The recent Hong Kong District Court case of Thomson v Jeans and Anor and Boewe v Jeans & Anor [2014] HKEC 1560 provides both a useful analysis and summary of the fundamental principles in determining whether a ‘Quistclose’ trust arises in common law in relation to payment of moneys from one party to another, and highlights the potential commercial pitfalls for the payer.

Background

In this case the Plaintiffs sued the defendants Mr Jeans (“D1“) and the firm of solicitors acting for him (“D2“) in separate proceedings (later consolidated) for the return of money they had agreed with D1 to invest in a company called Wanchai Bierkeller Ltd (“Company“), which was paid to D2 on the instructions of D1. The Plaintiffs claimed that they paid the money for the sole purpose of acquiring shares in the Company and that it was impliedly agreed and accepted by D2 that the money would be held by D2 until execution of the finalized shareholders agreement and issue of the shares, alternatively that D2 was a constructive trustee of the money until that occurred.

Unfortunately, no shares in the Company were issued to the Plaintiffs, D1 and the Company immediately used the moneys paid to D2, and the Company was subsequently put into liquidation.

The Plaintiffs sought, among other relief, a declaration that D2 was liable as a constructive trustee on the basis that D2 has breached its duties as constructive trustee and was therefore liable to account to the Plaintiffs as constructive beneficiaries.  D2 denied this claim and the relief sought. As such, the central issue in dispute between the Plaintiffs and D2 was:

  1. Whether the moneys paid to D2 by the Plaintiffs were immediately at the free disposal of D1 and / or the Company; and, if not,
  2. Whether D2 is then liable for releasing the moneys to D1 and / or the Company.

The applicable principles

Before the Court could consider whether a breach of trust had occurred, it had to first determine whether a trust had actually been constituted and, if so, what the terms of the trust were. The trust claimed by the Plaintiffs as having been breached was one known as a ‘Quistclose’ trust, in applying Barclays Bank Ltd v Quistclose Investments Ltd [1970].

In the present case, the Court considered and applied the applicable principles on Quistclose trusts that were summarized in the recent case of Bieber v Teathers Ltd [2013] 1 BCLC 248, which itself applied the House of Lords decision in Twinsectra Ltd v Yardley [2002] 1 AC 164, namely that:

  1. The question in every case is whether the payer and the recipient intended that the money passing between them was to be at the free disposal of the recipient;
  2. The mere fact that the payer had paid the money to the recipient for the recipient to use it in a particular way is not of itself enough;
  3. It must be clear from the express terms of the transaction (properly construed), or must be objectively ascertained from the circumstances of the transaction that the mutual intention of the payer and the recipient (and the essence of their bargain), is that the funds transferred should not be part of the general assets of the recipient but should be used exclusively to effect particular identified payments, so that if the money cannot be so used then it is to be returned to the payer;
  4. The mechanism by which this is achieved is a trust giving rise to fiduciary obligations on the part of the recipient which a court of equity will enforce;
  5. It is a resulting trust in favour of the payer with a mandate granted to the recipient to apply the money paid for the purpose stated. The key feature of the arrangement is that the recipient is precluded from misapplying the money paid to him.  The recipient has no beneficial interest in the money: generally the beneficial interest remains vested in the payer subject only to the recipient’s power to apply the money in accordance with the stated purpose.  If the stated purpose cannot be achieved, then the mandate ceases to be effective, the recipient simply holds the money paid on resulting trust for the payer, and the recipient must repay it;
  6. The subjective intentions of payer and recipient as to the creation of a trust are irrelevant. It is sufficient that they intend to enter into the relevant arrangement; and
  7. The particular purpose must be specified in terms which enable a court to say whether a given application of the money does or does not fall within its terms.

Court findings

In applying these principles, the Court had to determine the following issues:

  1. Whether the moneys paid by both of the Plaintiffs into D2’s client account were subject to Quistclose trusts;
  2. If so, the role of D2 in the Quistclose trusts; and
  3. Whether D2 had incurred liabilities to the Plaintiffs for paying out the Plaintiffs’ moneys in accordance instructions from D1 and/or the Company.

In considering these issues, the Court held on the facts of this case that:

  1. The payment of moneys to D2 for the specific purpose of investing in the Company was insufficient to create a Quistclose There had to be objective circumstances showing mutual intention to do so, but the factual evidence showed otherwise;
  2. lthough Quistclose trusts were created between the Plaintiffs and D1 / the Company in favour of the Plaintiffs, D2 only received the moneys as agent of D1 / the Company without knowledge or notice of the aforesaid Quistclose trust when it paid the moneys to D1 / the Company. D2 merely provided company secretarial services, which did not suggest the moneys paid into the solicitor firm’s client account would automatically form a trust created in favour of the non-client payers;
  3. Therefore, D2 was not liable to the Plaintiffs for breach of trust and this claim was dismissed; and
  4. Even if the D2 was a trustee, D2 would then be entitled to relief under section 60 of the Trustee Ordinance (Cap 29) as D2’s breach of trust would have involved an honest and reasonable mistake by D2 that the moneys paid to it were immediately at the free disposal of D1 / the Company.

Commentary

As the Court found in the Twinsectra case, a Quistclose trust does not necessarily arise merely because money is paid for a specific purpose.  In the present case, the Court found that mere payment of the Plaintiffs’ moneys to D2 for the specific purpose of investing in the Company, without more, was insufficient to create a trust.

The essence of a Quistclose trust is that money is paid over and pursuant to a mutual intention that the money was for a specific purpose. The parties have to have the intention of restricting the use of the money until the specific purpose is satisfied, such that the beneficial interest in the money remains in the payer until then. The retention of this beneficial interest gives rise to the trust, without which any application of moneys not in accordance with a contractual agreement will only give rise to a breach of contract claim.

The existence of Quistclose trusts in a commercial context often presents difficulties because whether such mutual intention exists is ascertained from the objective circumstances of each case; the subjective intentions of the parties to form a trust are irrelevant.  As the Court found in this case, “If the properly construed terms upon which, or the objectively ascertained circumstances in which, payer and recipient enter into an arrangement have the effect of creating a trust, then it is not necessary that either payer or recipient should intend to create a trust.”  It is sufficient that the parties intended to enter into arrangements which have the effect of creating a trust.

Practically speaking, this case is a useful reminder that payers of moneys to be held by the recipient for a specific purpose should ensure that both parties carefully document what their mutual intentions are in relation to such payment, in particular to ensure the agreement of the parties that the payer retains the benefit of the payment pending the specific purpose being satisfied.  Otherwise, the payer incurs the risk of being left out of pocket.