4 December 2023

Asset Protection Of Beneficiaries In Trusts Against Claimants

PAHA Law Firm


PAHA Law Firm
In this article we would like to analyze several key parameters related to the Chabra injunction.
Cyprus Wealth Management
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In this article we would like to analyze several key parameters related to the Chabra injunction. In essence it is a freezing order, granted under article 32(1) of the Courts Law L.14/60, but oposed to a Mareva injunction, it is directed to a third party which is not a party to the substantive proceedings at hand, and against whom the claimant has no available cause of action. (TSB Private Bank International SA v Chabra [1992] 1 WLR 231).

A Chabra injunction is not addressed against the third party per se, but against the principal defendant in the proceedings, and encompasses any assets held by the third party in its capacity as nominee shareholder (for companies) or as a trustee of the principal defendant (for Trusts). Thus, a grant of a Chabra injunction will block the third party from dissipating or parting with the assets, and thus ensuring their preservation until the case is fully litigated.

The Test:

As a general principle the Court will consider whether the following 3 requirements are jointly met when asked to grant a Chabra injunction:

1) "That there is a 'good reason to suppose' that assets held by a third party could later be available in the proceedings at hand to satisfy a judgment against the defendant. There is no need to establish the beneficial ownership of the defendant in a strict trust law sense, but instead to show that the defendant has 'substantive control"; (Dadourian Group International v Azuri (2005) EWHC 1768)

2) "That it is 'just and convenient' for the court to grant such an injunction"; (Yukos Capital Sarl v OJSC Rosneft Oil Co (2010) EWHC 784).

3) A Chabra injunction may be given in circumstances in which:

(i) "the third party holds, is using, or has exercised or is exercising a power of disposition over, or is otherwise in possession of assets, including "claims and expectancies of the judgment debtor or potential judgment debtor; or

(ii) some process, ultimately enforceable by the courts, is or may be available to the judgment creditor as a consequence of a judgment against that actual or potential judgment debtor, pursuant to which, whether by appointment of a liquidator, trustee in bankruptcy, receiver or otherwise, the third party may be obliged to disgorge property or otherwise contribute to the funds or property of the judgment debtor to help satisfy the judgment against the judgment debtor".

* [1] The 'good reason to suppose' test, is more or less materially the same with the 'good arguable case' test.

Conclusions in relation to claimants or creditors pursuing a Chabra injunction directed to a Trustee in order to reach a debtor-beneficiary's assets:

A. According to the 2 year rule embedded in article 3(3) of the Cyprus International Trust Law, should a person decide to defraud his creditors having knowledge that a debt was due and decides to alienate his property via settling that property in a trust fund, then the court could order the trustee to revoke such transfer and disposal of assets as being null and void due to unjust enrichment in restitutio ad integrum.

B. The recent trend is that the courts are adopting a flexible approach when issuing discovery orders for the claimant to be in position to examine whether a debtor-beneficiary has assets under management which could be subjected to a Chabra injunction. This can be seen in JSC Mezhdunarodniy Promyshlenniy Bank & Anr v Sergei Viktoovich Pugachev ("Pugachev") a Cayman Islands well known case which saw the light after the Panama Papers, where such a discovery Order was granted by the courts.

C. There is a very critical difference between a discretionary and fixed trust as based on this distinction one may determine whether the beneficiary has a proprietary right to the part of the trust fund that he is entitled to or such beneficiary's right will be crystallized only at the time that the trustee has decided so. Thus, whether a trust is a discretionary or a fixed one, depends on the powers and discretion conferred on the trustee. The courts shall not be occupied with the labelling of the trust, rather they will exercise their discretionary powers to decide if it is a fixed or a discretionary one depending on the provisions of the trust to seek the actual intention, i.e whether the Trustee has been granted an absolute power to administer and manage a Trust or if there are mandatory provisions (i.e regulations and ByLaws) which in essence dictate to the Trustee by the beneficiaries how their proprietary rights are to be managed or if for example there are fixed and pre-determined ascertainable rights allocated to each beneficiary with a fixed periodical payment. Where the courts find that a beneficiary has a substantive power and current control over his assets then the trust will be considered as a fixed trust and the creditor will be able to ask the court to issue a Chabra interim order and direct the Trustee to freeze his assets. In various US cases including Lineback v Stout it was determined that a trust where the trustee has discretion only as to the time or method of making payments is not a true discretionary trust.

D. It is important to note that in relation to the second requirement which must be jointly met for the courts to issue a Chabra injunction being the "just and convenient" condition, where multiple beneficiaries exist being members of various classes with different type of rights, the courts are generally reluctant to grant a Chabra interim order against the principle defendant – beneficiary in the proceedings in order to avoid affecting the rights of innocent third party beneficiaries in a Trust.

E. The primary principle being a trend in recent international case law, points out that if the beneficiaries have proprietary rights to the trust fund and can demand the same from the trustee as it applies in a fixed trust, then the creditors have the right to claim such proprietary interest of the beneficiary from the trustee. In a recent Jersey case Kea Investments v Watson (2021) which is typical of the trend seen in other cases reviewed, it was determined that the opposite applies to a discretionary trust whereby the beneficiaries did not have any form of ownership over the trust assets and could not assign or transfer their rights or interest in accordance with the provisions of the trust deed, whereby a judgment creditor could not compel the trustee to pay over any part of the trust funds because the court will not undertake to control the trustee with respect to the exercise of a discretionary power. However, the opposite applies to a fixed trust. If a trustee can be compelled by a beneficiary to pay out any of the trust funds since the beneficiary has a right to a payment from the trust as in a fixed trust, then a creditor of the beneficiary can compel the trustee to pay him by judicial order. In a US case, Brown v Fletcher, it was determined that the rights of the beneficiaries depended upon the terms of the trust, pursuant to which the beneficiary had an interest in and to the property which was an indefeasible proprietary right of possession which was to be made available at the age of 55, then a creditor had a right to demand such interest through the trustee under the same terms.

F. The settlor who has more confidence in the trustee may give that person more discretion. Under the terms of a discretionary trust, the trustee has discretion over payments of either the income or the principle or both. In some cases, the trustee has the discretion to choose the specific beneficiaries from a group that the trustee indicates. Unlike the mandatory trust beneficiaries, the beneficiaries of a discretionary trust cannot force the trustee to pay out any of the trust funds. This is an important distinction because if the beneficiary has no right to a payment from the trust, neither does the beneficiary's creditors. Thus, a creditor of the beneficiary cannot by judicial order, compel the trustee to pay him. Nonetheless, the creditor is not without a remedy because of the existence of the cutting off income rule. According to that rule, if the trustee exercises his discretion and pays the beneficiary, the trustee must pay the creditor who stands in the beneficiary's shoes. The lien attaches the moment in time between when the trustee exercises his discretion to pay the beneficiary and the time the property is transferred to the beneficiary. This rule also applies when the trustee pays money on the beneficiary's behalf.

G. It is worth mentioning that under US law there is a distinction between discretionary and spendthrift trusts relative to a creditor's ability to reach trust funds: In Bogert, Trust and Trustees § 228, pp. 524-32 (Rev.2d Ed. 1992) it is stated that:

"If the trust is a true 'discretionary' trust, the nature of the interest of the beneficiary, rather than any expressed restraint on his power to alienate or the rights of his creditors, determines questions of voluntary or involuntary alienation. The beneficiary cannot secure the aid of a court in compelling the trustee to pay or apply trust income or principal to him since the terms of the trust permit the trustee to withhold payments at his will. Until the trustee elects to make a payment the beneficiary has a mere expectancy. Nor can a creditor compel the trustee to exercise his discretion to make payments. If the beneficiary attempts to transfer his interest, or his creditors seek to take it, before the trustee has made an election to pay or apply, the transferee or creditor has no remedies against the trustee because he stands in the shoes of the beneficiary. If, however, the trustee exercises his discretion by making a decision to pay to or apply for the beneficiary, then the beneficiary can force the trustee to confer such a benefit on him, and he can transfer his right and his creditors can take advantage of it, if the trust does not have a spendthrift clause. If the trustee receives notice of an attempted voluntary transfer, or is served with process by a creditor of the beneficiary, before the making of his decision to allocate trust property to the beneficiary, he will be liable to the assignee or creditor if he thereafter uses his discretion and elects to pay to the beneficiary. In such a case his duty is to pay to the assignee or creditor if he decides to pay or apply, unless the discretionary trust instrument contains a spendthrift clause, or a statute gives rights to the creditor as in the case where the surplus of income over that needed for support is made liable to creditors."

H. The desire to protect assets from creditors whilst retaining ultimate control has resulted in the widespread creation of discretionary trusts which reserve extensive beneficial powers to settlors and/or beneficiaries. In Tasarruf Mevduati Sigorta Fonu (TMSF) v Merrill Lynch Bank and Trust Company (Cayman) Limited and others [2011] UKPC 17 the Privy council recently opined that in certain circumstances where a settlor has reserved a power of revocation to themselves, a judgment creditor can enforce its judgment via the appointment of a receiver over the power of revocation, who would then exercise that power to revoke the trust. The trust assets would revert to the receiver, but for distribution pari passu among the creditors of the settlor. What TMSF establishes is that contrary to what might have been supposed, such trusts may be attacked and destroyed by creditors. While in relation to existing trusts the position may be capable of improvement by a release of the powers in question, the concomitant relinquishment of control may well be unacceptable. When creating new trusts, trust providers will need to ensure that, in reserving powers, their clients understand that they may also be sowing the seeds of the trust's destruction.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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