JSC Mezhdunarodniy Promyshlenniy Bank & Anor v Pugachev & Ors

Factual and Procedural Background

This action concerns five New Zealand trusts established to hold assets beneficially owned by Mr Pugachev, a Russian national and former oligarch who founded a major Russian bank that entered insolvent liquidation in 2010. The claimants, the Russian bank in liquidation and its liquidator, claim Mr Pugachev owes them substantial sums. Over time, assets including significant properties in London, France, and elsewhere were transferred into these trusts, with Mr Pugachev and his family as discretionary beneficiaries and Mr Pugachev as Protector.

Following the bank's insolvency and criminal investigations, Mr Pugachev fled Russia in 2011. Subsequently, various trusts were created and assets transferred into them, administered by New Zealand trustee companies controlled by Mr Patterson and others acting on Mr Pugachev's instructions. Litigation commenced in London to enforce Russian judgments and to investigate the ownership and control of trust assets. The court made worldwide freezing orders, required disclosure of assets, and found Mr Pugachev in contempt of court for breaches of those orders.

The trustees applied in New Zealand for directions regarding their removal, which was upheld by the New Zealand court. The claimants seek declarations that the beneficial ownership of the trust assets remains with Mr Pugachev, or alternatively, that the trusts are shams and the assets should be vested in the claimants. The trial commenced in 2017 with the infant children of Mr Pugachev and Ms Tolstoy defending the claims.

Legal Issues Presented

1. Whether the trust deeds effectively divest Mr Pugachev of beneficial ownership of the assets placed in the trusts ("True Effect of the Trusts" claim).
2. Whether the trust deeds are shams, intended to mislead third parties as to the true beneficial ownership of the assets ("Sham" claim).
3. Whether the transfers of assets into the trusts were transactions at an undervalue made to defraud creditors under section 423 of the Insolvency Act 1986 ("s423 claim").
4. The nature and scope of the powers of the Protector under the trust deeds, including whether those powers are fiduciary or purely personal.
5. The validity of the removal and replacement of the original trustees and the conduct of the trustees and protector in administration of the trusts.
6. The appropriate relief following findings on the above issues.

Arguments of the Parties

Claimants' Arguments

• The trusts do not divest Mr Pugachev of beneficial ownership because the Protector's powers are unfettered and personal, enabling him to retain control.
• The trust deeds are shams as the parties intended Mr Pugachev to retain beneficial ownership despite the trusts' form.
• The transfers into trusts were designed to defeat creditors and are voidable under s423.
• Mr Patterson, the principal trustee/director, acted as a nominee of Mr Pugachev and lacked an independent intention.
• The administration of the trusts was controlled by Mr Pugachev and his close associates, not independent trustees.
• The exclusion and indemnity clauses in the trust deeds are wide enough to nullify trustee obligations, supporting the claim that the trusts are ineffective.

Defendants' Arguments

• The trusts are valid discretionary trusts with real duties and obligations and Mr Pugachev does not hold beneficial ownership.
• The Protector's powers are fiduciary in nature and must be exercised for the benefit of all discretionary beneficiaries.
• Mr Patterson is an experienced professional who acted independently and properly as trustee.
• The sham claim fails because the trustees were not parties to any sham and had no relevant dishonest intention.
• The exclusion and indemnity clauses do not exclude liability for fraud or wilful breach of trust and do not nullify beneficiaries' rights.
• The s423 claim is inadequately supported and the claimants have not proven Mr Pugachev's purpose to defraud creditors.
• The removal of original trustees was valid and the new trustees act independently.

Table of Precedents Cited

Court's Reasoning and Analysis

The court began by examining the terms of the trust deeds, focusing on the role and powers of the Protector, who was Mr Pugachev himself. The deeds conferred extensive powers on the Protector, including veto powers over trustee decisions on distributions, investments, variation of the trust deed, removal and appointment of trustees and discretionary beneficiaries, without express limitations or fiduciary constraints. The court found that if these powers were purely personal, Mr Pugachev could effectively control the trust assets, making the trusts bare trusts for him despite the formal language.

The court considered authorities on sham trusts, illusory trusts, and the nature of protector powers, concluding that the trust deeds must be construed objectively, ignoring subjective intentions, but considering the overall effect of the powers conferred. The court rejected the claimants' label of "illusory trust" as unhelpful, aligning with the New Zealand Supreme Court's approach in Clayton v Clayton.

On the sham claim, the court found that the trusts were not shams in the strict sense because the trustees did not share a common intention to deceive. However, the court accepted that Mr Pugachev intended to retain control over the assets and use the trusts as a pretence to mislead third parties regarding ownership. The trustees, especially Mr Patterson, acted recklessly or without independent intention, effectively facilitating this scheme.

The court critically analysed Mr Patterson's evidence, finding him not fully candid or reliable on key points, including his denial that Mr Pugachev was settlor and his assertions about his knowledge and control over trust assets. The court concluded that Mr Patterson acted primarily on Mr Pugachev's instructions and was aware that Mr Pugachev was the ultimate beneficial owner ("UBO").

Regarding the s423 claim, the court held that Mr Pugachev's purpose in transferring assets into the trusts was to defeat creditors by hiding ownership and control, satisfying the statutory test for transactions at an undervalue intended to prejudice creditors.

The court noted that the exclusion and indemnity clauses in the trust deeds did not exclude liability for fraud or wilful breach of trust and thus did not negate beneficiaries' rights or support the claimants' case.

On the nature of the Protector's powers, the court rejected the defendants' submission that these powers were fiduciary and subject to court supervision for the benefit of all discretionary beneficiaries. Instead, the court held that the powers were purely personal, exercisable by Mr Pugachev in his own interests, enabling him to retain effective control and beneficial ownership of the trust assets.

The court acknowledged the validity of the New Zealand court's decision upholding removal of original trustees but distinguished its findings on the construction of the Protector's powers, concluding that the deeds here confer non-fiduciary, personal powers.

Finally, the court refused to make factual findings on Mr Pugachev's conduct in Russia due to insufficient evidence and reserved the question of appropriate relief for further submissions, maintaining the freezing orders in the meantime.

Holding and Implications

The court holds that Mr Pugachev is the settlor and beneficial owner of all the assets held in the five New Zealand trusts, including assets transferred by his son Victor acting as nominee.

All powers conferred on Mr Pugachev as Protector under the trust deeds are purely personal and not fiduciary, allowing him to exercise those powers selfishly and retain effective control over the trust assets.

The true effect of the trust deeds is that they do not divest Mr Pugachev of beneficial ownership; the trusts are, in substance, bare trusts for him.

If the court were to construe the deeds as divesting Mr Pugachev of beneficial ownership, then the deeds would be shams intended to mislead third parties, and the trustees acted recklessly in facilitating this.

The court finds that Mr Pugachev's purpose in creating the trusts and transferring assets into them was to hide ownership and control to defeat creditors' claims, satisfying the requirements of section 423 of the Insolvency Act 1986.

The direct consequence of this decision is to recognize that the trust assets are effectively controlled and beneficially owned by Mr Pugachev and thus are potentially available to satisfy creditors' claims. No new legal precedent is established beyond the application of existing principles to the facts of this case.

The court will hear further submissions on the appropriate relief to be granted. Until then, the existing freezing orders remain in place.