Introduction

The “Panama Papers” have put offshore corporate and trust structures under the media spotlight again. As far as the public debate is concerned, the stigma of offshore structures stems from the perception that they are utilised for tax avoidance – if not tax evasion. Whilst the current focus is on tax issues, since the late 1980’s offshore structures have routinely cropped up in a large number of ordinary commercial frauds too. The tool of choice is often the discretionary offshore trust in jurisdictions such as the BVI, Bahamas, and Cayman Islands, but other jurisdictions such as the Cook Islands are also very popular.

A major attraction of these jurisdictions is the lack of publically available information regarding companies and trusts. This secrecy presents a hurdle for claimants in fraud cases as, barring the documents being leaked by an anonymous source (and even then issues may arise as to admissibility as it no doubt will regarding the Panama papers), the claimant must seek the courts’ intervention for disclosure orders.

In light of the Panama Papers leak, this article revisits the Court of Appeal judgment in JSC Mezhdunarodniy Promyshlenniy Bank & Anr v Sergei Viktoovich Pugachev (“Pugachev”)[1], which resolved the issue of what test needs to be met by claimants seeking disclosure of trust details as part of an application for a freezing order.

It is best to start with a crucial distinction. In a case of fraud a claimant will often be entitled to one or both of two types of order. First, a freezing injunction which prevents someone dealing with assets that do not belong to the Claimant, but might be available to him by enforcement of any judgment to the effect that the Defendant must pay him damages. Secondly, there is a proprietary injunction which prevents someone from dealing with assets that the Claimant says already belong to him or her. In a fraud case both will often be available: the freezing injunction because the Defendant may have to repair the damage that he has caused with his own monies; the proprietary injunction because the claimant may be entitled to the return of what has been stolen. The claimant cannot have a double recovery but he will not usually have to choose his remedy until the end of the action, so in the mean time the court may grant him a freezing order and a proprietary injunction.

Obtaining freezing orders

On the face of it, assets held by the trustees of the discretionary trust are not susceptible to execution if judgment is entered against a defendant who is only one of a class of discretionary beneficiaries. A discretionary beneficiary’s interest does not amount to a proprietary interest and the judgment will not be enforceable against the trust assets.

The inclusion of trust assets within the ambit of a freezing order is therefore justifiable only if the assets can be used to satisfy a judgment against the Defendant. This might be so, for example, if there is a good reason to believe that although the trust’s assets are purportedly held on the terms of a written trust deed, they are actually held for the defendant on a bare trust and are “his”[2]. An argument to this effect (that the trust is a “sham” because the assets are not held on its stated terms) is the best known of a number of ways in which the assets may still be accessed.

Continuing with the “Sham Trust” illustration, the Claimant will require evidence that the assets are held on this basis to meet the relevant legal test. However, he or she will often know very little about the trust at the stage of seeking a freezing injunction.

Disclosure orders for offshore trusts

In Pugachev, the Court of Appeal had to decide whether the courts could (a) order a member of a class of discretionary beneficiaries to make disclosure of the details of the trust and the trust assets; and if so (b) in what circumstances that jurisdiction should normally be exercised.

A bit of background: In 1992 Mr Pugachev, who is often referred to as “Putin’s banker”, co-founded the JSC Mezhdunarodniy Promyshlenny Bank (“the bank”). In November 2010 the Moscow Arbitrazh Court declared the bank to be insolvent, and in January 2011 the Russian authorities began a criminal investigation with regard to the bank’s insolvency. Three days later Mr Pugachev fled Russia to England. In December 2013 proceedings were brought against Mr Pugachev in the Moscow Arbitrazh Court in which he was accused of embezzling over USD 2 billion from the bank, while allegedly controlling and beneficially owning it. In July 2014 a without notice freezing order was obtained in England in aid of the Moscow proceedings.

The worldwide freezing order contained the usual orders in the standard Commercial Court order for disclosure of Mr Pugachev’s interests, including one (optional[3]) part of the Commercial Court wording which required disclosure of:

“any interest under any trust or similar entity including any interest which may arise by virtue of the exercise of any power of appointment, discretion or otherwise howsoever.”

Mr Pugachev subsequently provided a schedule of assets in purported compliance with the order. The stated value of the disclosed assets was USD 70 million. The schedule disclosed that Mr Pugachev is one of a class of discretionary beneficiaries under five New Zealand based trusts, which were then named. No further details were given.

The claimants subsequently applied for orders requiring the disclosure of details of the trusts and the trusts’ assets. Henderson J granted the order before the matter was appealed.

Evidence was available to the Court of Appeal which was said to illustrate that Mr Pugachev had substantial connections with the trusts and that there were good grounds for supposing that he was in a position to control assets held by companies which were owned by the trusts. However, clearly it was not possible at that stage to make out anything approaching a solid case of “sham”. Mere “connection” with the trusts would not make their assets available for enforcement of a judgment against Mr Pugachev.

The Court held that the wording in the freezing order (quoted above) did require a defendant to disclose any interest he has as discretionary beneficiary. It accepted that the claimants had raised issues which called for a fuller explanation.

The threshold for disclosure of discretionary trust information

The courts have jurisdiction, in the strict sense, to make whatever ancillary orders are necessary to make a freezing order effective.[4] CPR Part 25.1(1)(g) enables the courts to make:

“any order directing a party to provide information about the location of relevant property or assets or to provide information about relevant property or assets which are or may be the subject of an application for a freezing injunction.”

The issue in Pugachev was what the test is for when the courts should exercise their power under CPR 25.1(1)(g). It was argued on behalf of the trustee that the courts’ jurisdiction should not be exercised unless the test for granting a freezing order was met. If this was right, the test would be quite high. However, the Court was mindful that the courts’ power to order disclosure “would lose its utility if it was necessary to demonstrate [in advance of an application for a freezing injunction] that a freezing order would, in due course, be granted.”[5]

The Court held that the test for ordering disclosure of information was whether there is “some credible material” on which an application for a freezing order might be based. This test was a lower threshold than the “good reason to suppose” test used when considering freezing orders. The exploratory element of the order was therefore permissible. In other words the test to get a court order to enable the Claimant to ascertain whether the Defendant had an interest in an asset was lower than the one the courts would apply if the Claimant sought to freeze the asset.

What use is the information?

The question of whether to extend a freezing order over the assets of a discretionary trust puts the courts in a position where they have to decide between a formalistic application of trust law and the courts’ desire for a just outcome in the particular circumstances of each case.

The courts are concerned not to affect an innocent third party’s rights or interests unless claimants can make out an established ground for accessing trust assets.[6]

On the other hand, these concerns often seem devoid of reality in the context of the unscrupulous defendants subject to freezing orders in fraud cases. In International Credit and Investment Co (Overseas) Ltd v Adham [1996] BCC 134, 136, Robert Walker J emphasised that sophisticated and wily operators should not be able to make themselves “judgment-proof”:

“…the court will, on appropriate occasions, take drastic action and will not allow its orders to be evaded by the manipulation of shadowy offshore trusts and companies formed in jurisdictions where secrecy is highly prized and official regulation is at a low level.”

These conflicting concerns are clearly visible in the courts’ differing interpretations of the relevant test for extending a freezing order over assets purportedly held by a third party. In Dadourian Group International Inc v Azuri [2005] EWHC 1768 the Court held that “what needs to be considered is the substantive reality of control [over the trust assets], not a strict trust law analysis as to whether the third party is a bare trustee.”

Conversely, in AHAB v Saad,[7] Sir John Chadwick P (sitting as a judge of the Court of Appeal of the Cayman Islands) held:

But, as it seems to me, the existence of substantial control is not, of itself, enough to meet the first of the two requirements just mentioned. It is not enough that the CAD could, if it chose, cause the assets held by the NCAD to be used to satisfy the judgment. It is necessary that either: (i) that the CAD can be compelled (through some process of enforcement) to cause the assets held by the NCAD to be used for that purpose; or (ii) that there is some other process of enforcement by which the claimant can obtain recourse to the assets held by the NCAD.”

In Pugachev the Court of Appeal noted at [17] that there is now a considerable body of case law at first instance which holds the above summary of principle by Sir John Chadwick to represent the law in Wales and England, and that the principle has been cited by approval in the English Court of Appeal in JSC BTA Bank v Ablyazov[8].

Yet the judgment then went on to, albeit circumspectly, cast some doubt on whether the narrow approach in AHAB v Saad represents a just approach:

“I observe that the final sentence of paragraph 6 [of the Commercial Court standard form freezing order] says that a respondent will be regarded as having power to deal with or dispose of an asset “if a third party holds or controls the asset in accordance with his direct or indirect instructions”. This does not, at least on the face of it, distinguish between a legal right to give instructions and the fact that a person in reality follows instructions … It would, I think, be a matter of concern if a person could make himself judgment-proof merely by setting up discretionary trusts…However, at this stage in the proceedings, it is unnecessary to reach a firm conclusion.”

The Supreme Court has held that the words in the standard Commercial Court freezing order can include assets that do not belong to the Defendant, but their scope remains the subject of considerable uncertainty[9].

In the end Pugachev unravelled in a way where there was no question of excluding the trusts’ assets from the freezing order. In contempt of court, Mr Pugachev failed to relinquish one of his passports, to disclose certain bank account details and ultimately fled this jurisdiction, illustrating that he was, at every possible step, attempting to keep his assets out of the reach of judgment. Further, the terms of the trust deeds reinforced the Court’s conclusion (unfortunately those terms were redacted).[10] The Supreme Court decision in JSC BTA Bank v Ablyazov[11] which holds that an appropriately worded freezing order can prohibit dealings with rights that do not even constitute a Defendant’s assets also suggests that Ahab v Saad may be revisited soon.

Conclusion

This rather unsatisfactory conclusion to Pugachev only goes to show why the courts need to take decisive and sometimes drastic action in relation to freezing orders. The judgment has clarified that the test for ordering disclosure of discretionary trust details is not burdensome. Using those details to obtain a freezing injunction over trust assets is another matter altogether though, which poses a difficult balancing act for the courts and a challenge to claimants.