Trusts are an important tool for succession planning and wealth protection because they allow for a separation of legal and beneficial interests in the trust fund and trust assets. Trusts also provide flexibility as to how trust funds can be applied and enjoyed. As such they are a key element of any successful wealth management centre.
The growth of high-net-worth individuals (HNWIs) across the Asia region, especially in China, has stimulated a surge in the demand for wealth and estate planning services. As a global financial centre with a robust infrastructure, and a strong, sound legal system, Hong Kong continues to grow in strength as a trust hub.
Trusts are an effective mechanism for holding family assets collectively without the risks of individual ownership. The trust assets cease to be personal possessions of the settlor and are therefore protected in the event of future claims from creditors, family disagreements, divorces, financial difficulties or legal actions.
However, one recurring theme for many potential trust settlors is the issue of loss of control. In addition to the intentions set out in the trust deed, a settlor can aid the trustee in the management of the trust through a ‘letter of wishes’, which sets out how the trustee is to administer the trust after their death and, particularly, how they intend distributions to be made from a trust.
A letter of wishes, while not legally binding on the trustee, provides a general set of guidelines to determine the course of action that would be consistent with a settlor’s intentions. It is also possible to appoint a ‘protector’ in the trust deed to exercise control over the trustee – typically with powers to veto decisions of the trustee or even to terminate their appointment.
However settlors cannot avail themselves of the benefits of putting assets in trust whilst at the same time in reality maintaining control over the assets through extensive non-fiduciary personal powers. The transfer of assets into a trust should be a true divestiture of those assets.
The dangers of trying to retain too much control are amply illustrated by a recent decision of the UK High Court. It held that Sergei Pugachev, a Russian oligarch who was a settlor, ‘protector’ and discretionary beneficiary of five discretionary trusts worth approximately US$95 million, was the true owner of the trust assets and the Court could not therefore give effect to the trust instruments.
Pugachev was a prominent Russian businessman whose assets included a bank called Mezhprom, which collapsed following the financial crisis. In 2011, and after leaving Russia following the commencement of criminal investigations concerning his involvement in the collapse of the bank, he settled the first of five discretionary trusts.
A New Zealand solicitor drafted the trust deeds and the trustees were newly incorporated New Zealand companies. Each of the trusts was slightly different but the named discretionary beneficiaries included variously himself, his two adult sons, his current partner and their two children together. Each of the trust instruments named Pugachev as the ‘First Protector’, to be succeeded by his eldest son.
The bank’s liquidators, the Russian State Corporation Deposit Insurance Agency (DIA), brought claims against Pugachev in Russia seeking to recover losses claimed to amount to several billion dollars. By this time Pugachev was living in London so the DIA commenced proceedings in the UK to enforce the judgments obtained in Russia. The DIA claimed that the beneficial interest in the trust assets belonged to Pugachev, such that they could enforce their judgments against these assets.
The High Court found on the facts was that Pugachev’s intention was “not to cede control of his assets to someone else, it was to hide his control of them. In other words 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.”
The role of the protector was the means by which he did this. Pugachev had the power to refuse consent to the trustees’ exercise any of their powers which would normally vest in a trustee and he could dismiss trustees “with or without cause”. He was irrevocably appointed as a retiring trustee’s agent to vest the trust fund in continuing or new trustees. The Court held that the rights conferred on Pugachev could be exercised freely for his benefit and were not constrained by consideration of the interests of the discretionary beneficiaries.
The judge found therefore that the trusts did not divest Pugachev of control. The trust instruments were not shams: rather they fulfilled his true intention, which was not to lose control of the trust assets. If, on the other hand, the interpretation of the “true effect of the trusts” was wrong and they did divest Pugachev of his beneficial ownership, then the trust deeds would be a sham because “the settlor intended to use them to create a false impression as to his true intentions and the trustees went along with that recklessly”. The supposedly settled assets were therefore not held in trust and were available to meet the DIA’s claims.
Settlors should note that ultimately there must be a genuine alienation of the assets. Advisers and trustees need to be cautious in not being too accommodating of a settlor’s wishes where there is an aggressive scheme in terms of retention of control.