Part 2: The unholy trinity of recent cases: Clayton, Pugachev and Webb

This article is part of a mini series that explores the relationship between sham trusts and illusory trusts.

There have been three major cases in recent years that warrant extended consideration in Part 2 of this mini-series: the New Zealand case of Clayton;[1] the English case of Pugachev;[2] and the Cook Islands / Privy Council case of Webb.[3] Interestingly, all three cases had connections to New Zealand.

All three decisions have been subject to criticism, not least because they do not take a consistent approach to their analysis: ‘in developing the [illusory trusts doctrine], courts have not articulated clear tests for when “a trust is not a trust”. The continuing jurisprudence on illusory trusts should therefore focus on the analysis of the basic principles of trust law, and determine whether the idea of fiduciary obligations to nominated beneficiaries is sufficiently undermined by settlor powers and roles to mean that no trust has been created.’[4] Clearly, more consideration of this issue will be needed at the highest levels.

Clayton

In Clayton v Clayton,[5] the New Zealand High Court found that the control retained by the settlor was such that the trust was illusory. Mr Clayton, the settlor of the trust, was also the sole trustee. Its beneficiaries were Mr and Mrs Clayton and their children, although Mr Clayton had the power single-handedly, as the ‘Principal Family Member’, to add or remove beneficiaries, appoint or remove trustees, and appoint a successor to exercise these powers. Mr Clayton also had wide-ranging powers in his capacity as trustee, effectively enabling him to deal with trust property as an owner, including full discretion in relation to the payment of income and capital to beneficiaries. The trust deed also included a self-benefit clause, enabling the trustee to exercise any power or discretion for their own benefit. The trustee also had unfettered discretion in the exercise of their powers and discretions, and any conflicts of interest were waived. Finally, Mr Clayton as trustee, with the consent of Mr Clayton as Principal Family Member, had the power to vary or revoke any provisions of the trust deed (save insofar as such variation infringed the rules against perpetuities).

The case was argued before four courts as it worked its way up the levels. Although invited to find that the trust was a sham, the Family Court, at first instance, found instead that the trust was illusory, on the basis that the irreducible core of obligations required for a valid trust – namely, the ability of the beneficiaries to hold the trustee to account[6] – was missing. The High Court disagreed with the analysis in relation to the effect of the trust’s provisions insofar as the irreducible core obligations were concerned,[7] although it upheld the finding that the trust was illusory based on the structure of the trust as set out in the deed, including the provisions granting significant control to Mr Clayton as set out above. The Court of Appeal found that the trust was neither a sham nor illusory,[8] but found that the power of appointment was relationship property for the purposes of the Claytons’ divorce.[9] The Supreme Court[10] found that some of Mr Clayton’s other powers (but not the power of appointment) under the trust deed were relationship property (having equal value to the net assets of the trust), but did not reach a concluded view on whether the trust was illusory.

Pugachev

Perhaps the best-known case in recent years in relation to sham and illusory trusts is Pugachev.[11] In contrast to some of the cases that came before it, which might be considered to have been more extreme examples of retention of control by the settlor, the English High Court in Pugachev found five trusts to be illusory based on powers that were much more commonplace.[12] Although an authority on illusory trusts, Birss J actually expressed the view that the term was unhelpful, noting that the question was whether ‘according to the terms of the deeds, properly construed and on a proper application of the law to them, the trusts were not effective to divest Mr Pugachev of his beneficial ownership of the assets put into them.’[13]

Mr Pugachev set up a number of discretionary trusts for himself and his family in New Zealand. He was the first protector, with his son due to take his place as protector if he came under any “disability”, which in fact happened when an order was made in England and Wales freezing his assets (Mr Pugachev having been Putin’s former banker). The trustees were ostensibly independent, although the directors of each trust company were found to act at Mr Pugachev’s direction. The trustees required the protector’s consent to exercise various powers, including powers of distribution of income or capital, investment powers, and the power to vary the trust deed.

The liquidators of a Russian bank brought proceedings against Mr Pugachev alleging that he had misappropriated substantial funds from the bank and the question arose whether the trust assets were available to meet the judgment debt. The bank claimed that the trusts should be set aside as illusory or sham trusts, or alternatively as transactions designed to defeat the interests of creditors contrary to the Insolvency Act 1986. At trial, all three of these lines of attack on the trusts were successful, although we will focus here on the first two. Birss J found that the trusts were illusory because, on an interpretation of the trust deeds (which gave Mr Pugachev significant control), Mr Pugachev had retained beneficial ownership of the assets: ‘The true effect of all the trust deeds in this case, properly construed, is to leave Mr Pugachev in control of the trust assets. Mr Pugachev is the beneficial owner. They amount to a bare trust for Mr Pugachev.’[14] This primary finding was sufficient to set aside the trusts and there was no need for Birss J to consider whether, in the alternative, the trusts were a sham. Nevertheless, he did consider this issue, relying on the requisite shamming intent on the part of the New Zealand solicitor who drafted the trusts to find that the trusts were a sham.

The authors of Lewin on Trust disagree with the analysis in Pugachev, noting that Birss J’s reasoning depended on an analysis of the powers of the settlor as protector as personal powers exercisable for the settlor’s own benefit. There are obvious difficulties with this analysis when it comes to the power to appoint or remove trustees, for example, because, unless the settlor can direct a new trustee to act contrary to the interests of beneficiaries, he would not have effective beneficial ownership of the trust assets (and of course, such a power would be inconsistent with the court’s finding that the trustee’s powers were fiduciary in nature).[15]

‘The doubts about the court’s decision [in Pugachev] arise, not from the statement of the test that was considered to be applicable, but, from the court’s decision that it was enough to satisfy that test that the settlor retained a personal power to appoint and remove beneficiaries and to veto exercises of the trustees’ fiduciary powers in favour of beneficiaries other than the settlor, as well as a personal power to remove trustees.’[16] It is true that the Court in Pugachev found an illusory trust in circumstances where the settlor’s powers were relatively commonplace, but those powers cannot be analysed individually and in a vacuum. ‘The deed of trust must be construed as a whole against the background facts which existed at the time the trust deed was executed.’[17] The following factors in particular meant that, whilst individual powers reserved to the settlor may have appeared on their face to be commonplace, the overall effect was to create an illusory trust (or more accurately, to fail to create a trust):[18]

• Mr Pugachev’s tripartite status as settlor, protector and beneficiary (suggesting that his powers qua protector were conferred to protect his own interests rather than those of other beneficiaries);
• There was nothing in the drafting of the trust deed to indicate that the settlor’s powers were to be fiduciary rather than personal in nature;[19]
• The trustees were all SPVs incorporated for the purpose of acting as trustees and controlled by Mr Pugachev;
• It was the concatenation of powers that ultimately rendered the trust illusory, rather than the effect of any one power.[20]

Webb

The Privy Council had cause to consider the extent to which a retention of control by a settlor could invalidate a trust in Webb v Webb, a case in which the husband was the settlor, trustee and beneficiary under discretionary trusts and reserved extensive powers to himself, including a power to make himself the sole beneficiary.[21] Rather unhelpfully, for present purposes, the Board found that the husband had reserved powers to himself that were indistinguishable from ownership but without making any clear finding that this invalidated the trusts.[22]

Mr Webb settled a family trust, known as the Arorangi Trust, to hold land and other assets in the Cook Islands, including a property in which he lived with his wife and children. He appointed himself as trustee and “consultant” and nominated himself and his son (from a previous marriage) as beneficiaries. Mr Webb was the sole trustee and, in his capacity as consultant, had the power to appoint or replace trustees at any time at his absolute discretion and without having to give reasons. He also had the power to advise on all matters relating to the trust’s investments and consent to variations of the trust deed. Any conflict of interest was waived.

Crucially, Mr Webb also had the power to ‘nominate himself as sole beneficiary in place of the existing beneficiaries and in that way to become settlor, Trustee, Consultant and sole beneficiary.’[23] He enjoyed this power as settlor, not as trustee; it was therefore not subject to any fiduciary duty. As sole trustee, and in his absolute discretion, he could pay himself the whole capital and income for his personal use as beneficiary, and had no obligation to preserve assets for the trust.

In due course, Mr and Mrs Webb separated. Mr Webb started a new relationship and arranged for the establishment of a new family trust, known as the Webb Family Trust, with himself and his new partner as trustees and himself and his children as beneficiaries on broadly the same terms as the Arorangi Trust. The settlor was purported to be a third party, Mr Leslie Ellison, but he only contributed an initial fund of NZ$ 10. Mr Webb then arranged for the Arorangi Trust to transfer some of its assets to the Webb Family Trust for nominal consideration.

Mrs Webb subsequently commenced proceedings for matrimonial property orders, asserting that the trusts were invalid because ‘they lacked the irreducible core of obligations necessary for a trust to exist; they were shams; and the settlor of each trust did not intend to relinquish control of the beneficial interest in the trust property.’[24]

At first instance, the Court found that the trusts were valid, despite finding Mr Webb’s evidence to be ‘vague, evasive, at times contradictory and unreliable’,[25] and that in any event, a debt that Mr Webb owed to the New Zealand Inland Revenue Department (“IRD”) of approximately NZ$ 26 million would exhaust any matrimonial property in the trusts leaving nothing available for division. The Court of Appeal, however, found that ‘the trust deeds failed to record an effective alienation of the beneficial interest in the assets in question’,[26] such that the trusts were valid. Moreover, the Arorangi Trust was unaffected by the IRD debt, which was not enforceable in the Cook Islands. These findings were upheld by the Privy Council.

Further articles in this series

This article is part of a mini series that explores the relationship between sham trusts and illusory trusts. Other articles in the series include:

• Part 1: An introduction to sham and illusory trusts;
• Part 3: The effect of reserved powers legislation;
• Part 4: The idea of emerging validity; and
• Part 5: The nomenclature for the future.

 

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[1] Clayton v Clayton [2016] NZSC 29

[2] JSC Mezhdunarodniy Promyshlenniy Bank v Pugachev [2017] EWHC 2426 (Ch)

[3] Webb v Webb [2020] UKPC 22

[4] Bennett, M. J., (2021) The illusory trust doctrine: formal or substantive? Victoria University of Wellington Legal Research Papers. 11 VUWLRP 7/2021, at 28. See also at 20: ‘The discussion above of the courts’ reasoning demonstrates that courts’ discussions of [the illusory trust doctrine] take a variety of approaches, none well justified or explained.’

[5] [2013] NZHC 309

[6] See Armitage v Nurse [1998] Ch 241 at 253H: ‘there is an irreducible core of obligations owed by the trustees to the beneficiaries and enforceable by them which is fundamental to the concept of a trust. If the beneficiaries have no rights enforceable against the trustees there are no trusts.’ See also the defining characteristics of a trust as enshrined in Bermuda’s Trusts (Special Provisions) Act 1989 at s.2(2).

[7] The High Court found that the trustee had to act honestly and in good faith, and that the beneficiaries could enforce this, such that the irreducible core required for a trust was present.

[8] The Court of Appeal in fact considered that the terms “sham trust” and “illusory trust” were synonymous, which in turn caused it to make the mistake of finding that the trust was not illusory (because it lacked the intent required for a sham).

[9] [2015] NZCA 30

[10] The parties actually settled their dispute before the Supreme Court handed down its decision, but the Supreme Court considered it appropriate to deliver its judgment in any event, ‘given the importance of the issues’ – see: Clayton v Clayton, Op. Cit. (n. 3) at [3].

[11] Op. Cit. (n. 2)

[12] Russell, D. & Graham, T., (2018) Illusory Trusts, Trusts & Trustees. 24 (4), 307-318, at 307.

[13] Op. Cit. (n. 2)  at [71]

[14] Ibid. (n. 2) at [455]

[15] Lynton, T., Le Poidevin, N., and Brightwell, J., (2020) Lewin on Trusts, (20^th ed.), London Sweet & Maxwell at § 5-035A

[16] Ibid. at § 5-035D

[17] Russell, D. & Graham, T., Op. Cit. (n. 12), at 316.

[18] Loc. Cit.

[19] It is worth noting that personal powers may not always be exercisable entirely without regard to the interests of the trust’s beneficiaries. In Bermuda, for example, the court in In the matter of an application for information about a trust [2013] SC (Bda) 16 Civ found, in relation to a trust instrument which expressly provided that the protector’s powers were non-fiduciary, that: ‘The protector is implicitly to have regard to the interests of the beneficiaries in exercising his admittedly non-fiduciary powers of supervising the trust’s administration.’ Of course, the inherent jurisdiction of the Court to oversee trust administration means that the fact that a power is personal in nature does not preclude the Court from intervening in its exercise.

[20] This was consistent with the earlier Bermudian decision of Re AQ Revocable Trusts [2010] Bda LR 26 at [29]: ‘the concatenation of rights and powers in the Settlor, when coupled with the fact that he was the sole trustee at the time of the constitution of the Trusts, rendered this trust illusory during his lifetime.’

[21] Op. Cit. (n. 3)

[22] There were some indications in the judgment that the Privy Council was making a finding about the validity of the trust, for example at [89] where it found that the Court of Appeal was justified in finding that the settlor had reserved such broad powers that he had failed to make an effective disposition of property, but the analysis was not totally clear in its treatment of the issue. See further the assessment in Lynton, T., Le Poidevin, N., and Brightwell, J., Op. Cit. (n. 15) at § 5-035B.

[23] Op. Cit. (n. 3) at [83]

[24] Ibid. at [10].

[25] Ibid. at [12].

[26] Ibid. at [14].