The Trustee, The Creditor, And The Divorce: Setting Aside Transactions Made In Ancillary Relief Proceedings

I𝐍𝐓𝐑𝐎𝐃𝐔𝐂𝐓𝐈𝐎𝐍

1. Covid-19 has posed unprecedented challenges worldwide.  Social isolation, confinement measures, spousal hygiene and money (or lack thereof due to unemployment) have been sources of many soured relationships.  As such, the pandemic’s impact on people’s personal relationships and finances have become inadvertent fuel for divorce and bankruptcy cases.

2. It is no surprise that local law firms are handling an uptick in divorce cases and receiving more enquiries related to divorce.

3. Furthermore, despite the recent cash pay-outs to Hong Kong permanent residents, government guaranteed concessionary low interest rate loans to small and medium enterprises and the establishment of the Anti-epidemic Fund, there were still over 8200 cases of individuals petitioning to bankrupt themselves in 2020.

4. The subsequent fallout from a couple’s divorce invariably includes a determination of ancillary relief and/or the arrangements of children, if any are involved.  The separation may further be complicated if one of the spouses becomes bankrupt.

5. In many cases, the most valuable asset in the bankrupt’s estate is his interest in the matrimonial home, which is most often also the home of the bankrupt’s spouse, as well as the most significant asset in the pool of matrimonial assets.

6. What happens when a spouse is ordered to transfer his/her interest in the matrimonial home to the other spouse pursuant to a court order made under the Matrimonial Proceedings and Property Ordinance (Cap. 192) (“MPPO”), but the transferor is subsequently made bankrupt?  Can the trustees in bankruptcy seek to set aside such a transfer for being undervalued pursuant to section 49 of the Bankruptcy Ordinance (Cap. 6) (“BO”)?

7. The operation of the two statutory schemes of bankruptcy and matrimonial rights creates inevitable tension.  On the one hand, there are social and legal policies underlying the court’s discretion in the matrimonial proceedings for the protection of the bankrupt’s spouse and child.  On the other hand, the BO acts as a statutory scheme to protect a bankrupt’s creditors.  The interplay between these schemes inevitably pit the creditors against the bankrupt’ spouse and child to compete for the bankrupt’s limited assets.

𝐓𝐇𝐄 𝐄𝐍𝐆𝐋𝐈𝐒𝐇 𝐏𝐎𝐒𝐈𝐓𝐈𝐎𝐍

8. In the English Court of Appeal case of Hill v Haines [2007] EWCA Civ 1284, the Court was asked to determine under what circumstances could a transfer of matrimonial assets made in the context of ancillary relief proceedings be set aside by the transferor’s trustee in bankruptcy.

9. In Hill (supra.), the Court had made an order ordering the husband to transfer his beneficial interest in the former matrimonial home to the wife.  A bankruptcy order was subsequently made against the husband on his own petition.  The husband’s trustees in bankruptcy sought to set aside the transfer of the husband’s beneficial interest of the matrimonial home at undervalue pursuant to the Insolvency Act 1986.

10. The appellate Court refused to set aside the transfer as it took the view that a spouse’s statutory right to apply for money or property to be transferred from the respondent spouse to the applicant spouse had value by reference to the value of the money or property being ordered to be transferred.  Whether following contested proceedings or by way of compromise, in the absence of vitiating factors of fraud, mistake or misrepresentation, the value of the applicant’s spouse’s right and the value of the money/property to be transferred balanced each other.

11. The Court was of the view if the ancillary relief order was the product of collusion between the spouses designed to adversely affect the creditors, then the trustee would intervene to set aside such a transaction and the Courts would be prepared to order as such.

12. However, where there was no dishonest collusion and the matrimonial court has approved or determined the sum or property to be transferred, it would be entirely foreign to the concept of a “clean break” if the bankrupt’s creditors could thereafter seek to recover, in bankruptcy, the property transferred or its value.

𝐓𝐇𝐄 𝐏𝐎𝐒𝐈𝐓𝐈𝐎𝐍 𝐈𝐍 𝐇𝐎𝐍𝐆 𝐊𝐎𝐍𝐆

13. Wong Ka Sek and Wong Ka Lam King, the Joint and Several Trustees of the Property of Leung Siu Wai, a Bankrupt v Kwok Sin Man Kat [2020] HKCFI 1502 (“Re Leung Siu Wai”) appears to be only one case in Hong Kong that has directly addressed the legal principles concerning whether or not a trustee in bankruptcy can set aside a transfer of a spouse’s interest in the matrimonial home for undervalue prior to becoming bankrupt.

14. During the couple’s divorce proceedings, a consent order (“the Consent Order”) was made in which the bankrupt husband (“the Bankrupt”) was ordered to transfer all his interest of and in the matrimonial home at nil consideration to his wife (“the Wife”) within 6 months after the Decree Absolute had been granted (“the Transaction”).

15. The joint and several trustees (“the Trustees”) of the Bankrupt sought, inter alia, a declaration from the Court that the Transaction was entered for undervalue pursuant to section 49 of BO.

16. The Trustees mainly relied on circumstantial evidence such as the Bankrupt’s self-petition for bankruptcy soon after the Transaction and that he was aware of the mounting debts he owed to third parties and his obligations under the consent order regarding maintenance to the Wife and his son.  The Court was cognizant that the Trustees adduced limited evidence that directly showed the Bankrupt’s state of mind at the time of the Transaction.  For whatever reason, the Trustees also did not choose to cross-examine the Wife.

17. The Court accepted the principle from Hill v Haines that a property adjustment order could be attacked as a transaction at undervalue where there was a vitiating factor.  However, based on the sum total of the evidence available, the Court took the view that the Bankrupt was quite irresponsible about his affairs and his duty to his family and to others, hence he was “childish and irresponsible” rather than having any premeditated plan to pass his interest in the property to defeat creditors.

18. Furthermore, even though it may have raised some suspicion when the Bankrupt was financially worse off than he was before the Consent Order was made, the Court considered what financial settlement the Wife would have ended up with if the divorce proceedings were fought to the bitter end.

19. On the evidence, the judge could not conclude that the terms of the Consent Order would be much different if the divorce proceedings were fought out, considering that (1) the couple’s child was a student and needed stability in the form of a permanent roof over his head; (2) the Wife had made contributions both in terms of the mortgage payments as well as general contributions in terms of time and money; and (3) she had paid HK$300,000 to bail the Bankrupt out.

20. More importantly, the judge was also of the view that short of dishonest collusion between the spouses, it would be hard to imagine any case where it could be demonstrated that the settlement in favour of a spouse to be worth “significantly less” than what the other spouse agreed to provide for, bearing in mind that it is not a science and that there was bound to be a range of reasonable outcomes in such proceedings, especially due to the fact sensitivity inherent in the exercise under section 7 of the MPPO. Unless it could be shown that the settlement was outside such a generous and wide ambit, the jurisdiction of the Court would not even be triggered under the BO to impeach the transaction.

21. The judge was further of the view that even if statutory requirements of the BO were all met, the Court retained a discretion to not make an order to set aside the suspect transaction because in cases where there was no dishonesty or collusion, it would in many cases be unjust to re-open what spouses had assumed to be foregone litigation, especially if the transaction sought is to be re-opened years after the event.

22. For the above reasons, the judge declined to grant the order sought by the Trustees.

23. Re Leung Siu Wai shows that the Hong Kong Courts are fully prepared to accept the principles as stated in Hill v Haines.  This means a trustee in bankruptcy will find it challenging to set aside ancillary relief settlement entered prior to bankruptcy.  This is especially true when it would be difficult, if not impossible, to obtain sufficient evidence to show collusion between the spouses, especially without documentary evidence.

24. Unfortunately, Re Leung Siu Wai was unable to fully explore the extent and relevance of the knowledge of the non-bankrupt spouse in relation to the assets of the bankrupt before he/she is adjudged bankrupt in a setting aside application.

𝐂𝐎𝐍𝐂𝐋𝐔𝐒𝐈𝐎𝐍

25. In determining whether to set aside a transaction, a prudent trustee may need to carefully review the financial information put forward by each party in the ancillary relief proceedings.  If sufficient facts are found to be untrue or if the non-bankrupt spouse fails to make full and frank disclosure of assets, then these may support a setting aside.

26. However, it appears a trustee only has a very narrow path to a successful setting aside application because either he has to prove there was a vitiating factor relating to the suspect transaction, or attempt to convince a bankruptcy judge that the family judge would not have granted such an ancillary relief order in the first place.

27. Until then, family lawyers may breathe a little easier knowing their work in the matrimonial proceedings will not be easily undone.

Written by : Isaac Yung, Barrister-at-law

* This article first appeared in the November 2021 issue of the Hong Kong Lawyer, the official journal of The Law Society of Hong Kong. (Please click here)

*The article is also available on Lexology.