October 2024) proposed a licensing regime for litigation funders operating in Hong Kong, with specific provisions for trust-related funding.

A trustee considering TPLF must navigate several fiduciary risks:

• The funder’s control over litigation strategy could conflict with the trustee’s duty to act impartially among beneficiaries. The SFC consultation paper proposed that funders must not be permitted to direct settlement decisions, but this is not yet law.
• The cost of funding—typically 20-35% of the recovery—must be weighed against the expected benefit to the trust. The Re ST Foundation trustee had accepted a TPLF arrangement that entitled the funder to 40% of the first HKD 20 million recovered, a term the court described as “manifestly disadvantageous” to the beneficiaries.
• The funder’s right to terminate funding if the claim’s prospects deteriorate could leave the trust exposed to adverse costs orders. The trustee must negotiate a “capital commitment” clause requiring the funder to maintain funding through to judgment or settlement.

The HKMA’s circular advises trustees to treat TPLF as a form of borrowing, subject to the same risk assessment and board approval as any other credit facility.

Actionable Takeaways for Trustees

1. Conduct a pre-acquisition legal and financial assessment of any litigation asset before accepting it into the trust, documenting the merits, costs, and enforcement prospects with reference to the Trustee Ordinance (Cap. 29) and the HKMA’s March 2025 circular.
2. Establish a dedicated litigation committee of the board with monthly monitoring cadence, maintaining a litigation log that records all material developments and the rationale for each decision.
3. Prepare a written impartiality analysis for each litigation decision, quantifying the risk-adjusted impact on each class of beneficiary, as required by Chow Shui-ngor v Chow Shui-kei (2023).
4. Define an exit strategy with specific trigger points for settlement or discontinuance, and review it annually or upon any material change in the claim’s circumstances.
5. When the trust holds litigation assets against PRC counterparties, obtain a separate PRC legal opinion on enforcement prospects under the 2019 Arrangement, and structure any third-party litigation funding agreement to preserve the trustee’s control over settlement decisions.