In Xu Qiangli v Elabs Company Limited [2024] HKDC 1230, the Court examined the limits to the constructive trust frequently asserted in fraud cases, and struck out the Plaintiffs’ plea of constructive trust on the basis that it disclosed no reasonable cause of action. The decision illustrates the limits to this species of constructive trust, and provides insight into what considerations practitioners should have regard to in properly formulating such a claim.
The essential facts in Xu appear to be straightforward. The Plaintiffs and the Defendant had no direct dealings with each other, and were apparently set up against each other by someone appearing to be a fraudster, leading to a payment being made from the Plaintiffs to the Defendant believing that the payment was for the delivery of a car.
The Defendant’s case is that it was a cryptocurrency trader. Believing that the money paid was for the purchase of cryptocurrency by the fraudster (posing as the controller of the 2nd Plaintiff), the Defendant released the equivalent market value of cryptocurrency to the fraudster, who was nowhere to be found thereafter.
When the case proceeded to trial, the only claim pleaded by the Plaintiffs was a claim for constructive trust based on a fraud perpetuated against the Plaintiffs. For the purposes of the striking out application, the Court examined the Plaintiffs’ pleaded case together with the last minute amendments proposed by the Plaintiffs.
Noting that the Plaintiffs maintain (by their proposed amendments) a case of dishonesty and fraud directly against the Defendant, the Court referred to the well-established principle that the facts pleaded in the Statement of Claim must be sufficient for the inference of fraud. Since the factual averments were consistent with honesty, the Court held that the pleas of fraud/dishonesty should be stuck out.
The Court also considered the question of whether a constructive trust can arise over proceeds directly received by a party from a victim of fraud when the recipient is not otherwise implicated in the fraud. This possibility was somewhat suggested in Guaranty Bank and Trust Company v Zzzik Inc Ltd (Unrep., HCA 1139/2016, 18 July 2016), a well-known case where DHCJ Cooney SC applied Lord Browne Wilkinson’s dicta in Westdeutsche Landesbank Girozentrale v Islington London Borough Council [1996] AC 669 that a fraudulent recipient (such as a thief) would hold proceeds of fraud on constructive trust for the victim on grounds of unconscionability (sometimes called the “fraud trust”).
Insofar as the recipient was implicated in the fraud, the dicta has now been applied and assumed to be good law in Hong Kong, a view also shared by the Court of Appeal in R Stahl Inc v AJ Development Ltd [2021] HKCA 1093. However, since the allegations of fraud have been struck out, this line of authority does not assist the Plaintiffs.
In holding that a non-fraudulent recipient will not be subject to the constructive trust, the Court’s decision followed a recent line of authorities, namely Zief Incorporated v Tekchandani Ajai Mohan [2021] HKCFI 38, JSP International SRO v Alacrity Limited & Ors [2022] HKCFI 977 and RPB SA v Xinwangyi Trade Ltd [2022] HKCFI 2541.
These authorities brought clarity to the limits of the “fraud trust”. In Guaranty Bank, DHCJ Cooney SC suggested that the unconscionability justifying imposition of the constructive trust can arise not at the time of receipt, but subsequently while the money is in the recipient’s hand (at [32]-[33]). This tends to suggest that a recipient who was not implicated in the fraud may also be subject to a constructive trust when he or she was informed of it while still retaining the sum or its traceable proceeds. The dicta was not essential to the decision of Guaranty Bank, where it was clear that the fraudster must have controlled the immediate recipient. It appears that this aspect of Guaranty Bank no longer represents the law of Hong Kong.
Another pragmatic but important consideration is that if the recipient is not a relevant wrongdoer, the rules of tracing will be the usual “first-in-first-out” principles rather than the presumptive rules available against the wrongdoer. This in practice means that it is unlikely that the victim of fraud can identify any traceable proceeds representing his payment for a constructive trust to bite, especially if there has been a long passage of time between the receipt and the plaintiff’s claim.
The case serves as a reminder that where there is no credible evidence that a recipient is implicated in a fraud practiced upon the intended claimant, the usual claim for “fraud trust” may not be viable. Further considerations, such as the likely application of the relevant tracing rules, may further militate the utility of such claim. A simpler personal claim may well be the better avenue for recovery.
The full judgment is available at https://legalref.judiciary.hk/lrs/common/ju/ju_frame.jsp?DIS=161772&currpage=T
Mr Brian Fan, instructed by TITUS, for the defendant.
