Comment: The Strange Case of the Oligarch and Putin's Banker

Comment: The Strange Case of the Oligarch and Putin's Banker

The story behind the recent BBC documentary The Countess and the Russian Billionaire is surely of interest to the high net worth community and their advisers in more ways than one. Ryan Mowat and Katherine Pymont report on a sham trust fund and its consequences.

The programme recounts the failed romance between Alexandra Tolstoy, a descendent of the great Russian writer Leo Tolstoy, and the Russian oligarch Sergei Pugachev, once worth £10bn and known as Putin's banker.

Not only is it a sorry tale involving the flight of a former member of Putin's inner circle from Russian to London then France, allegations of his pursuit by the KGB and more poignantly his estrangement from his children, it also serves as salutary reminder to anyone tempted to use trust structures to hide wealth from creditors and in divorce cases, tax investigations or inheritance battles. 

The tale serves as salutary reminder to anyone tempted to use trust structures to hide wealth from creditors and in divorce cases, tax investigations or inheritance battles."

Mr Pugachev was a co-founder of Mezprombank which collapsed in 2010. In 2014 he was sued by the bank's liquidator, the Russian Deposit Insurance Agency (DIA), over claims he orchestrated one of the world's largest bank thefts, stealing $1bn from the bank after it was bailed out in the financial crisis. 

A freezing order over his assets was issued with various legal actions from the DIA following. In one of the actions, Mr Justice Birss of London's High Court found in 2017 that Mr Pugachev had used sham trusts to conceal his ownership of about £100m of wealth.

While the decision did not give rise to new precedent, it usefully restated the legal principles governing the concept of a sham trust  and is therefore 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 Pugachev. Although he had named himself as a beneficiary, he argued that his three children with former partner Countess Alexandra Tolstoy, were the real beneficiaries and that the trust was created to ensure their financial security. The claim was defended by the children (their mother Ms Tolstoy acting as litigation friend) and the companies which Pugachev had incorporated as trustees. 

Justice Birss ruled that Pugachev was in fact the sole beneficial owner of all five trusts. He concluded that 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 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 was this a critical decision in the long running dispute between Pugachev and the DIA in that it exposed the trust assets as his hidden wealth, but the ruling showed 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. 

As the documentary about Pugachev shows there are many lessons to be learned from his life story. His creation of discretionary trusts is one such lesson. The sham trust case JSC Mezhdunarodniy Promyshlenniy Bank & Anor v Pugachev & Ors [2017] EWHC 2426 (Ch) 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 the possibility of a challenge from a third party and a strong likelihood that, if challenged, the court will set aside the trust and declare it a sham. 

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

Subscribe to International Investment's free, twice-daily, newsletter