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The Pugachev Chronicles: Revisiting the Law on Trusts

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About The Author

Jamil Mustafa (Private Law Editor)

Jamil is currently undertaking pupillage at a commercial chancery chambers, after obtaining an Outstanding on the BPTC at BPP University and a Distinction on the BCL at Oxford. His main legal interests are contract, tort and equity. Before the law, Jamil graduated with an MPhil in American History with Distinction from Clare College, Cambridge, and with First Class Honours in Government and History from the LSE. Outside academia, Jamil enjoys cricket, rugby and rowing and is a staunch supporter of Manchester United FC.

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The greater the power, the more dangerous the abuse. 

Edmund Burke

The litigious saga of Sergei Viktorovich Pugachev and Mezhpromn Bank has all the features of a Hollywood screenplay. Pugachev (P) founded Mezhprom Bank (the Bank) in 1992 and developed it into one of Russia’s largest private banks, whilst also playing a part in Vladimir Putin’s rise to power.

Fast-forward to 2008, P commenced a relationship with Alexandra Tolstoy, the daughter of Count Tolstoy and a descendent from a prominent line of Russian nobles dating back as far as the 11th century. P was now a man of vast wealth, with an estimated net worth of $15 billion. Not only did he own the Bank, but he also owned the largest shipyard in Russia and the second largest coking coal mine in the world.

However, around the same time that his relationship with Tolstoy began, things started to go wrong for P. The Bank suffered heavily in the global financial crisis. Even support from the Russian Central Bank came to no avail; the Bank had its licence revoked and was declared insolvent. This saw the Deposit Insurance Agency (DIA) appointed as its liquidator.

In early 2011, P fled Russia for England. The DIA subsequently claimed that P had misappropriated funds from the banks and placed them into five discretionary trusts he settled between 2011 and 2013. These trusts were alleged to consist of around $95 million worth of assets, held mostly for the benefit of himself, Tolstoy and their children. It allegedly also included various overseas properties, the trustees of which were specially incorporated New Zealand companies.

P soon became the subject of a worldwide freezing order, alongside various other subsequent orders, to assist in proceedings against him in Russia and other jurisdictions. In 2014, the English courts recognised the liquidation of the Bank, and P fled to his chateau in France.

In 2016, the Bank and the DIA brought proceedings in England to enforce a substantial judgment they had obtained against P in relation to the assets in the trusts. These enforcement proceedings produced a significant judgment: as this article examines, Birss J in JSC Mezhunarodniy Promyshlenniy Bank v Pugachev [2017] took an in-depth look at how trusts operate and the ways in which they can be stretched to breaking point.

The Claim

In Pugachev [2017], the Bank and the DIA sought to enforce judgment against assets in P's trusts on three bases:

  1. The trusts were illusory in that they were ineffective in divesting P of beneficial ownership of the assets settled under them. Birss J called this the ‘true effect’ of the trust claim.
  2. Alternatively, the trusts were shams and thus had no effect.
  3. If the first two bases failed, the trusts should be set aside pursuant to Section 423 of the Insolvency Act 1986, as the assets were transferred into the trusts to prejudice creditors.

Birss J found in favour of the claimants on all three bases. However, for the purposes of this article, it is the only the first two of these which are relevant; in particular, it is Birss J's remarks in respect of the first base that are of the most interest.

The ‘True Effect’ of the Trust Claim

The first claim, as identified by Birss J, principally raised a dispute as to the construction of the trust deeds themselves. The question was whether they divested P – the settlor of the trusts – of beneficial ownership in the assets settled under the trust, such that judgment could not be enforced against them.

In order to have a valid trust, the settlor must in principle part with the beneficial ownership of the assets settled thereunder, even if they are one of the beneficiaries of that trust. This is true, regardless of whether it is a fixed or discretionary trust. Furthermore, as per Wright v Atkyns [1823] Turn & R 143, any trust must comply with the three certainties of intention, subject and object; this was not in dispute in Pugachev [2017].

The approach to construction of the trust deeds was not a significant point of contention between the parties. Birss J held that when construing such documents, the court must:

[I]dentify the meaning of the relevant words (a) in the light of (i) the natural and ordinary meaning of those words, (ii) the overall purpose of the document, (iii) any other provisions of the document, (iv) the facts known and assumed by the party or parties at the time of execution of the document, and (v) common sense, but (b) ignoring subjective evidence of the parties' intentions.

However, what was contested fervently by the parties in Pugachev [2017] was whether  applying these principles articulated by Birss J – the trusts that P had settled were either:

  • Illusory. They would therefore represent bare trusts in favour of the settlor, such that P was not divested of beneficial ownership; or
  • Valid discretionary trusts. They would therefore involve real duties, rights and obligations, in a way that did see P divested of beneficial ownership.

Trusts: Some Basic Principles

The trusts in question in Pugachev [2017] were discretionary trusts. The distinguishing feature of such a trust is that the size and scope of the benefits that will be received by the beneficiaries under the trust is subject to the trustees’ discretion. The beneficiaries, unlike under a fixed trust, have no absolute current right to direct the trustees to give them any benefit.

It is on this basis, alongside other reasons, that Patrick Parkinson argues that beneficiaries under a discretionary trust do not necessarily obtain any proprietary right in the trust property (though he does concede that a closed list of discretionary beneficiaries can benefit from the principle of Saunders v Vautier [1841], and should therefore be regarded as holding a collective equitable estate).

Instead, whether a given beneficiary within the class of beneficiaries defined by the trust deed will receive any property depends upon whether the power given to a trustee in respect of the division of property is a trust power, which they are compelled to exercise in favour of that class. If a settlor fails to exercise a trust power, the court will usually compel them to exercise such powers according to the principles in Burrough v Philcox [1840], unless this would be clearly contrary to the settlor’s intention.

Crucially however, a trustee is under no duty to exercise a mere power. This was made clear by Lord Upjohn in Re Gulbenkian’s Settlement Trusts (No.1) [1968]. Mere powers are divided into two kinds:

  1. Fiduciary powersmere powers held by trustees; and
  2. Non-fiduciary powersmere powers held by anyone else.

A person vested with a fiduciary mere power, while having no duty to exercise that power, must still periodically consider its exercise, survey the objects within the power and consider the appropriateness of individual appointments. This was made clear in Re Gestetetner [1953] 1 All ER 1150. Consequently  as Warner J explained in Mettoy Pension Trustees Ltd v Evans [1991] 1 WLR 1587 – such powers are ‘to some extent subject to the control of the courts in relation to its exercise’. Indeed, if necessary, the court will step in to prevent malfeasance of use.

However, by contrast, a person vested with a non-fiduciary mere power is under no duty to either exercise the power or consider its exercise. Such powers thus fall outside the scope of judicial control, and are entirely personal.

Mezphrom Bank v Pugachev

The relevance of this sojourn into the nature of discretionary trusts, fiduciary and non-fiduciary powers becomes plain upon examination of the terms of the trust deeds that P settled with the allegedly misappropriated assets. Under each of these trusts, P was simultaneously the settlor, a beneficiary and a ‘protector’.

A protector is typically the holder of a group of powers or requirements of consent. They are more common in offshore trusts than trusts settled under English law (even though the trusts in question were settled under New Zealand law, for all intents and purposes in the proceedings, English law and New Zealand law were the same).

The powers that a protector may hold include powers of appointment (to appoint trustees), the power to veto any amendment to the trust deeds, or the power to remove any beneficiaries. The powers that P enjoyed as protector under the various trusts were very extensive and included the following:

  • To veto the distribution of income or capital from the trusts;
  • To veto the investment of the trust funds;
  • To veto any changes to the trust deeds; and
  • To appoint or remove trustees, with or without cause.

Although these powers were wide-ranging, they are not uncommonly held by a protector. The crucial question was therefore not what powers P had as protector under the trust, but concerned their nature: were they personal or fiduciary? Birss J held that a power would not be:

[P]urely personal if it must be exercised for a purpose, such as having regard to the interests of the discretionary beneficiaries as a whole or in order to promote the objects of the trust.

Their nature was a matter of construction of the deed, considering all the relevant circumstances. In particular, Birss J identified as a crucial factor was whether ‘the donee of the power also has other roles such as trustee, discretionary beneficiary and/or settlor’. He also considered that 'the actual powers conferred and their effect both individually and together’ would be relevant. Accordingly, it was the collective effect of all the powers that P enjoyed as protector, and the fact he was also the settlor and a beneficiary under the trusts, that led Birss J to conclude that the powers were merely personal and for the benefit of P. Birss J further stated:

If such extensive powers had been conferred on a third party as protector, with provisions barring that person from being a beneficiary, then I can see that a different result might follow but the fact it is a beneficiary on whom these powers are conferred militates against the idea of a limitation… Conversely if less extensive powers were conferred on a beneficiary/protector then again one might arrive at a different result but that is not this case.

Thus, Birss J significantly held that whether the powers were personal or fiduciary was not simply a function of the nature of those powers, but the differing capacities that the person who wielded them occupied in respect of the trust. Birss J opined that P had settled the trusts and intended the trust deeds to enable him to retain ‘complete control’ over the assets settled thereunder through his tripartite roles of settlor, beneficiary and protector.

The consequence of this, and its importance for the case, was that – as the extensive powers P wielded as protector were personal – the trusts were nothing more than simply bare trusts constructed in his favour. As P had not in fact divested himself of beneficial ownership of the assets, the creditors could enforce judgment against them.

The fact that the trust deeds stated that if P were under a disability  which included being subject to a claim by his creditors  he would be succeeded as protector by his son Viktor did not negative Birss J’s conclusion. Birss J concluded that Viktor would simply do his father’s bidding.

Ultimately, having regard to all of these factors, Birss J acceded to the claimants’ submission that the trusts were merely a vehicle by which he kept his assets away from creditors. Judgment was entered judgment in their favour on this basis.

The Sham Trust Claim

The claimants in Pugachev [2017] submitted that if the first base failed, the trusts were shams. Because the first base succeeded, Birss J’s remarks on the sham trust claim were purely obiter.

While there is some controversy as to whether there is any such thing as a sham trust, a sham trust is generally defined as a trust intended to mislead third parties and the court as to the true basis upon which assets are held. In Shalson v Russo [2003], it was held that a sham trust requires a subjective common intention of the trustee and settlor that the trust be a sham. In A v A [2007], it was accepted that reckless indifference is enough to constitute a common intention, but also confirmed that a trust that was not originally a sham cannot subsequently become a sham.

Birss J in Pugachev [2017] concluded that it was clearly P's intention that he would not cede control of the assets by settling them under the trusts. The trusts merely served to hide his ownership of those assets; a conclusion supported by the factors referred relevant to the the ‘true-effect’ of the trusts base. Birss J further held that the trustees of the trusts, who simply went along with P's scheme, were recklessly indifferent to that intention if not acutely aware of it.

However, in the view of Birss J, this did not therefore make the trusts ‘shams’; they fulfilled P's intention of retaining beneficial ownership of the assets. There was no intention to mislead third parties or the court as to the true nature of the basis upon which the assets were held. It was clearly their common intention, and clear to third parties and the court, that the wide-ranging personal powers held by P meant that he was the true owner of the assets.

Yet Birss J suggested that, if the powers were held to be fiduciary in nature, then the trusts would be shams because P retained beneficial ownership of the assets; the trust deeds therefore gave the false impression to third parties that P did not retain beneficial ownership, and the trustees were recklessly blind towards the extent of his control over these trusts. Birss J likened this situation to a phenomenon in patent law known as the Angora cat problem, whereby in some circumstances, a patentee can argue for a narrow interpretation of a document in one context, and a wider one in another.

The same principle applied here: the sham, if the powers were fiduciary, was therefore a sophisticated one. In some dealings, P could put forward the argument that his powers as protector were limited and fiduciary. Meanwhile, in another context, P could assert that they were personal, and that he remained the ultimate beneficial owner of the assets.


In light of his conclusion on the previous two bases, Birss J could deal with the third claim briefly. He held that, whether under the ‘true effect’ of the trusts claim or the alternative sham trust basis, the trusts were a transaction to defraud creditors under Section 423 of the Insolvency Act 1986.

Herein perhaps lies the most importance feature of the judgment in Pugachev [2017]; the disposal of the ‘true effect’ of the trusts claims highlighted a distinct avenue for creditors to enforce judgment against assets settled under certain trusts. 

Indeed, a party making an allegation of a sham trust  such an allegation being one of dishonesty by the defendant  must satisfy a high evidential threshold, and the burden of proof falls squarely upon them. Accordingly, as Neuberger J averred in National Westminster Bank v Jones [2001] 1 BCLC 98, the court will be slow to find dishonesty and consequently a sham. Furthermore, the protection of Section 423 of the Insolvency Act 1986 may not be engaged in all situations.

However, the decision in Pugachev [2017] has now clarified that creditors have a distinct means of enforcing their claim against the assets of a debtor-cum-settlor by discerning whether upon the ‘true construction’ of the trust deeds the settlor had in fact divested himself of beneficial interest in the assets. Despite the fact that such an avenue will most likely be restricted to cases where the settlor is found to have a further role under a trust  whether as a trustee, protector or otherwise  the practical importance of this judgment should not be underestimated.

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Tagged: Banking & Finance, Equity, Litigation, Property Law, Trusts

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