The Pugachev tale

In October 2017, the High Court handed down its latest judgment in the long-running dispute between JSC Mezhdunaodniy Promyshlenniy Bank (the "Bank") and its liquidators and Sergei Pugachev, the Bank's founder. The Bank went into insolvent liquidation in Russia in 2010. The Bank and its liquidators claim that Mr Pugachev misappropriated approximately USD 1bn from the Bank. Proceedings have been underway in England since July 2014, when the Russian insolvency proceedings were recognised and a worldwide freezing order was granted in support. Click here for an earlier update in relation to these proceedings.

This latest decision concerns the fate of assets (worth approximately USD 95m before being depleted) in five New Zealand discretionary trusts. The claimants contended that the trust assets should be vested in them or a receiver on their behalf on the basis that they belonged beneficially to Mr Pugachev despite the trusts being in place.

Settlor retained control of the assets

The claimants' case was put on three alternative bases: (a) that properly construed, the trust deeds were not effective to divest Mr Pugachev of the beneficial interest in the assets, particularly given his role as "Protector" of the trusts; (b) that if the trusts were effective on their face, they were nevertheless a "sham" and hence should not be effective; and (c) that if grounds (a) and (b) were unsuccessful then the transfers of assets into the trusts were intended to prejudice the interests of creditors and therefore that a claim lay under s.423 of the Insolvency Act 1986 to set aside the disposition.

In a lengthy and reasoned judgment which considers jurisprudence from a number of Commonwealth countries on the relevant issues, Birss J agreed with the claimants' primary case and found that on the face of the trust deeds themselves, Mr Pugachev had not relinquished control over the assets in the five trusts. This being so, the Court found that the trusts were not "shams" as such (as they were not properly discretionary trusts at all) but that they would have been shams even had Mr Pugachev relinquished control over the trust assets, as his intention was to retain control, and the trustees had recklessly gone along with that intention. The Court also held that the trusts were a device to mislead future claimants, which would have materially assisted s.423 claims, had they been required.

Mr Pugachev's colourful history in these proceedings means that the court's desire to "bust" his trusts is perhaps not surprising. Of more interest is the approach taken to achieve that end. By applying a textual analysis to the trust deeds, the Court avoided what is often a difficult evidential burden on claimants to prove a trust is a sham; namely the need to show a "common intention" between a settlor and, typically, a trustee. On the facts in this case, the trustees had the requisite intention. However, this will not always be so and it may be that claimants in future are assisted by the Court's approach here.

Application in future cases

That said, like commercial contracts, trust deeds will vary in their terms and it remains to be seen whether the court's approach here will be taken up more widely. What is likely is that those establishing discretionary trusts will pay close attention to this decision and look to avoid Mr Pugachev's fate by careful drafting. The role of "Protectors" in particular will be carefully scrutinised. In this case, as well as being the (undisclosed) settlor and one of the named discretionary beneficiaries, Mr Pugachev was also the "Protector" of the trusts and as such had powers which ultimately led the court to find against him. Those powers included a right of veto over many of the powers usually vested in trustees (such as the distribution of income or capital) and over the removal of a beneficiary and making variations to the trust deed. The Protector could also remove trustees without cause.

The key point in the Court's reasoning in relation to these powers is that they could be exercised by Mr Pugachev alone without regard to the interests of the class of beneficiaries. As a result, future trust deeds may cast the powers of Protectors as "fiduciary", in an effort to avoid another Court applying the reasoning in this decision to future trusts. However, the Court's willingness to "bust" Mr Pugachev's trusts after finding that they were being used for improper purposes should give anyone looking to use discretionary trusts for nefarious purposes pause for thought.

JSC Mezhdunarodniy Promyshlenniy Bank & Anr v Pugachev & Ors [2017] EWHC 2426 (Ch)

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