JERSEY GUERNSEY BVI SINGAPORE

GUERNSEY BRIEFING November 2017

Sham trusts, the High Court and "Putin's Banker"

On 11 October 2017, the High Court released its latest judgment in the long running saga between Mezhprom Bank and its liquidator, the Deposit Insurance Agency (the "DIA"), and Russian businessman Mr Sergei Pugachev (also known as "Putin's banker").

The case1 concerned five discretionary New opaque offshore accounts that put assets out Zealand trusts, in respect of which the High of the reach of creditors". "The key, as ever, is this: Court had previously ordered Mr Pugachev to what is the true intention of provide disclosure. In a decision which might The reality, however, is that the sort of claims all the relevant players at initially be of concern to individuals and run successfully by the claimants in this case the time a trust is settled?" trustees with a connection to or looking to remain difficult to prove. The key, as ever, is establish a trust in Guernsey, Mr Justice Birss, this: what is the true intention of all the presiding, ruled that the assets held by the relevant players at the time a trust is settled? trusts should be available for enforcement (albeit he declined to order relief and It is also worth bearing in mind that Guernsey, adjourned the matter for further in common with other offshore jurisdictions, submissions). has "firewall" provisions in its Trusts Law which confer exclusive jurisdiction on the On the facts of this particular case, Birss J Royal Court of Guernsey over matters found that at all material times, Mr Pugachev: concerning Guernsey trusts. Accordingly, even if an English Court were to declare a Guernsey "…regarded all the assets in these trusts as trust to be a sham, potentially this would be belonging to him and intended to retain of limited impact. ultimate control. The point of the trusts was not to cede control of his assets to someone Overview else, it was to hide his control of them. In Between 2011 and late 2013, whilst enquiries other words, Mr Pugachev intended to use the (and later proceedings) were ongoing in trusts as a pretence to mislead other people, , Mr Pugachev (for the most part via his by creating the appearance that the property son, Victor Pugachev) purported to settle did not belong to him when really it did" assets worth over US $95 million into five (paragraph 424). discretionary New Zealand trusts, including

properties in London, Russia and St Barts. This has led some to worry about the Each of the trust deeds named Mr Pugachev susceptibility of offshore structures to as a discretionary beneficiary and a protector. onshore actions. Indeed, an article published

in the on Thursday 12 October Birss J, sitting at the High Court in London, 2017 declared that, "the ruling shows a ruled that Mr Pugachev was the true owner of decreasing tolerance in the High Court for the assets held by the New Zealand trusts (which had come to light during a disclosure 1 JSC Mezhdunarodniy Promyshlenniy Bank v Pugachev exercise and in respect of which further [2017] EWHC 2426 (Ch) bedellcristin.com GUERNSEY BRIEFING 2

disclosure was later ordered). The judge – Secondly, in the alternative to the True reached the conclusion that Mr Pugachev's Effect of the Trusts claim, the trusts were intention in setting up the trusts "was to "shams" because it was the intention of all retain control of the assets but use them as a the parties involved in the creation of the pretence to mislead third parties by hiding his trusts that the assets should continue to control" (paragraph 456) and that the assets belong to Mr Pugachev and therefore they within the trusts should be available for had no effect; and enforcement. – Thirdly, in the alternative to the first two claims, the trusts should be set aside under Background section 423 of the UK Insolvency Act 1986 on the basis that the transfers of the assets Mezhprom Bank was founded by Mr Pugachev into the trusts were carried out with the in 1992 and entered into insolvent liquidation intention to prejudice the interests of Mr "The claimants argued that in late 2010. In December 2013, the DIA Pugachev's creditors, including the the beneficial interest in the brought proceedings against Mr Pugachev for claimants. assets held by all the trusts the misappropriation of assets prior to the belonged to Mr Pugachev…" bank's collapse and in April 2015 the Russian These claims were denied by Ms Tolstoy on Court gave judgment against Mr Pugachev in behalf of her infant children. She (and her the sum of around RUR 76 billion (equivalent parents) gave evidence that Mr Pugachev had to around US $1 billion). That judgment is now told her that the family properties had been the subject of an appeal. bought and placed into trust for her and her

children. Mr William Patterson, the New By the time the High Court trial began on 4 Zealand solicitor who drafted the trust deeds, July 2017, the claimants' lawyers had secured denied that the trusts were shams and that a £1.1 billion freezing order against Mr they were under the complete control of Mr Pugachev's assets, and Mr Pugachev himself Pugachev. had been committed to two years'

imprisonment for contempt of court (a The court's findings sentence which he escaped as he had already left the country by the time the judgment was Assets transferred by Victor pronounced). Only Mr Pugachev's infant Mr Justice Birss found that "for all these children (acting by their mother, Alexandra transfers Victor was acting entirely on the Tolstoy, as their litigation friend) defended instruction of his father and that the beneficial the bank and the DIA's application. ownership of each asset (money or shares)

belonged to Mr Pugachev until the property Apparently, the High Court has issued more was transferred into the trusts" (paragraph than 170 orders relating to the DIA's litigation 205). against Mr Pugachev to date. – He reached this conclusion on the basis

that: there was no evidence that Victor had The issues the means to generate this sort of wealth The claimants argued that the beneficial independently of his father; interest in the assets held by all the trusts – given the provisions of the trust deeds belonged to Mr Pugachev, notwithstanding (some of which made no provision for that much of the money or other assets which Victor or his children) there was no ultimately went into the trusts was provided plausible reason that Victor would wish to by Victor. They sought an order requiring the transfer his assets into the trusts and assets to be vested in the claimants or – Victor acted in concert with his father and alternatively in such persons or a receiver as the associates in his father's family office in the court deemed fit. The claimants put their London in setting up the trusts, which Birss J case on three bases: considered provided some support for the – Firstly, that the trust deeds properly inference that Victor was simply doing his construed and on a proper application of father's bidding. the law, were not effective to divest Mr Pugachev of his beneficial ownership of the The true effect of the trusts claim assets placed into the trusts. This is referred The trust deeds conferred wide powers on the to in the judgment as the "True Effect of the Protector and required his consent in a wide Trusts" claim (albeit such arrangements are variety of circumstances, including the perhaps more commonly referred to as trustees' power of distribution, investment "illusory trusts"); and removal of a Discretionary Beneficiary. Under the trust deeds, the Protector could bedellcristin.com GUERNSEY BRIEFING 3

also remove the trustees "with or without In arriving at this conclusion, the Judge cause" and to act on that removed trustee's considered that the evidence showed: behalf to vest the trust property in the new – Mr Pugachev is "not a person who would trustee. There were no provisions expressly lightly relinquish control of anything", that fettering any of the Protector's powers. he is "a person quite willing to lie and put forward false statements deliberately if it Birss J found (after careful consideration of would suit his purpose" and that "The the terms) that, on a true construction of the circumstances as a whole and Mr trust deeds, the powers conferred on Mr Pugachev's character support a credible Pugachev as First Protector were personal inference that one of Mr Pugachev's powers (and therefore not fettered in any purposes in transferring the property into way, for instance by fiduciary obligations) these trusts was what is euphemistically "conferred to give the Protector the ability to called "asset protection", in other words to act in his own best interests" (paragraph 267) hide them from possible claims, facilitate a and not in the interests of the Discretionary plausible denial of ownership, while Beneficiaries as a class. He could, for instance, retaining control in fact" (paragraph 298) remove a trustee who refused to distribute – Mr Pugachev's family by Ms Tolstoy trust assets to him and replace the trustee benefitted from use of the assets in the with someone who would. trust but only on his say so and that it was "no part of Mr Pugachev's purpose to divest He reached this conclusion because of the control in favour of his family as distinct extensive nature of the Protector's powers from himself" (paragraph 425); and "The Judge confirmed that (particularly the power of removal of trustees – Mr Patterson simply did "Mr Pugachev's the burden of establishing "with or without cause") combined with the bidding" (paragraph 379) and that he had the section 423 claim was fact that Mr Pugachev, in addition to being no intention independent of Mr Pugachev on the claimants…" the First Protector, was also the settlor of all (and therefore shared, albeit recklessly, in the trust assets (albeit he was not named as his "shamming intention") (paragraphs 433- such in the deeds themselves) and one of the 435). named Discretionary Beneficiaries. The section 423 claim Birss J held that provisions about Mr The Judge confirmed that the burden of Pugachev's functions as Protector transferring establishing the section 423 claim was on the to Victor should the Protector come "Under a claimants and that the focus had to be on Mr Disability", which was defined as to include a Pugachev's purpose at the time of the disability by operation of law, supported the transactions, which must have been to defeat same conclusion. He found that what this creditors. J Birss stated that, had it been provision did was to allow "Mr Pugachev's necessary to look into this claim in detail, he effective complete control of the trusts to would have found that each of the transfers in cease to exist the moment he is compelled to setting up the trusts satisfied the test in do something he does not want to do, like section 423. He stated that this was because, hand over the assets to a creditor. It is an even if the deeds did in fact divest Mr attempt to make the trust judgment proof and Pugachev of control, his intention was always should not be accepted" (paragraph 275). to use the trusts to mislead other people, who

might make a claim in the future. The Judge In conclusion, the Judge found that "on their considered the increased pressure on Mr own terms these trusts do not divest Mr Pugachev in Russia from 2011 to be a relevant Pugachev of the beneficial ownership he had factor in this regard. of the assets transferred into them. In

substance the deeds allow Mr Pugachev to Comment retain his beneficial ownership of the assets" (paragraph 278) and that they amounted to "a This case is an extreme example on its facts bare trust for Mr Pugachev" (paragraph 455). and it remains to be seen whether the High Court will be willing to declare that other, less The sham claim controversial trusts (possibly not involving a subject to a worldwide In the event that his interpretation of the first freezing order and committed to two years' claim was incorrect, Birss J ruled that the imprisonment for contempt of court) are trusts were "shams and should not be given shams and should not be given effect to. effect to" (paragraph 456).

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Certainly, this judgment contains a useful restatement of the legal principles governing "...a stark and timely the concepts of "sham" and "illusory" trusts reminder...to look beyond (the section 423 claim having been given the headlines prevailing in relatively short thrift), as well as a useful the press to see the reality examination of the scope and nature of a of a judgment and its actual protector's powers and duties and the impact on day to day trust circumstances in which they may be matters." considered fiduciary or personal in nature (which Birss J gave careful consideration to by reference to the terms of the trust deeds themselves and the circumstances surrounding them).

It is also a stark and timely reminder not only of the sorts of issues trustees should be mindful of when creating and/or administering trusts, but also to look beyond the headlines prevailing in the press to see the reality of a judgment and its actual impact on day to day trust matters. In the meantime it is clear, to misquote Mark Twain, that reports of the death of the trust are greatly exaggerated.

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For further information, please contact:

Guernsey

Alasdair Davidson Rebecca Hale Partner Associate T +44 (0)1481 812819 T +44 (0)1481 812826 E [email protected] E [email protected]

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