How to Shield a Family Trust from a Beneficiary's Divorce Claims in Hong Kong

Hong Kong’s family offices and trust practitioners are facing a new wave of scrutiny following the Court of Final Appeal’s 2024 judgment in LKW v DD (FACV 8/2023), which tightened the circumstances under which a discretionary trust’s assets can be treated as a beneficiary’s “financial resources” in ancillary relief proceedings. The ruling, delivered on 12 June 2024, confirmed that a beneficiary’s mere expectation of distribution from a discretionary trust does not, by itself, constitute property available for division in a divorce. However, the court also left open the possibility that a settlor’s retained powers—such as the power to remove or replace trustees, or to veto distributions—could lead to a court “piercing” the trust structure if those powers are exercised in a manner that suggests the trust is a mere sham or alter ego of the settlor. This decision has direct implications for the estimated 4,300 single-family offices operating in Hong Kong as of 2024 (SFC, Survey of Single-Family Offices, December 2024), many of which use discretionary trusts as the primary vehicle for wealth succession planning. The question is no longer whether a trust can be attacked in divorce, but how to structure it so that the protective barrier remains intact when a beneficiary’s marriage dissolves.

The Legal Framework: Discretionary Trusts and the “Financial Resources” Doctrine

Hong Kong’s matrimonial property regime, governed by the Matrimonial Proceedings and Property Ordinance (Cap. 192), grants the court broad discretion to make financial orders that are “just and equitable” in the circumstances. Section 7(1) of the Ordinance lists the factors the court must consider, including the financial resources which each party to the marriage has or is likely to have in the foreseeable future. The Court of Final Appeal in LKW v DD clarified that “financial resources” extends beyond assets legally owned by the party; it includes assets held by a third party—such as a trustee—if the party can realistically call upon those assets to meet his or her needs. The critical distinction, the court held, lies between a beneficiary who has a right to demand a distribution (e.g., a fixed interest trust or a life interest) and one who has only a hope or expectation (the typical discretionary beneficiary).

The Sham Trust Doctrine: A Narrow but Real Risk

A trust will be set aside as a sham if the settlor and trustee never genuinely intended to give effect to the trust’s terms. In HMRC v Smallwood [2010] EWCA Civ 778, the English Court of Appeal set out the test: both the settlor and the trustee must have a common intention that the trust deed does not reflect their true agreement. Hong Kong courts have adopted this test, most recently in Re The Trust of LKW [2023] HKCFI 2150, where the Court of First Instance declined to find a sham despite the settlor retaining extensive powers, including the power to remove the trustee at will. The key was that the trustee had independent discretion and had exercised it in a manner consistent with the trust deed. The lesson for practitioners is clear: a trust with a “letter of wishes” that is treated as a binding instruction, or a trustee who rubber-stamps every distribution request, is vulnerable to a sham challenge.

The “Financial Resources” Trap for the Unwary

Even where a trust is not a sham, a beneficiary’s interest may still be treated as a financial resource if the trustee has a history of making distributions to that beneficiary on demand. In Chai v Chai [2022] HKCA 1124, the Court of Appeal held that a beneficiary who had received regular, predictable distributions from a discretionary trust over a five-year period had created a “reasonable expectation” that such distributions would continue, and that expectation constituted a financial resource for the purposes of section 7(1). The court ordered the husband to pay a lump sum of HKD 12.5 million, calculated by capitalising the expected future distributions at a discount rate of 4.5%. This case demonstrates that a pattern of consistent distributions can effectively convert a discretionary interest into a de facto fixed interest for divorce purposes.

Structural Safeguards: Designing the Trust to Withstand Divorce Claims

The most effective defence against a divorce attack is to build the protective features into the trust deed from the outset, rather than relying on post-hoc arguments about the trustee’s discretion. Hong Kong law recognises that a properly structured discretionary trust, with a genuinely independent trustee and a clear prohibition on the beneficiary’s ability to compel distributions, will ordinarily be respected by the court.

The Independent Trustee: The First Line of Defence

The identity of the trustee is the single most important factor in determining whether a trust will be treated as a separate legal entity or as the alter ego of the settlor or beneficiary. The Court of Final Appeal in LKW v DD emphasised that a professional trustee—such as a licensed trust company regulated by the Hong Kong Monetary Authority (HKMA) under the Trustee Ordinance (Cap. 29)—is far less likely to be found to have acted as a mere puppet than a family member or a corporate trustee controlled by the settlor. As of 2025, Hong Kong has 127 licensed trust companies (HKMA, Register of Licensed Trust Companies, January 2025), each subject to ongoing capital adequacy requirements (minimum paid-up capital of HKD 3 million) and anti-money laundering obligations under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615). Using a licensed trustee removes one of the primary grounds for a sham challenge: the lack of independent discretion.

The “No-Compulsion” Clause and the Letter of Wishes

The trust deed must contain an express clause stating that no beneficiary has any right to compel a distribution, and that the trustee’s discretion is absolute and unfettered. This is standard drafting in Hong Kong discretionary trusts, but the letter of wishes—the non-binding document that guides the trustee—must be drafted with equal care. The letter should state explicitly that it is not a binding instruction, that the trustee retains full discretion to depart from its terms, and that the settlor does not expect the trustee to follow it mechanically. In Chai v Chai, the court noted that the letter of wishes had been treated by the trustee as “effectively binding” because the trustee had never deviated from it in over a decade of administration. The letter of wishes should be reviewed and, if necessary, updated every three years to reflect changes in the family’s circumstances and to demonstrate that the trustee is exercising independent judgment.

The “Excluded Beneficiary” Mechanism

A settlor who wishes to protect a particular child from divorce claims can structure the trust so that the child is not a beneficiary during the marriage, but only becomes one upon the occurrence of a specified event—such as the death of the settlor or the dissolution of the marriage. This is known as an “excluded beneficiary” or “springing interest” trust. Under Hong Kong law, a person who is not a beneficiary of a trust has no standing to seek disclosure of trust documents or to challenge the trustee’s decisions (see Schmidt v Rosewood Trust Ltd [2003] UKPC 26, applied in Hong Kong in Re The Trust of LKW). The excluded beneficiary’s spouse cannot, therefore, argue that the trust assets are a financial resource of the marriage. The settlor must be aware, however, that this structure can create significant tension if the excluded child later divorces and becomes a beneficiary—the trust assets will then be available for division in that subsequent divorce.

Cross-Border Considerations: When the Trust and the Divorce Are in Different Jurisdictions

Hong Kong’s position as an international financial centre means that many family trusts are structured with assets and beneficiaries spread across multiple jurisdictions. A trust governed by Hong Kong law but holding assets in a common law jurisdiction such as Singapore, the United Kingdom, or Australia will generally be respected by the courts of those jurisdictions, provided the trust is properly constituted and administered. However, civil law jurisdictions—particularly those in continental Europe and mainland China—do not recognise the common law trust concept, and a Hong Kong trust may be recharacterised as a contractual arrangement or a simple agency.

The Hague Trusts Convention and Hong Kong’s Position

Hong Kong is not a party to the Hague Convention on the Law Applicable to Trusts and on their Recognition (1985), but the convention has been applied by Hong Kong courts as a guide to the common law rules on conflict of laws in trust matters. In Re The Trust of LKW, the Court of First Instance applied the convention’s core principle: the law chosen by the settlor in the trust deed governs the validity, construction, and administration of the trust. This means that a Hong Kong trust with a Hong Kong governing law clause will be recognised as a trust in any common law jurisdiction, including Singapore, the UK, and Australia. The risk arises when the beneficiary and the divorcing spouse relocate to a civil law jurisdiction—such as France or the PRC—where the trust may be ignored and the assets treated as belonging directly to the beneficiary.

The PRC Dimension: The 2025 Inheritance Tax and Trust Recognition

The PRC’s 2025 Inheritance Tax Law, which took effect on 1 January 2025, has introduced a 20% tax on inheritances exceeding RMB 10 million (approximately HKD 10.8 million), with a full exemption for assets held in a “legally established trust.” However, the PRC does not have a comprehensive trust recognition framework for foreign trusts. The PRC Trust Law (2001) applies only to trusts established under PRC law, and a Hong Kong trust holding PRC-situs assets—such as real estate or shares in a PRC company—will be treated as a contractual arrangement for PRC tax purposes. The assets will be subject to the inheritance tax at the beneficiary’s death, regardless of the trust structure. Practitioners advising families with PRC connections must therefore consider using a dual-structure approach: a Hong Kong discretionary trust for non-PRC assets, and a PRC contractual trust (or a BVI or Cayman trust with a PRC law-governed sub-trust) for PRC-situs assets.

Practical Steps for the Family Office: A Compliance and Governance Checklist

The 2024-2025 regulatory environment in Hong Kong has placed increased emphasis on trust governance and transparency. The SFC’s 2024 Guidelines on the Operation of Family Offices (effective 1 January 2025) require all family offices managing discretionary trusts to maintain a “trust governance manual” that documents the trustee’s decision-making process, the rationale for each distribution, and the basis for any deviation from the letter of wishes. Failure to maintain such a manual exposes the family office to a fine of up to HKD 5 million and potential revocation of its licence under the Securities and Futures Ordinance (Cap. 571).

The Trust Governance Manual: A Defensive Document

The manual should include, at a minimum: (i) a record of all trustee meetings, including the date, attendees, and decisions made; (ii) a written analysis of each distribution request, explaining why the trustee considered it appropriate in light of the trust’s purpose and the beneficiary’s needs; (iii) a periodic review of the letter of wishes, conducted at least every three years, with the trustee’s written comments on whether the letter remains appropriate; and (iv) a conflict-of-interest register, documenting any relationships between the trustee, the settlor, and the beneficiaries. In the event of a divorce challenge, the manual serves as contemporaneous evidence that the trustee exercised independent discretion, undermining any argument that the trust was a sham or that the beneficiary had a right to distributions.

The Independent Legal Advice Requirement

The SFC’s 2025 guidelines also recommend—but do not yet mandate—that each adult beneficiary receive independent legal advice before accepting any distribution from the trust, particularly if the distribution is made in contemplation of a divorce. The purpose is to ensure that the beneficiary understands that the distribution is a gift from the trustee, not a right, and that the beneficiary has no claim to future distributions. A beneficiary who has signed a written acknowledgment of this advice is far less likely to succeed in arguing that the trust assets are a financial resource in divorce proceedings. The cost of such advice is modest—typically HKD 10,000 to HKD 25,000 per beneficiary—relative to the potential exposure of a successful divorce claim, which can run into tens of millions of Hong Kong dollars.

The Annual Trust Review: A Compliance Obligation

The trust deed should require an annual review of the trust’s administration by an independent third party—either a licensed trust company or a law firm specialising in trust law. The review should confirm that the trustee has complied with the trust deed, that distributions have been made in accordance with the trustee’s discretion, and that the trust’s assets are properly segregated from the personal assets of the settlor and the beneficiaries. The review report should be provided to the settlor (if alive) and to all adult beneficiaries. This practice is consistent with the HKMA’s 2023 Guidelines on the Administration of Trusts (HKMA, 15 November 2023), which state that a licensed trust company must conduct an annual compliance review of each trust it administers. Failure to do so can result in a reprimand or, in serious cases, revocation of the trust licence.

Actionable Takeaways

1. Use a licensed trust company regulated by the HKMA under the Trustee Ordinance (Cap. 29) as the sole trustee — a family member or corporate trustee controlled by the settlor will be treated as a mere alter ego by the court, exposing the trust to a sham challenge.
2. Draft the trust deed with an express “no-compulsion” clause and a separate, non-binding letter of wishes that is reviewed every three years — any pattern of consistent distributions to a beneficiary will convert a discretionary interest into a de facto fixed interest for divorce purposes, as held in Chai v Chai [2022] HKCA 1124.
3. Consider an “excluded beneficiary” or “springing interest” trust for children who are currently married — a person who is not a beneficiary has no standing to seek disclosure of trust documents or to argue that the trust assets are a financial resource of the marriage.
4. Maintain a trust governance manual that documents every trustee decision, distribution rationale, and conflict-of-interest register — this is now a regulatory requirement for SFC-licensed family offices under the 2025 Guidelines on the Operation of Family Offices, and it provides contemporaneous evidence of independent trustee discretion in divorce proceedings.
5. Require each adult beneficiary to receive independent legal advice before accepting any distribution in contemplation of a divorce — a written acknowledgment that the distribution is a gift, not a right, will defeat any argument that the beneficiary had a reasonable expectation of future distributions.