How sham trusts served ‘Putin’s banker’

The case of the Russian billionaire Sergei Pugachev raises important points on why the power of settlors should be kept in check, write Ryan Mowat and Katherine Pymont

The recent decision in a long running High Court dispute between Russian oligarch Sergei Pugachev, who has been accused of ‘one of the world’s largest alleged bank thefts’, and the Russian Deposit Insurance Agency (DIA) which is fighting him to recover funds relating to the collapse of Mezhprombank which he co-founded, saw Mr Justice Birss declaring five offshore trusts a sham.

Whilst the decision does not give rise to new precedent it contains a useful restatement of the legal principles governing the concept of a sham trust and is a reminder to the settlors (and in turn trustees) of the inherent risks in seeking to retain too much control over trust property. It is relevant to any professional that advises high net worth individuals in connection with trust property or structures, and of course to individuals themselves who are protectors, trustees, settlors or beneficiaries of a trust.

The case concerned the beneficial ownership of five discretionary New Zealand trusts  purporting to settle assets at one time said to be worth in the region $95 million, allegedly including valuable London properties in Battersea and Chelsea as well as a holiday home in the Caribbean.

The DIA argued that the beneficial interest in the various assets held under the trusts belonged to Mr Pugachev who had named himself as a beneficiary, along with his three children with former partner Countess Alexandra Tolstoy. The claim was defended by the children (their mother Ms Tolstoy acting as litigation friend) and the companies which Mr Pugachev had incorporated as trustees.

Mr Justice Birss ruled that the Russian oligarch, who was once known as Putin’s banker before he fell out with the Russian PM and fled for London, was in fact the sole beneficial owner of all five trusts. He concluded that Mr Pugachev’s wide powers as First Protector were purely personal powers as opposed to fiduciary powers enabling him to retain ultimate ownership and control of the assets.

He went on to set out a useful summary of the law surrounding the concept of a ‘sham trust’ and found ‘that at all material times [Mr Pugachev] regarded all the assets in these trusts as belonging to him and intended to retain ultimate control. The point of the trusts was not to cede control of his assets to someone else, it was to hide his control of them. In other words Mr Pugachev intended to use the trusts as a pretence to mislead other people, by creating the appearance that the property did not belong to him when really it did’.

Not only is this a critical decision in the long running dispute between Mr Pugachev and the DIA in that it exposed the trust assets as his hidden wealth, but the ruling is important for anyone tempted to use trust structures to hide wealth in divorce cases, tax investigations or inheritance battles.

It shows the English courts are willing to probe offshore trust structures and that if a trust is to withstand the scrutiny of the court, it needs to fulfil the necessary requirements of a trust.

The case serves as a reminder that when setting up a trust extra consideration must be given where the settlor reserves any powers or retains any control over the trust property. If a trust is operated in such a way that an ‘independent’ trustee is appointed simply to carry out the wishes of the settlor/beneficiary and the trust assets are not treated properly as trust property, then there is a strong likelihood, if challenged, the court will set aside the trust and declare it a sham.

Ryan Mowat is a partner and Katherine Pymont is an associate in the Contentious Trusts and Probate team at Kingsley Napley LLP