November 29, 2020 Matthew Smith

WEBB v WEBB – PRIVY COUNCIL RULES COOK ISLANDS TRUSTS INVALID FOLLOWING EXCESSIVE RETENTION OF POWERS BY SETTLOR

MATTHEW SMITH, GENERAL COUNSEL

In a case which could have far-reaching implications for trust settlors loath to relinquish control of the assets they place into trusts, the Judicial Committee of the Privy Council has ruled in the case of Webb v Webb[1] that two Cook Islands domestic trusts established by a settlor who occupied multiple roles in respect of those trusts were invalid due to the extent of the powers over the trust fund which the settlor reserved to himself. A copy of the judgment is available here: https://www.jcpc.uk/cases/docs/jcpc-2019-0013-judgment.pdf.

The Judicial Committee of the Privy Council is based in London and acts as the highest court of appeal and court of last resort for a total of 32 Commonwealth and British Overseas Territories. Its decisions bind the courts of those territories, which include the Cook Islands, St Kitts and Nevis, the British Virgin Islands, the Cayman Islands, Bermuda, the Bahamas, Jersey, Guernsey, Gibraltar and the Isle of Man. This decision will therefore have binding effect in most of the major offshore trust centres, and will no doubt be regarded as highly persuasive in others.

The decision underscores the willingness of courts to prioritise substance over form when reviewing trust agreements, and continues the line of authority set down by the High Court of England and Wales in the 2017 case of Mezhprom Bank v Pugachev[2] (which is described in more detail here: ‘Introducing the Foundation Trust Structure’). It should act as a warning to settlors who believe that a separation of powers in the trust agreement will always be effective in allowing them to occupy multiple roles and to retain effective control and ownership of the trust fund.

Background

W, the settlor and a national of New Zealand, established the trusts in question in 2006 and 2016. W was also the sole trustee, the protector[3] and a beneficiary of each trust. As settlor, he retained a power to nominate himself as sole beneficiary of the trusts in place of the existing beneficiaries. As trustee, he was empowered, in his uncontrolled discretion, to pay and apply the whole of the capital and income of the trust fund for his personal use and advancement as a beneficiary, to the exclusion of any other beneficiary.

In due course W and his wife divorced and the wife claimed an entitlement to the assets held within the trusts. The wife sought to stake a claim to those assets by impugning the validity of the trusts on the basis that they lacked the irreducible core of obligations necessary for a trust to exist, that they were shams, and that W had had no intention of relinquishing control of the beneficial interest in the trust property when he had established the trusts.

Lower Court Findings

While the High Court of the Cook Islands found in favour of the settlor, the Cook Islands Court of Appeal ruled differently. It found that the trusts were invalid because there had been no effective alienation of the beneficial interest in the trust property by the settlor. The Court found that, as W had effectively retained beneficial control of the trust assets, the trusts did not, and never had, existed. The Court of Appeal reached some interesting conclusions as to whether the trusts were shams, as argued by the wife. It ruled that the trusts were not shams on the basis that there was no subjective intent, at the time of their establishment, to create a veneer of validity which would disguise the true intention behind the trusts; however, it found that as W, ‘on an objective view of the trust deed, had retained for himself the uncontrolled power to recover [trust] property, it could not be said that he had divested himself of his beneficial ownership of the property. The latter situation might usefully be described as an “objective nullity” to distinguish it from ‘sham’[4]. For more on trust validity and findings of sham, see ‘Is My Trust Valid’.

[1] [2020] UKPC 22
[2] [2017] EWHC 2426 (Ch)
[3] In this instance, the role of trust protector was named ‘consultant’

The Privy Council’s Findings

On further appeal, the Privy Council undertook a detailed analysis of the trust deeds of the two trusts, of the powers conferred by those deeds upon W, in his various capacities, and of the effect of those powers.

The Privy Council ruled that the powers exercised by W were ‘amply sufficient for [him] to arrange matters in such a way that he alone would hold the trust property on trust for himself and no-one else, with the consequence that the legal and beneficial interest in all of that property would vest in him[5]. It went on to find that the powers W had reserved to himself were so extensive that, in equity, he could be regarded as having rights which were indistinguishable from ownership, and upheld the Court of Appeal’s finding that the trust deeds of the trusts had failed to record an effective alienation by W of any of the trust property[6].

Accordingly, the Privy Council found that the trusts were invalid, and that the assets held within them had never left W’s ownership and therefore were subject to the wife’s matrimonial property claim.

Application to Cook Islands International Trusts

As stated above, the two trusts which were found to be invalid in this case were Cook Islands domestic trusts, rather than international trusts registered under the Cook Islands International Trusts Act 1984 (the ‘ITA’).

Had these trusts been international trusts, it would have been interesting to see how the Privy Council would have dealt with the effect of s 13C of the ITA, which specifically provides that a trust is not invalid where the settlor retains certain powers. These include powers of revocation, disposition, amendment and, at s 13C(g), where the settlor is a beneficiary, trustee or protector of the trust, either solely or together with others. However, given that the Privy Council’s findings were couched in terms of the settlor having retained equitable ownership, it is quite possible that equity would have prevailed and the Privy Council would have found that s 13C could not be relied on to validate the trust. Rather than focusing on the number of individual trust officer roles occupied by the settlor, the Privy Council took a more expansive approach and considered whether the accumulation of powers effectively reserved by the settlor was such as to allow it to draw the conclusion that he had retained effective ownership of the trust property.

It should not, therefore, be assumed that s 13C would necessarily come to the rescue in any future similar case involving an international trust.

[4] Paragraph 56 of Court of Appeal judgment, repeated at para 73 of Privy Council judgment.
[5] Paragraph 87 of Privy Council judgment.
[6] Paragraph 89 of Privy Council judgment.

Use of Nominee Settlor

One of the trusts in issue was settled not by W but by a professional settlor acting on W’s instruction. The Privy Council was quick to draw the inference that W was to be regarded as the true settlor of the trust in question. Again, this shows a willingness to focus not on what the trust deed says, but on what its effects are, and on the intention of the parties to it. This approach shows that the use of a nominee settlor to conceal the true identity of a settlor or beneficial owner will be ignored and of no effect.

Which Trusts Will be Affected by this Decision

Clients who have set up properly structured trusts, which provide for a genuine separation of powers between different trust officers and which are operated in such a manner as to ensure that an independent trustee can exercise proper oversight and management over the trust, have nothing to fear from this decision. However, it should act as a shot across the bows for those who have set up a trust structure which, on its surface, complies with the basic formalities but which has the effect of allowing a settlor to retain effective control over, and ownership of, the trust assets.

Settlors who occupy other roles within their trust structures, especially that of a co- or managing trustee, should pay particular heed to this decision and strongly consider resigning from their trustee role, or at the very least, seek to vary the trust deed to enable a transfer of power from themselves to the (independent) foreign trustee. Settlors who also occupy the role of trust protector, depending on the powers conferred on that role, would be well-advised to resign in favour of an independent third party (ideally a corporate entity situated in an offshore jurisdiction).

That said, it is important not to focus just on the number of roles occupied, but on the overall effect – again, we come back to substance over form. Another high-risk situation would arise where a settlor settles a trust, which may have an independent trustee and protector, but where the sole trust asset is a membership interest in an LLC which is managed by the settlor. In this scenario, the settlor retains day-to-day power over the management of all underlying trust assets and must ensure that they carry out their management functions in the best interests of the trust (as owner of the LLC), as distinguished from their own personal interests. They must also ensure that the trustee is kept regularly updated on transactions undertaken by the LLC, and that trustee consent is sought prior to making any distributions. For further insight as to how the trustee/manager relationship should be conducted in a way that maintains the integrity of a trust structure, see ‘A Company Underlying a Trust’.

A trust settlor who uses their position as manager of an underlying LLC to treat the LLC assets as their own, cut the trustee out of the loop and make distributions of LLC property for their own benefit without recourse to the trustee could now most likely expect to see their trust invalidated in the event it were challenged.

For a creditor unable to meet the extremely high fraudulent transfer bars set out in the ITA and the Nevis International Exempt Trust Ordinance, this decision could be a boon and could open up fresh areas of challenge in situations where a settlor has failed to divest themselves of sufficient control over trust assets by treating and dealing with them as his own.

If you wish to discuss this case and assess what action may be required to ensure your assets remain fully protected, please get in touch with your regular Southpac contact or contact us here.

Matthew Smith

Matthew Smith joined Southpac’s New Zealand office in March 2017 and is currently employed as Southpac’s General Counsel. He has a particular interest in Cook Islands and Nevis legislation and keeps a close eye on developments in those jurisdictions. Matthew is a dual-qualified lawyer/attorney, having been admitted as a Solicitor of the Senior Courts of England and Wales in 2008 and as a Barrister and Solicitor of the High Court of New Zealand in 2017. Prior to joining Southpac, he worked as a court lawyer at the Royal Courts of Justice in London, UK, where he advised judges of the High Court and Court of Appeal on case law, practice and procedure in appeals and judicial reviews across a variety of practice areas.
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