Abstract Mezhprom v Pugachev is an important ‘trust-busting’ decision of the English Chancery Division (Birss J). The Judge held that the true effect of five detailed trust deeds was to create a series of bare trusts for the settlor, though he would (if necessary) also have concluded that the trusts were shams. The decision makes it easier for discretionary trusts settled for asset preservation purposes to be unwound where the settlor retains substantial control over the trust assets; it will, therefore, be welcomed by those acting for claimants in civil fraud actions. Background facts The case has colourful background facts. Mr Pugachev is a former Russian senator and close associate of President Putin. He is also the former owner and controller of Mezhprom Bank (the ‘Bank’), which entered into insolvent liquidation in late 2010 with liabilities exceeding US$1 billion (much of which is owed to the Russian Central Bank). Mr Pugachev fled Russia when a criminal investigation was opened against him in connection with the Bank’s demise in early 2011. In late 2011 and mid- and late 2013, Mr Pugachev established five New Zealand law discretionary trusts (the ‘Trusts’). They predominantly held real estate in London, St Barths, Russia, Switzerland, and Massachusetts. The St Barths property, a stunning seafront villa, was the jewel in the crown—valued at approximately US$40 million and available for rent for as much as US$250,000 a week. At about the same time as the final two trusts were established, civil proceedings were started against Mr Pugachev in Russia seeking to hold him liable for the Bank’s insolvency. The trustees of the Trusts (the ‘Trustees’) were freshly incorporated New Zealand companies. Their directors included certain individuals loyal to Mr Pugachev working from his family office in London and Mr William Patterson, an experienced New Zealand solicitor. The Trusts were purported discretionary trusts, whose beneficiaries included Mr Pugachev and three infant children of Mr Pugachev’s relationship with Ms Alexandra Tolstoy (the broadcaster and granddaughter of Leo Tolstoy). Mr Pugachev was the Trusts’ first protector, having wide negative consent powers and the power to remove trustees ‘with or without cause’, to appoint new trustees, and to vest the trust property in his chosen replacements pursuant to a power of attorney contained in the trust deeds. In mid-2014, the Bank and its liquidator started proceedings against Mr Pugachev in London, where he was living in one of the trust properties.1 A worldwide freezing order was granted and Mr Pugachev’s subsequent disclosure of assets in purported compliance therewith was heavily criticized by the courts. This led to a hearing before the Court of Appeal in early 2015 in which it held that a discretionary beneficiary of a trust subject to a freezing order could be required to disclose detailed information about the trust’s assets:  1 WLR 160 (Arden, Lewison, Christopher Clarke LJJ). This was an important decision in its own right: the disclosure was ordered even though the Bank could not at that stage establish a good arguable case, that it would be able to enforce against the Trusts’ assets. The case returned to the Court of Appeal in August 2015, when the Claimants sought a freezing order against the new and replacement Trustees. The injunction was granted pursuant to the Court’s Chabra jurisdiction,2 because the Bank could by then establish (i) a good arguable case that it would be able to enforce its judgments against Mr Pugachev against the assets of the Trusts and (ii) there was a real risk that, without such an injunction, the Trust assets would be dissipated at Mr Pugachev’s behest. The Bank’s claims The Bank claimed to be able to enforce against the assets in the Trusts on three bases: First, a combination of Mr Pugachev’s position as settlor and discretionary beneficiary, together with his extensive powers as protector, meant that the true effect of the deeds of trust was to create bare trusts for Mr Pugachev. The Bank referred to this as the ‘illusory trust’ claim, although Birss J described it as the ‘True Effect of the Trusts’ claim. Secondly, the deeds of trust were shams and that the true intention was to create bare trusts for Mr Pugachev. Thirdly, the Trusts should be set aside under section 423 of the (English) Insolvency Act 1986 on the basis that they were entered into by Mr Pugachev for the purpose of putting assets beyond the reach of a person, the Bank, who was making or may make a claim against him. Birss J acceded to the first claim and delivered a detailed judgment explaining why he would, in any event, have acceded to the second claim. His essential reasoning was as follows: That on a proper construction of the trust deeds, the wide powers conferred on the protector were purely personal powers which the protector could exercise in his own selfish interests. Mr Pugachev’s powers were so extensive that he retained beneficial ownership of the assets. Alternatively, if on an objective interpretation of the trust deeds the protector’s powers were fiduciary such that Mr Pugachev did not have unfettered control and ownership of the assets, then the trust deeds were shams because it was the parties’ subjective intention that Mr Pugachev retain the sole beneficial interest in the assets. The remainder of this article will explain the Judge’s reasoning and its implications for those involved in the establishment or administration, or seeking to enforce against the assets, of discretionary trusts. References found in square brackets are to paragraphs of Birss J’s decision. The Judge’s starting point The Judge’s starting point was that discretionary trusts are structures that are particularly attractive for unscrupulous settlors wishing to shield their wealth from the claims of creditors. This is for a number of reasons: Trust assets will not be held in the settlor’s name. The asset can instead be vested in the name of an anonymous special purpose vehicle established to act as trustee. All the better if the trustee is a long way away: ‘that just makes the job of searching a little bit harder’ (). Discretionary trusts have the additional feature that discretionary beneficiaries have no beneficial interest in the trust assets. This confers two advantages: if required to provide information as to his assets, a beneficiary will be able to decline to disclose that the trust assets or any interest in them belongs to him (); and assets held within a true discretionary trust are not amenable to execution if judgment is entered against one of a class of discretionary beneficiaries (). But there is a problem. As the Judge put it: Subject to the law on unwinding transactions to defraud creditors, if a person gives away their property to someone else then it is no longer theirs. But that is not what the unscrupulous person in the example wants to do at all. As far as they are concerned the property is theirs. The objective is not to lose control of it, the objective is to hide it and protect it from creditors. () This is where the role of protector may come in: the settlor can grant himself wide powers as protector. He can, for instance, prevent the trustees from distributing the money to anyone but himself, and can remove recalcitrant trustees who fail to do his bidding and replace them with trustees willing to do what he wants. A discretionary trust may thus be seen as an effective shelter from attack. The trustee can, after the trust is established, go along with the settlor/protector’s instructions, regarding him (and perhaps referring to him) as the ‘client’ or ‘Ultimate Beneficial Owner (UBO)’. But as soon as the trust is challenged by creditors, the trust can be presented in a radically different way: the settlor/protector can be said to be subject to the full range of fiduciary obligations when exercising his powers. This, said the Judge, reminded him of the Angora cat problem encountered in patent law: when validity is challenged, the patentee says his patent is very small: the cat with its fur smoothed down, cuddly and sleepy. But when the patentee goes on the attack, the fur bristles, the cat is twice the size with teeth bared and eyes ablaze. ( citing from the decision of Jacob LJ in European Central Bank v Document Security Systems  EWCA Civ 192 at paragraph 5) The ‘True Effect of the Trusts’ claim As we have noted, Mr Pugachev had extensive powers as protector of the Trusts. The key powers were to: Withhold consent to the Trustees’ exercise of their powers to invest and distribute the Trusts’ assets. Withhold consent to the Trustees’ exercise of a range of other powers, such as to remove beneficiaries and vary the terms of the Trusts. Appoint additional beneficiaries. Dismiss the Trustees ‘with or without cause’ and appoint replacement trustees. Having removed the Trustees, he could exercise a power of attorney to ensure the transfer of the trust property to newly appointed trustees. Birss J asked himself two questions: (i) were Mr Pugachev’s powers purely personal; and (ii) if so, did that mean that he had failed to divest himself of beneficial ownership of the Trusts’ assets. As to the first question, the Judge held that these powers were purely personal powers in the sense that they could be exercised by Mr Pugachev in his own selfish interests and without regard to the interests of the other beneficiaries. The Judge relied in particular on the fact that Mr Pugachev was the settlor, a discretionary beneficiary, and the protector of the Trusts (). Much turns on the particular facts of the case. As the Judge continued: If such extensive powers had been conferred on a third party as protector, with provisions barring that person from being a beneficiary, then I can see that a different result might follow but the fact it is a beneficiary on whom these powers are conferred militates against the idea of a limitation. One would expect a beneficiary ordinarily to be entitled to act in their own interests. Conversely if less extensive powers were conferred on a beneficiary/protector then again one might arrive at a different result but that is not this case. (ibid) Other reasons supporting the Judge’s conclusion that the protector’s powers could be selfishly exercised included: That the trust deeds failed to identify a settlor at all. Birss J concluded that this was not accidental (): Mr Pugachev’s name was instead omitted to hide his involvement in establishing the Trusts. The ability to remove trustees ‘without cause’ negatived the notion that the power was subject to a limitation (). There was no warrant to conclude that certain powers are fiduciary and others non-fiduciary (). As to the second question, the Judge held that the effect of Mr Pugachev being able to exercise his powers in his own interests was to ‘allow him to retain complete control over the assets he settled into the trusts’. More specifically: if the Protector’s powers were personal then ‘in substance the ability of any of the Discretionary Beneficiaries to receive any distribution … would be in the hands of the Protector’ (); the Protector would be able to appoint new discretionary beneficiaries (); the Protector could use these powers, appoint a replacement Protector, or exercise the powers via Victor (who ‘for all intents and purposes would do his father’s bidding’) (); the making of a distribution of all of the trust assets to a single discretionary beneficiary by carrying out the Protector’s wishes would not be open to ‘realistic challenge’ (); but even if it was, the Protector would remove a trustee who refused to put the Protector’s interests ahead of the other discretionary beneficiaries (). The Judge’s overall conclusion was that: on their own terms these trusts do not divest Mr Pugachev of the beneficial interest he had in the assets transferred into them. In substance the deeds allow Mr Pugachev to retain his beneficial ownership of the assets (). The sham claim As Birss J noted, there was little dispute on the law relating to sham trusts (–). A deed of trust is a sham or pretence if it is intended to mislead third parties and the court as to the true basis on which the assets are held. If assets are transferred to a trustee, then the deed of trust is only a sham if the parties subjectively share a common ‘shamming’ intention. However, this requirement will be satisfied if the trustee prepares and signs a trust deed acting entirely recklessly as to the settlor’s true intentions (). In this case, the Trustees were each specially incorporated New Zealand companies, so the intentions attributable to the companies were those of the natural persons who managed and controlled the relevant actions of the companies. On the facts, Birss J held that Mr Pugachev intended at all times to retain ultimate control of the assets and he intended to use the Trusts to hide his ownership of the assets. His method of exercising control was through his position as protector. He further held that the New Zealand solicitor who acted as a director of each of the trustee companies had no intentions independent of those of Mr Pugachev. He simply went along with what Mr Pugachev wanted (–). As Birss J recognized, the case on sham dovetailed with the case on ‘illusory trust’. The case on sham depended on whether the Trustees and Mr Pugachev subjectively intended Mr Pugachev to have complete control and ownership of the Trusts’ assets. The trust deeds indisputably provided for Mr Pugachev to have some control in his capacity as protector. If Mr Pugachev’s powers were fettered in some way then the question was: did the parties subjectively intend Mr Pugachev’s powers to be fettered, or was he intended to be the sole owner and unfettered controller of the assets? (see –) Birss J concluded that: if a proper approach to the construction of these deeds was to lead to a conclusion that the Protector’s relevant powers are fiduciary, as Mr Patterson [the New Zealand solicitor] now says they are, and that in turn was to lead to a conclusion that under the deeds Mr Pugachev is not a beneficial owner, then those deeds are a sham. The settlor intended to use them to create a false impression as to his true intentions and the trustees went along with that intention recklessly. () The judge recognized that this is a sophisticated and subtle form of sham. Mr Pugachev’s role in relation to the assets was not completely disguised, but he could say to third parties (as he did to the Claimants in this case) ‘I am only a discretionary beneficiary and I have limited powers as protector.’ On the other hand, the true intention was that Mr Pugachev had ultimate ownership and control of the assets. The section 423 claim In light of his decision on the other heads of claim, Birss J reached the unsurprising conclusion that if the trust deeds did operate to divest Mr Pugachev of his beneficial interests in the assets, then their purpose was to hide his control of the assets from his creditors. He did not go on to consider the question of the appropriate remedy under section 425 of the Insolvency Act 1986. Implications First, this decision is to be welcomed by creditors looking to attack complicated trust structures. They have traditionally alleged that the trusts are shams or should be set aside under anti-avoidance legislation. But an allegation of sham is often hard to prove and some debtor-friendly jurisdictions (particularly in the Caribbean) have limited or no anti-avoidance legislation. This decision gives creditors a new angle of attack in cases where the debtor has retained extensive powers under the trust instrument. Secondly, the decision is a salutary reminder that those who are involved in the establishment and management of discretionary trusts must take care when a settlor/beneficiary is also given wide powers as protector. Mr Patterson was criticized in a number of respects. They included: the impression given to Mr Pugachev’s agents, when establishing the first of the Trusts, that Mr Pugachev could ‘change this document at any time’ (–); Mr Patterson carrying out ‘Mr Pugachev’s bidding’ by removing a discretionary beneficiary when told to do so (–); Mr Patterson referring to Mr Pugachev being ‘the client’ or ‘the UBO’ in internal correspondence; and Mr Patterson giving evidence to the English court in interlocutory proceedings that was ‘reckless’ (), not ‘candid’ (, ) or which constituted an attempt to mislead the court (). Thirdly, the decision cannot be seen as a one-off. The courts are increasingly reluctant to allow defendants to keep assets away from their creditors when they retain de facto control over them. The trend can be traced back to Robert Walker J’s decision in ICIC v Adham  BCC 134, where he made reference to ‘shadowy’ structures ‘formed in jurisdictions where secrecy is highly prized and official regulation is at a low level’ in the context of the appointment of interim receivers. A more recent example is to be found in the Privy Council’s decision in Tasarruf v Merrill Lynch  1 WLR 1721, where a power to revoke a trust deed was regarded as ‘tantamount to ownership’ and was vested in an equitable execution receiver. The same year, Toulson LJ stated that ‘Family trusts are a well-known possible device for trying to place assets ostensibly beyond the reach of creditors’ (North Shore Ventures v Anstead Ventures  EWCA Civ 11, ). Indeed, in the Court of Appeal in Mezhprom, Lewison LJ—when concluding that Mr Pugachev should give disclosure about the Trusts—relied upon ‘… the court's concern that sophisticated and wily operators should not be able to make themselves immune to the courts' orders …’ ( 1 WLR 160, ).3 Tim Akkouh is a barrister at Erskine Chambers. He appeared for the Claimants, led by Stephen Smith QC, in Mezhprom v Pugachev. He was called to the bar in 2004 and is the co-author of Trusts Law (5th edn, Palgrave MacMillan 2017). He specializes in commercial, civil fraud, and contentious trusts work. Christopher Lloyd is a barrister at Erskine Chambers. He appeared for the Claimants, led by Stephen Smith QC, in Mezhprom v Pugachev. He was called in 2011 and is an assistant editor of Lewin on Trusts. He specializes in commercial, civil fraud, and contentious trusts work. Footnotes 1. Following Mr Pugachev’s agreement to submit to the jurisdiction of the Russian courts in connection with the claim seeking to hold him liable for the losses caused by the Bank’s insolvency, the English proceedings were initially confined to the grant of interim relief under s 25 of the Civil Jurisdiction and Judgments Act 1982. 2. Named after the decision in TSB Private Bank v Chabra  1 WLR 231. 3. See also the Supreme Court’s decision in Prest v Petrodel  2 AC 415, where Lord Sumption suggested that a single purpose vehicle that is the registered proprietor of a family home will often hold it on trust for the spouse that owns and controls the company. He continued as follows at : ‘…The intention will normally be that the spouse in control of the company intends to retain a degree of control over the matrimonial home which is not consistent with the company's beneficial ownership. Of course, structures can be devised which give a different impression, and some of them will be entirely genuine. But … judges exercising family jurisdiction are entitled to be sceptical about whether the terms of occupation are really what they are said to be, or are simply a sham to conceal the reality of the husband's beneficial ownership.’ © The Author(s) (2018). Published by Oxford University Press. All rights reserved.
Trusts & Trustees – Oxford University Press
Published: Mar 1, 2018
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