Trust validity: oh what a tangled Webb we weave

If the powers retained by a settlor are so extensive and of such a nature that they amount to an uncontrolled power to recover the trust property, then the settlor’s rights are "tantamount to ownership" and he or she cannot be said successfully to have alienated his or her beneficial interest.

Tom McPhail reports on the Privy Council decision in Cook Islands case Webb which scrutinises the trust structure and the true reach of the settlor.

Webb v Webb [2020] is the latest in a line of recent cases in which the courts have applied equitable principles to prevent judgment debtors or divorcing spouses from putting their assets beyond reach in trust structures while in reality retaining control of them. It is suggested that the decision is consistent with a recent trend in common law jurisdictions around the world, involving courts showing a greater willingness by one route or another to prise open trust structures to achieve a just outcome as between the parties to a dispute. See, for instance, the judgment of Lord Collins in Tasarruf Mevduati Sigorta Fonu (TMSF) v Merrill Lynch Bank and Trust Company [2011] at para 8.

This is a rapidly developing area of law and the number of different analytical approaches courts have taken to achieve similar results has not provided great clarity for practitioners. The judgment in Webb offers useful guidance as to the approach to be adopted when assessing trust validity.

The case was an appeal to the Privy Council from the Court of Appeal of the Cook Islands and was heard by a board comprising Lord Wilson, Lord Carnwath, Lady Black, Lord Briggs and Lord Kitchin. Judgment was given on 3 August 2020 and the leading judgment was given by Lord Kitchin. All references are to the Court of Appeal judgment unless stated otherwise.

There were broadly three issues raised on the appeal:

• the enforceability in the Cook Islands of a tax debt incurred by Mr Webb to the New Zealand Inland Revenue Department (IRD);
  
  
• the validity of two trusts – the Arorangi Trust (the AT) and the Webb Family Trust (the WFT) – established by Mr Webb; and
  
  
• the approach to be taken by the court to the valuation of matrimonial assets.

Although the IRD tax issue in particular raises interesting questions on statutory construction and the application of the foreign tax principle, this article focuses on the validity issue, in respect of which the board was unanimous in its decision (Lord Wilson gave a dissenting judgment in respect of the IRD tax issue).

Background

As regards the validity issue, the relevant factual background can be summarised briefly. Mr Webb was an entrepreneur who operated his affairs through a complex structure of companies and trusts. He married his wife Rosemary in 2005. In 2006 they had a daughter, Bethany. Mr Webb also had a son, Sebastian, from a previous marriage.

Shortly after Mr and Mrs Webb married, Mr Webb established the AT for the purpose of acquiring land in the Arorangi area of the Cook Islands and other assets in that jurisdiction. As settlor, he appointed himself trustee and nominated himself and Sebastian as beneficiaries. In August 2013 the family moved from New Zealand to the Cook Islands. In April 2016 Mr and Mrs Webb separated. Mrs Webb and Bethany continued to live in the Cook Islands in a property acquired by the AT (the Arorangi property) but Mr Webb and Sebastian returned to New Zealand where Mr Webb began a relationship with a Ms Brenda Dixon.

At this time Mr Webb arranged for the establishment of the WFT. The formal settlor of the WFT was a Mr Leslie Ellison. Mr Webb and Ms Dixon were appointed as trustees and Mr Webb, Sebastian and Bethany were named as beneficiaries. Mr Webb also arranged for the AT to transfer some assets to the WFT for nominal consideration. In May 2016 Mrs Webb issued proceedings in the High Court of the Cook Islands seeking matrimonial property orders on the basis that she and Mr Webb had been unable to agree upon a division of the matrimonial property.

The decisions of the lower courts

High Court of the Cook Islands

The proceedings in the High Court of the Cook Islands were heard in May 2017 by Potter J. Mrs Webb contended that the property held in the AT and WFT (together, the trusts) should be subject to the matrimonial property orders as the trusts were both invalid. She advanced three principal arguments in support of her claim of invalidity:

• that the trusts lacked the irreducible core of obligations owed by trustees to beneficiaries and enforceable by the beneficiaries, without which no trust can be said to exist;
  
  
• that the trusts were shams; and
  
  
• that as a matter of construction of the terms of the trust deeds the settlor had not relinquished control of the beneficial interest in the trust property: what Birss J in JSC Mezhdunarodniy Promyshlenniy Bank v Pugachev [2017] described as the ‘true effect of the trusts’ claim.

Despite expressing concerns about Mr Webb’s evidence, Potter J rejected Mrs Webb’s case.

Mrs Webb’s first argument in relation to the irreducible core was largely based on clause 19 of the AT trust deed (and its equivalent in the WFT). This provided:

[...] it is hereby declared that no Beneficiary hereunder nor any third party shall have any claim, right or entitlement to call for accounts (whether audited or otherwise) from the Trustee in relation to the Trust Fund and the income thereof, or to obtain any information of any nature from the Trustee in relation to the Trust Fund and the income thereof or in relation to the trusts and powers hereof.

Mrs Webb submitted that as this clause limited the ability of the beneficiaries to obtain trust accounts and other information from the trustee it impaired the ability of the beneficiaries to enforce the trusteeship, a core element of a trust. However, Potter J held that although the clause appeared to impede the beneficiaries’ rights to call for accounts, it did not oust or purport to oust the court’s inherent jurisdiction to facilitate flow of information. In doing so, Potter J may have had reasoning in Schmidt v Rosewood [2003] in mind, where the Privy Council concluded that:

... a beneficiary’s right to seek disclosure of trust documents, although sometimes not inappropriately described as a proprietary right, is best approached as one aspect of the court’s inherent jurisdiction to supervise (and where appropriate intervene in) the administration of trusts.

Potter J took Mrs Webb’s second and third arguments together, as in her view they were both "essentially a sham allegation" and amounted to one point, namely that the trusts were invalid because ‘neither the settlors nor the trustees intended to create the rights and obligations of a trust’. In this regard, Potter J found that although Mr Webb had administered the AT in a ‘cavalier’ manner, she was not persuaded that he had intended it to be a sham when he established it. She came to substantively the same conclusion in relation to the WFT.

Court of Appeal of the Cook Islands

Following the dismissal of her claim by Potter J, Mrs Webb appealed to the Cook Islands Court of Appeal (CI CA). The appeal was heard in November 2017 and, in a judgment dated 24 November 2017, the appeal was allowed.

It was common ground on appeal that the trusts stood or fell together. The court therefore focused on the AT trust deed. Because of the way in which the matter had been approached by Potter J at first instance, the CI CA did not address the issue of sham in any detail, stating only that "it is sufficient to say that on the factual findings of the Judge the trusts were not shams" (para 66). Instead, the key issue identified by the court was (para 53):

... whether, on an objective analysis of the powers reserved to the respondent in [the AT trust deed], the settlor has evinced an intention to irrevocably relinquish a beneficial interest...

Answering this question required careful consideration of the terms of the AT deed. The court’s suggested approach in this connection merits setting out in some detail (para 56):

The matter is best tested by asking what would have occurred if the respondent had attempted to recover the property which he ostensibly settled on the trust. If a critical step in such an attempt would have required the assent of a truly independent person, or would have been subject to an enforceable fiduciary duty on his part, it could not be said that that the purported settlement on the trust was ineffective. Conversely if, on an objective view of the deed, the respondent had retained for himself the uncontrolled power to recover the property it could not be said that he had divested himself of his beneficial ownership of the property...

Adopting this approach, the court considered the terms of the AT trust deed and concluded (para 65):

... the two deeds of trust fail to record an effective alienation of the beneficial interest in the assets in question. The powers retained by [Mr Webb] meant that at any time he could have recovered, and still could recover, the property which he had purported to settle on the trusts. The trusts are therefore invalid.

The CI CA accordingly found for Mrs Webb. As she had made clear before the court that if the Arorangi property was allocated to her she would forego any claim against the other matrimonial assets, the CI CA directed that the interest in the property should vest in her (UKPC judgment para 17).

The Privy Council’s ruling

On appeal to the Privy Council, Mr Webb submitted that the CI CA had adopted an ‘unduly literal’ interpretation of the trust deeds and emphasised that as trustee of both trusts he owed fiduciary obligations to the beneficiaries, including in particular to act honestly and in good faith, to observe the terms of the trusts and to act in the best interests of all the beneficiaries (UKPC judgment para 76).

Lord Kitchin’s judgment largely adopted the approach taken by the CI CA. He began by noting that it has long been recognised that a completely general power of appointment may be "tantamount to ownership" (UKPC judgment at para 77, citing Lord Collins’ judgment in TMSF at paras 41-43) and then moved on to a consideration of the terms of the AT trust deed. He noted that in addition to Mr Webb’s role as sole trustee and one of two beneficiaries of the trust, he had reserved to himself very substantial powers. These included:

• clause 5.1, which permitted the trustee to appoint a "consultant", whose powers included:
  
  - assisting the trustee in the management of the trust (clause 5);
  - the ability, at his absolute discretion, and without giving reasons, to remove the trustee and appoint a replacement (clause 6.2);
  - the ability to request with any nominated beneficiary the early vesting of the trust property (clause 9.1); and
  - the ability to consent to a variation by the trustee of the trust deed (clause 18.1).
  
  Mr Webb had appointed himself as consultant when establishing the AT, so had reserved all these powers to himself from the outset;
  
  
• clause 14.1(c), which permitted Mr Webb to exercise all his powers as trustee "notwithstanding that his interests may conflict with his duties to the funds of the Trust or any beneficiary" (UKPC judgment at para 82); and
  
  
• clause 10, which reserved to Mr Webb qua settlor the power to nominate himself as sole beneficiary in place of the existing beneficiaries. In this way, Mr Webb would have become settlor, trustee, consultant and sole beneficiary.
•  

Having identified these powers, Lord Kitchin then set himself the task proposed by the CI CA, namely "to consider next various ways in which it is said that Mr Webb can exercise these powers to secure the benefit of the trust property to himself" (UKPC judgment, para 83). In doing so, he placed particular emphasis on clause 10, stressing that as Mr Webb held this power qua settlor he was not subject to any fiduciary duty in its exercise, irrespective of the operation of clause 14.1(c). He also held (dismissing Mr Webb’s submission to the contrary) that there was no inconsistency between the finding made by Potter J that the trusts were not shams and a conclusion that Mr Webb’s attempts to create the trusts had failed. He concluded that the CI CA was entitled to find that the trust deeds did not record an effective alienation by Mr Webb of his beneficial interest in the assets settled on trust.

Discussion

The "true effects" analysis

While analysis of trust validity along "true effects" lines will always necessarily involve careful analysis of the terms of a trust, the Privy Council’s decision in Webb provides helpful guidance in relation to the questions practitioners should have in mind when performing this exercise.

The decision also clarifies the law in this area and importantly endorses the approach taken by Birss J in Pugachev in his "true effects" analysis. In this regard, it is interesting to note that the editors of Lewin on Trusts describe the decision in Pugachev as "doubtful" (Lewin at §5-035), suggesting that earlier authority indicates:

... that even the retention of a personal power to revoke a trust or to appoint the entire trust property to the settlor does not prevent there being a valid trust in the meantime, taking effect in accordance with its terms.

In this regard, the editors rely on the judgment of the Supreme Court of New Zealand in Clayton v Clayton [2016] at para 125. There, the court referred to TMSF (emphasis added):

... it can be argued that, even though the VRPT [the trust] is effectively defeasible, in the sense that the VRPT powers in substance give Mr Clayton power to bring the VRPT to an end, there is no reason in principle why it should not be regarded as a trust and required to be administered in accordance with the VRPT deed until the exercise of the VRPT powers in that manner. In TMSF, the Privy Council found that the settlor’s powers to revoke the trust were such that the settlor could be regarded as having rights tantamount to ownership. It made no finding about the status of the trust in the period before the revocation powers were exercised, because it was not required to do so in order to resolve the issue before it. However, there was nothing in the judgment to indicate that the trust was invalid in the period before the power to revoke it was exercised.

The editors of Lewin conclude (at §5-035):

... the fact that the settlor reserves powers rather than an absolute beneficial interest means that the trusts can and will take effect in default of exercise of the retained powers...

In the light of the decision in Webb, this must now be thought to be doubtful. It should be noted that in Clayton the judgment went on to say that the court did not have a unanimous view about the argument raised in para 125 and that it did not intend to determine the issue (Clayton at para 127). Moreover, the significance of the judgment in TMSF not making any suggestion of invalidity should arguably not be accorded too much weight in circumstances where it was common ground between the parties in that case that the relevant trusts were valid (TMSF at para 9). Finally, it is relevant to note that Birss J had the distinction between the approach taken in TMSF and a conclusion that no valid trust had been created firmly in mind (Pugachev at para 164), so cannot be thought to have overlooked this possible alternative analysis.

It is not suggested in this article that a trust cannot exist in circumstances where a settlor has retained very extensive powers. The scenario described in Lewin, in which trusts take effect in default of the exercise of retained powers, can certainly occur. However, it is submitted that the key question is whether a right held by a settlor to recover trust property is uncontrolled. As the CI CA held (para 56, emphasis added):

If a critical step in [an attempt to recover the trust property] would have required the assent of a truly independent person, or would have been subject to an enforceable fiduciary duty on his part, it could not be said that that the purported settlement on the trust was ineffective.

In Webb the board found that Mr Webb’s ability to recover the trust property could not be said to be constrained, in particular because the clause 10 power was held by him qua settlor and he was not therefore subject to fiduciary obligations in its exercise.

It is submitted that this approach must be right analytically. In order for a settlement on trust to be valid it must involve the disposal by the settlor of both their legal and beneficial interests in the relevant property. If the powers retained by a settlor are so extensive and of such a nature that they amount to an uncontrolled power to recover the trust property, then the settlor’s rights are indeed ‘tantamount to ownership’ and he or she cannot be said successfully to have alienated his or her beneficial interest. No valid trust can therefore exist.

Sham

For the reasons set out above, the Privy Council did not consider the arguments raised at first instance that the AT and WFT were shams. This might be thought to reflect the evidential difficulties associated with a finding of sham (practically speaking, if courts have a more concrete route to the same result they are likely to take it) and also perhaps a wariness about following the potentially problematic reliance by Birss J in Pugachev on the trustee, Mr Patterson’s, "reckless indifference" as to Mr Pugachev’s true intentions as sufficient to implicate him in the shamming intent. One can easily imagine Potter J’s finding that Mr Webb had administered the AT in a "cavalier" fashion, when taken together with her finding that his evidence was generally unreliable, leading to a finding of sham along Pugachev grounds. That she did not do so arguably reflects a general lack of judicial enthusiasm for sham when presented with less arduous alternatives for arriving at the same result.

Conclusion for practitioners

The Privy Council’s decision in Webb provides useful clarification of the law on trust validity in the context of construction arguments. For private client practitioners, the judgment emphasises the importance of giving careful thought to the drafting of trust instruments and, in particular, to the extent of any retained powers and whether appropriate limitations on their exercise should be incorporated, particularly where it is anticipated that a settlor will also act as trustee and will be appointed as a beneficiary. For contentious trust lawyers, the judgment offers useful guidance on for how to approach an analysis of the "true effect" of the terms of a trust deed and when different conclusions as to the ability of creditors and divorcing spouses to access assets held in trust (and the route by which they can be accessed) will be appropriate.

Cases referenced:

• Clayton v Clayton [2016] WTLR 955 NZ SC
• JSC Mezhdunarodniy Promyshlenniy Bank & anor v Pugachev & ors [2017] EWHC 2426 (Ch)
• Schmidt v Rosewood Trust Ltd [2003] WTLR 565 PC
• Tasarruf Mevduati Sigorta Fonu v Merrill Lynch Bank & Trust Co (Cayman) Ltd [2011] WTLR 1249
• Webb v Webb [2020] WTLR 1461 PC

If you require further information about anything covered in this briefing, please contact Tom McPhail, or your usual contact at the firm on +44 (0)20 3375 7000.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, April 2021

This content was originally published in the April 2021 edition of Trust and Estates Law & Tax Journal, view here.