Balance of Power: Settlor Reserved Trust Powers Following Webb

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Overview


In 2017, the English High Court decision of Mezhprom v Pugachev caused ripples in the trusts world as to the extent to which a settlor of a trust can reserve powers for the trust to be considered valid. Several commentators dismissed the decision as an anomaly. However, the Privy Council’s 2020 decision in Webb v Webb suggests that courts in common law jurisdictions may be more inclined to strike down a trust as invalid if the settlor’s powers go too far.

The cases discussed below illustrate a new line of attack on trusts on the basis that they fall short of the following requirements for a valid trust to be established under the common law:

  • The settlor must adequately divest herself of any beneficial interest in the trust assets.
  • There must be an irreducible core of obligations that the trustees owe to the beneficiaries of the trust which are enforceable against the trustees (such obligations are fiduciary in nature, meaning that they must be exercised in the best interests of the beneficiaries as a whole, and the exercise of such powers are subject to the supervisory jurisdiction of the courts).

As well as the extent of the powers retained by the settlor, a determinative feature in each of these cases was the court’s analysis of the nature of the reserved powers, i.e., whether the powers were fiduciary or personal.

In Depth


Webb v Webb 2020

This recent case concerns discretionary trusts set up by a New Zealand individual, Mr Webb (H). Shortly after H’s second marriage to W in 2005, he set up a trust in the Cook Islands for the benefit of himself and his son from his first marriage (A Trust), appointing himself as the sole trustee. H and W subsequently had a daughter. In 2013, the A Trust acquired property in the Cook Islands, and the family moved from New Zealand to live there.

By 2016, the marriage had broken down, and H and his son moved back to New Zealand. H started a new relationship with D and set up a new trust in New Zealand (W Trust) for the benefit of H and his children, with H and D appointed as trustees. H then arranged to transfer assets from the A Trust to the W Trust for nominal consideration.

W commenced proceedings in the Cook Islands seeking a matrimonial property order; whilst she had no beneficial interest under the trusts, she argued that the trust assets should be taken into account when the court determined the assets she would receive on divorce. H claimed that the trust assets were held in trust and were not available for division with W under the matrimonial proceedings. W argued that the A and W Trusts were invalid such that H still owned the trust assets and that the trusts were shams.

W’s attack on the trusts failed initially, and the court sided with H. However, that decision was reversed by the Court of Appeal in the Cook Islands, which held that the trusts were invalid because (a) the trust deeds failed to record that H had divested himself of his beneficial interests in the trust assets, and (b) H retained powers under the trust deeds, which meant that he could recover the property purportedly settled on trust at any time.

H appealed to the Privy Council, contending that the lower court’s analysis of his powers was wrong. In his capacity as trustee, his powers were fiduciary in nature, and consequently he owed obligations to the beneficiaries to act in their best interests when exercising them. This was inconsistent with a finding that he could deal with the assets as his own.

The Privy Council considered H’s various roles and powers under the A Trust (the terms of the trusts were similar and therefore the analysis applied to both):

  • H was the sole trustee and was one of two beneficiaries.
  • H adopted the role of “consultant” as defined in the trust deed, which gave him various powers, including the power to remove and appoint new trustees.
  • H had various powers as trustee which were fiduciary in nature, meaning they must be exercised in the best interests of the beneficiaries. However, the court considered that there were various ways by which H could exercise his various powers to vest the trust assets in himself personally:

    – As settlor, H retained the power to nominate himself as the sole beneficiary—this power was non-fiduciary in nature.
    – The trust deed provided that the trustees could exercise their powers even where their interests conflicted with those of the beneficiaries.
    – As trustee, H had fiduciary powers to advance assets to another trust and to amend the trust deed, subject to consent of the consultant—i.e., himself.
    – H had a wide fiduciary power as trustee to appoint capital and income to himself to the exclusion of other beneficiaries “in his uncontrolled discretion”. The Privy Council considered that this amounted to a general power of appointment and relied on several previous decisions which have equated a general power of appointment with property ownership.

The Privy Council dismissed H’s appeal on the basis that H “had the power at any time to secure the benefit of all of the trust property to himself and to do so regardless of the interests of the other beneficiaries.” It also found that the trusts were invalid from the outset as “the trust deeds failed to record an effective alienation by Mr Webb of any of the trust property. The bundle of rights which he retained is indistinguishable from ownership”.

Pugachev Revisited?

Interestingly, the Privy Council did not refer to the Pugachev decision in the Webb judgment (although the lower courts referred to it in Webb). Pugachev concerned several New Zealand discretionary trusts set up by Mr Pugachev for the benefit of his family. Independent New Zealand trust companies were initially appointed as trustee of the trusts, and Mr Pugachev was also a beneficiary and protector of the trusts. As protector, he held fairly typical protector powers, such as powers to appoint and remove trustees, direct a sale of specific trust property and veto certain trustee decisions. Mr Pugachev did not have the power to appoint trust assets to himself; that power lay with the trustee, although Mr Pugachev could veto any proposed appointments to others.

Mr Pugachev founded the Mezhprom bank in Russia, which was liquidated by the Russian Government after the financial crisis in 2014, owing $2.2 billion. The liquidator sought to recover the $95 million assets Mr Pugachev settled on trust after he fled Russia, by attacking the validity of the trusts. The liquidator argued that Mr Pugachev effectively retained control of the trust assets through the powers he reserved in the trusts, and also challenged the transfer of the assets into trust. Even though there was nothing unusual about the powers that Mr Pugachev held as protector, the English High Court ruled that the trusts were invalid, and that the assets were held on bare trusts for Mr Pugachev and were therefore available to his creditors. Some points to note from the decision:

  • The beneficiaries argued that all of the protector powers were fiduciary and must be exercised in the interests of beneficial class; even if they were not fiduciary, the powers must be exercised in good faith and for their proper purposes such that the protector was subject to supervisory jurisdiction of the court. The court rejected this argument and found that all of the numerous powers held by Mr Pugachev as protector were purely personal in nature, meaning he was free to exercise them entirely in his own interests as a beneficiary rather than for the benefit of all of the beneficiaries. The court placed reliance on the fact that Mr Pugachev was a beneficiary and had the power to remove trustees “without cause”. Accordingly any exercise of these personal powers would not be subject to scrutiny by the courts. This finding contradicted a previous ruling by the New Zealand Court that Mr Pugachev’s power to remove trustees in these trusts was fiduciary.
  • The beneficiaries argued that the trusts were valid given that the trustee had fiduciary powers and was accountable to the beneficiaries. The court agreed that the trustees owed fiduciary powers, but stated that this would not be sufficient to prevent Mr Pugachev from simply removing a trustee who did not administer the trust in accordance with his wishes and replace them with a “friendly” trustee (although commentators have suggested that the court would have jurisdiction to intervene in such circumstances).
  • The court concluded that the terms of the trusts and the amount of powers held by Mr Pugachev did not “divest” him of his beneficial interests and effectively allowed him to retain his beneficial ownership of the trust assets. The court noted that had an independent or non-beneficiary protector been appointed instead of Mr Pugachev, it would have held that the protector powers were fiduciary.

The Pugachev decision was criticised at the time for the reasons set out above. On the facts, the Webb case goes further than Pugachev, as H held wide-ranging powers and held virtually all of the roles within the trust, namely trustee, consultant, settlor and beneficiary of the trusts. However, to set the Pugachev decision in context, when considering the separate question of whether the trusts were shams, the court formed the impression that Mr Pugachev had deliberately sought to use the trusts to hide his assets from his creditors. Further, it made findings on the evidence that (i) the trustees were not sufficiently independent of Mr Pugachev and followed his directions, and (ii) the transfers into trust were made for “asset protection” purposes.

In both cases, the courts held that the trusts were invalid from the outset because the powers they retained meant that the settlors never really surrendered their beneficial interests. This contrasts with the Privy Council’s approach in the 2011 TMSF v Merrill Lynch decision, where the court held that the settlor’s power to revoke the trust was similar in nature to a general power of appointment and as such was tantamount to ownership (the power was held to be personal rather than fiduciary). However, the trust was found to have been validly established until such time that the power of revocation was exercised. In Clayton v Clayton (2015), the New Zealand Supreme Court objectively examined the terms of the trust and concluded that the package of powers held by the settlor (who was also the sole trustee and a beneficiary, and held a “protector” type role) entitled him to appoint the trust property to himself without the need to account to the other beneficiaries. However, the court did not rule on whether the trust was valid until those powers were exercised as the parties settled the dispute. Both Webb and Pugachev analysed the Clayton decision in some detail.

In future cases where courts conclude that a settlor’s powers are tantamount to property ownership, in light of Webb and Pugachev it seems that courts will more readily find that no valid trust was established at all.

This type of attack on the validity of trusts is becoming more commonplace, in both the creditor and matrimonial context. The English High Court recently considered Webb in Law Society v Dua [2020], in which the Law Society unsuccessfully argued that trusts established by the defendants were invalid because the settlors had failed to divest themselves of their beneficial interests in various residential properties placed into trust. The defendants were trustees of the trust and had varied the terms such that they were excluded as beneficiaries. The Court held that on a true construction of the trust documents, the defendants owed fiduciary duties as trustees, which meant that their exclusion from benefit could not be reversed. Webb was also recently cited in divorce proceedings concerning a Cypriot trust, although the judgment has yet to be published.

The Position Offshore – Reserved Powers Legislation

Webb is a Privy Council decision and therefore will have weight in offshore jurisdictions where the Privy Council operates as the court of final appeal. However, several of these jurisdictions have already introduced reserved powers legislation which state that the reservation of one or more specific powers to the settlor or a protector will not invalidate the trust. These jurisdictions include the Bahamas, Bermuda, the BVI, the Cayman Islands, Guernsey and Jersey. (Gibraltar and the Isle Man have also ratified the Hague Convention on Trusts, which includes the general statement that a reservation of powers by the settlor is not necessarily inconsistent with the existence of a trust.) The general range of powers permitted by the legislation include powers of revocation, appointment/removal of trustees, powers to appoint income/capital, and powers to amend or vary the trust, to name a few. Some jurisdictions also expressly confirm that a trust will not be invalidated where a settlor retains a beneficial interest. Whilst there are differences in the legislation, it is designed to give some comfort to settlors that their chosen trust structures will be upheld. The question thus remains: will the Webb decision have any impact on trusts where reserved powers legislation applies?

Prior to the introduction of the reserved powers legislation, the position in Bermuda reflected the Hague Convention language that the reservation of powers was not necessarily inconsistent with the existence of a trust. Nevertheless, the Bermudan courts held in AQ Revocable Trust [2010] that the combination of the extensive powers held by the settlor, including a power of revocation, rendered the trust invalid during his lifetime. Since then, Bermuda and other jurisdictions have introduced legislation providing that a trust will be valid even if all of the specified powers have been retained in favour of the settlor or a protector. On the face of such legislation, it seems that Webb will not have much impact in those jurisdictions, although their courts have yet to interpret the reserved powers legislation, so we are still somewhat in the dark as to how rigidly the legislation will be applied. Also, many of these jurisdictions have looked to English law to develop their trust law principles such that the requirement that settlors divest themselves of the trust property and the irreducible core of obligations remain fundamental principles. Will the reserved powers legislation apply to validate a trust even if the fundamental principles are absent? There therefore remains a risk that even if the powers reserved are permitted by statute, if the combination of those powers and the factual circumstances have the true effect that the settlor still retains effective control of the trust property, the courts may find that trust is not valid. With that in mind, the Webb decision is likely to have some sway in how reserved powers trusts are treated in the offshore world.

Practical Points

Whilst Webb should give settlors and practitioners some pause for thought, on its facts it was a more extreme example of a settlor retaining too much control over the trust assets through extensive powers. Webb does not prohibit settlors from retaining powers over trust structures, but similarly it does not give any guidance on how far settlors can go. It is a question of balance as to the type and amount of powers that a settlor can safely retain; individual powers may on their own be unobjectionable, but in combination may tip the balance. To avoid getting caught out by the principles set out in Webb, a prudent settlor will:

  • Avoid holding all of the roles in the trust. For example, does the settlor really need to be a trustee and/or protector? Does the settlor need to be named as a beneficiary at all?
  • Engage an independent, professional fiduciary as a trustee or protector (on its own or in addition to the settlor), as its powers are more likely to be deemed fiduciary in nature.
  • Avoid granting powers that the settlor does not need in practice to protect the settlor’s interests or which do not serve the purpose of the trust.

With careful thought and planning, settlors should be able to retain sufficient powers and roles to ensure that the trust serves its function, safe in the knowledge that the structure will remain intact and not be susceptible to challenge from creditors or on divorce.