In a world where the creation of schemes to exploit loopholes in global tax laws causes social uproar about 'hiding money' (the leaking of the Panama Papers and Paradise Papers being good examples), the recent decision of JSC Mezhdunarodniy Promyshlenniy Bank and another v Pugachev and others [2017] EWHC 2426 (Ch) shows a continued willingness of the courts to strike down sham trusts which would have done just that.

Reasons for placing money in these investment structures vary but can include tax and creditor avoidance and considerations of privacy or protection. The current climate suggests that the courts are holding a strong line on what is considered legally acceptable in these circumstances. This decision sends a clear message: the courts will prevent the global super-rich, be they individuals or corporate bodies, from exploiting complex multi-jurisdictional trusts to hide money from their creditors.

Background

Mr Pugachev founded Mezhprom Bank, a private Russian bank, in 1992. Mezhprom Bank suffered in the 2008 financial crisis and was ultimately declared insolvent in late 2010. The Russian state agency, Deposit Insurance Agency (DIA), was appointed as liquidator.

Between 2011 and 2013, and whilst enquiries into his assets following the liquidation of Mezhprom Bank were ongoing, Mr Pugachev settled over US $95 million of his assets in five New Zealand discretionary trusts.

In Russian proceedings, DIA alleged Mr Pugachev had misappropriated Mezhprom Bank assets prior to the liquidation. In April 2015, the Russian court gave judgment against Mr Pugachev in the sum of RUR ₽76 billion (approximately US $1 billion). Mr Pugachev fled Russia and moved to England.

DIA began enforcement proceedings in England and obtained a GBP £1.1 billion worldwide freezing order against Mr Pugachev's assets. He was also sentenced to two years' imprisonment for contempt of court which he has not served as he fled to France.

As part of the enforcement proceedings, Mezhprom Bank and the DIA (the Claimants), sought to "bust the trusts" and enforce against the assets of the trusts on three bases:

1. The trusts were illusory and of no substance because the trust deeds, properly construed, did not divest Mr Pugachev of his beneficial ownership in the trust property;

2. Alternatively, the trusts were shams and of no effect because the common intention was that the assets would continue to belong to Mr Pugachev; and

3. In the alternative to the first two claims, if the trusts were effective and divested Mr Pugachev of ownership of assets, they should be set aside under section 423 of the Insolvency Act 1986 because the intention was to prejudice the interests of Mr Pugachev's creditors.

Illusory Trusts

The High Court in London concluded that these were bare "illusory" trusts. Mr Pugachev was the settlor, discretionary beneficiary and protector of the trusts. He retained extensive control because he could dismiss the trustees and veto how they exercised their powers, and consequently retained beneficial ownership of the assets he put into the trust.

A sham

The High Court decided that it was a sophisticated and subtle form of sham. The intention was for Mr Pugachev to retain ultimate control, but to hide this control from third parties by giving a false impression that he had only limited powers as protector. The second protector, Mr Pugachev's son Victor, acted on his father's instructions and whilst the other beneficiaries (his children) would benefit from the trust, they only did so through the decisions of Mr Pugachev. In addition, the New Zealand solicitor who acted as director of each of the trustee companies had no independent will to that of Mr Pugachev.

Section 423

The Court found that if the trust deeds did divest Mr Pugachev of his beneficial interests in the assets, then it was with the purpose of hiding his control of the assets in the trusts from his creditors and so should be set aside.

Commentary

This decision is consistent with a trend towards greater global transparency of financial transactions. The new global standard on Automatic Exchange of Information should reduce the possibility for tax evasion by providing for the exchange of non-resident financial account information with the tax authorities across jurisdictions. It is often not easy to demonstrate that a complex trust structure is little more than a sham although if ultimate control is never truly removed from the settlor this is easier. In this case, the attempt to artificially divest the settlor of control over assets was sufficiently transparent for the courts to see through the smoke and mirrors.