A recent significant decision of the Chancery Division of the UK Courts, which challenged the Discretionary Trust as a vehicle for protecting assets, has potentially wide-ranging ramifications. A third party may now be able to attack a trust on the basis that, on an objective interpretation of the trust deed, the settlor retains the beneficial interest (and without needing to prove the Trust is a Sham).
Mr Pugachev was a Russian businessman, politician and the founder of Russian Bank Mezhprom bank which collapsed in 2010. Following the initiation of criminal investigation into Mr Pugachev’s role in the collapse of the bank he went to live in London with his partner and children. The liquidators of Mezhprom Bank commenced proceedings in the UK to enforce judgements against Mr Pugachev and sought to seize assets held in five New Zealand-domiciled trusts.
Mr Pugachev established five New Zealand discretionary trusts between 2011 and 2013 and placed assets worth in the region of $95 million in those trusts. The trustee of each trust was a New Zealand company, of which the New Zealand lawyers advising Mr Pugachev were the directors and shareholders.
The trust was set up with himself, his partner and his children named as discretionary beneficiaries. Each of the Trusts named Mr Pugachev as First Protector to be succeeded by his eldest son.
In the High Court proceedings the creditors sought an order requiring the trust assets be vested in them. Their case was put on three bases of which the first two are of particular relevance.
The first claim was referred to as the "True Effect of the Trusts" claim. The Claimants argued that on a proper construction of the trust deeds, the trusts were not effective in divesting Mr Pugachev of his beneficial ownerships of the trust assets. In support of this claim, the Claimants relied heavily on the fact that Mr Pugachev was named as both a discretionary beneficiary and the protector of each of the five trusts. As protector, he had unusually extensive powers. These included the right to request information from the trustee and the ability to refuse to consent to the trustees' exercise of their powers thereby allowing him to control the trustees decision making. He was also able to dismiss the trustees "with or without cause" and had the power, on removal of the trustees, to exercise a power of attorney to ensure the transfer of the trust property to newly appointed trustees. The court distinguished between fiduciary powers i.e. those that must be exercised in the interests of beneficiaries and those that are purely personal and could be exercised in the protectors own selfish interests without the oversight of the Court.
The existence of control in the hands of Mr Pugachev resulted in the Court concluding that the beneficial ownership of the assets had not been transferred to the trusts and thus remained with Mr Pugachev. The Court reached this conclusion because of the extensive nature of the Protector's powers (particularly the power of removal of trustees "with or without cause") combined with the fact that Mr Pugachev, in addition to being the First Protector, was also the settlor of all the trust assets (albeit he was not named as such in the deeds themselves) and one of the named Discretionary Beneficiaries. The Court ultimately concluded that the Trusts were Bare Trusts.
The second basis of claim was referred to as the "Sham" claim. The Claimants argued that the trusts, or strictly the trusts deeds, were shams and therefore the trusts had no effect. In order for a trust deed to be a sham, it must be created with an intention to mislead. The judge did not consider the trust deeds in this case to be shams as they fulfilled Mr Pugachev’s true intention which was not to lose control of the Trust assets.
The Importance Of Independence
This case is a significant ruling which arguably provides support for an additional head of claim for a creditor wishing to attack assets of a trust. Until now, a creditor's primary means of attack had been to allege a trust is a sham, which requires the claimant to show a common intention of all parties to retain control and ownership of the trust assets.
The case may be said to pave a smoother path for claimants to challenge the validity of a trust by examining the true effects of the trust documentation rather than seeking to identify the parties’ subjective intentions.
The approach to the construction of the trust instruments in this case is significant and will carry lessons for the future. Trustees of trusts should review the trust deed and ensure that not only does the trust have at least one truly independent trustee but also that the trust itself is structured in a way to ensure that independence cannot be compromised.