The ties that bind

Mezhprom v Lenux

The decision of Justice Adrian Jack of the British Virgin Islands’ (BVI’s) Eastern Caribbean Supreme Court (the BVI Court) in Mezhprom v Lenux^[1] has triggered speculation among practitioners regarding the enforcement of foreign judgments in offshore jurisdictions with ‘firewall’ provisions.

The Mezhprom decision is a consequence of a long-running piece of litigation between the JSC Mezhdunarodniy Promyshlenniy Bank (Mezhprom), the State Corporation Deposit Insurance Agency (DIA) and Sergei Viktorovich Pugachev. Pugachev founded Mezhprom in 1992. However, following the 2008 financial crisis, Mezhprom went into liquidation, with the DIA appointed as liquidator. The DIA established that Pugachev had schemed to extract USD1.5 billion from Mezhprom for his personal benefit and a judgment to recover this sum was obtained in Russia.

The DIA initiated proceedings in England and Wales and obtained a worldwide freezing order against Pugachev, which included an order for disclosure of assets. As part of Pugachev’s disclosure, he stated that he was a discretionary beneficiary of five New Zealand-based trusts. The claimants then commenced proceedings in the England and Wales High Court (the English Court) seeking declarations that the beneficial interests in five discretionary trusts, all governed by New Zealand law, were held by Pugachev. The five trusts were set up, on professional advice, to hold approximately USD100 million of Pugachev’s assets. On the face of the documents, the trusts were discretionary, with Pugachev, his partner and his children among the discretionary class of beneficiaries. Pugachev was the protector of each trust, with his son Viktor named as successor protector, and was granted such extensive powers that it would be difficult for the trustees to act without the consent of the protector on any material matters. The English Court held that the powers in the trust instrument allowed Pugachev to exercise complete control of the trusts and it determined that the trustees of each trust held the trust assets on bare trust for Pugachev.

One of the New Zealand trusts, the Green Residence Trust (the Trust), held all of the issued share capital in Lenux Group (Lenux), a BVI company that, in turn, owned a large country house and estate in the Gorki-10 village near Moscow. The order required the current trustee of the Trust, Miharo, a company based in New Zealand, to execute a stock transfer form transferring the Lenux shares to Mezhprom.

In the circumstances, Miharo failed to comply and Master Price was authorised to execute the stock transfer form. However, Lenux had been struck off the register of companies on 1 November 2018 for failing to pay fees, so there was no means of registering the transfer of shares. The claimants sought an order in the BVI for rectification of the register of shareholders and the making of a new register of members to enable them to restore Lenux to the register of companies.

Determining jurisdiction

As a matter of BVI law, Jack J first had to determine whether the English Court had jurisdiction over Miharo. Under Rule 43 of Dicey, Morris and Collins’ on the Conflicts of Laws,^[2] sets out the four circumstances when a court outside the UK has jurisdiction to give a judgment in personam capable of enforcement or recognition against the person against whom it was given:

1. If the person against whom the judgment was given was, at the time the proceedings were instituted, present in the foreign jurisdiction.
2. If the person against whom the judgment was given was the claimant, or counterclaimed, in the proceedings in the foreign court.
3. If the person against whom the judgment was given, submitted to the jurisdiction of that court by voluntarily appearing in the proceedings.
4. If the person against whom the judgment was given had before the commencement of the proceedings agreed, in respect of the subject matter of the proceedings, to submit to the jurisdiction of that court or of the courts of that country.

The only possible case applicable in Mezhprom was the third case. The only defendant parties represented in the proceedings were the three minor children of Pugachev, represented by their mother as a litigation friend. Miharo’s only direct involvement in the English Court proceedings was to challenge the making of a freezing order but it expressly reserved its right to challenge the jurisdiction of the English Court.

Counsel for the claimants submitted that the English Court had jurisdiction under Practice Direction 6B of the Civil Procedure Rules 1998, which corresponds to the Eastern Caribbean Supreme Court Civil Procedure Rules 2000. The BVI Court accepted that the English Court, under its own rules and jurisdiction, had jurisdiction over Miharo. However, this was irrelevant to whether it had jurisdiction in accordance with the BVI rules of private international law.

Jack J held that the claimants failed to show that Miharo had submitted to the jurisdiction of the English Court, given that it had expressly reserved its right to challenge the jurisdiction of the English Court. Jack J held that there must be some positive act showing that Miharo accepted the jurisdiction of the English Court if it was to be treated as having submitted to that jurisdiction. As such, the claimants failed to show that the English Court had jurisdiction over Miharo under Rule 43 of Dicey.

Estoppel of privity of interest

Although Jack J held that the English Court did not have jurisdiction under Rule 43 of Dicey, he drew counsel for the claimants’ attention to the case of House of Spring Gardens Ltd v Waite.^[3] This case related to a dispute over a bullet‑proof vest invention where William Waite persuaded the plaintiff to impart valuable information in respect of the invention on the basis that they would enter into a joint venture to supply the vests to the Libyan army and share the profits. This arrangement was not documented, it was a mere oral agreement. Waite, his son Seamus Waite, (the Waites) and his son-in-law Gordon McLeod, went on to deceive the plaintiff into thinking that discussions with the Libyan army had broken down, while secretly entering into a contract with the Libyan army themselves (without the plaintiff) and began manufacturing the vests in Cork, Ireland.

The plaintiff discovered the deception and brought a claim in Ireland for damages. The Irish action culminated in Justice Costello’s Supreme Court of Ireland (the Irish Court) judgment in favour of the plaintiff, with an award of GBP3.75 million.^[4] The Irish Court judgment was then challenged by the Waites on the basis that the plaintiff had obtained the judgment by deception or fraud. They sought a new trial of this action on the basis that the new evidence had come to light which indicated the plaintiffs had conducted the proceedings to deceive the Irish Court in the administration of justice. The third defendant, McLeod, was not involved in this action. Their claim failed and was dismissed.

The plaintiff issued enforcement proceedings in the English Court seeking to obtain a freezing junction to prevent the defendants from removing assets from the jurisdiction. All three of the defendants, the Waites and McLeod, filed defences and again claimed that the Irish judgment had been obtained by deception or fraud. The English Court held that the Waites were estopped from alleging fraud and that McLeod was bound by the estoppel of privity of interest between him and the Waites.^[5] The third defendant, McLeod, appealed.^[6]

Under Rule 48 of Dicey, a foreign judgment that is final and conclusive on its merits and is not impeachable on the grounds of fraud (or other grounds that are not material) is conclusive as to any matter thereby adjudicated upon and cannot be impeached for any error of fact or law.^[7] Although McLeod was not a party to the Irish fraud action, an estoppel will bind those who are privy to the parties bound.^[8] This must be privity of either blood, title or interest. The England and Wales Court of Appeal noted that the only relevant privity in this case was privity of interest and it considered what amounts to a sufficient interest. A judgment against a defendant in one capacity does not bind him in another capacity. Further, a mere interest in the outcome of the litigation is not sufficient to establish privity of interest.

The Court of Appeal judgment set out the test for privity of interest that was propounded by Vice‑Chancellor Megarry in Gleeson v J Wippell and Co Ltd:^[9]

‘Having due regard to the subject matter of the dispute, there must be a sufficient degree of identification between the two to make it just to hold that the decision to which one party should be binding in proceedings to which the other is party.’

Megarry’s judgment discussed the ability for a defendant to put his own defence in his own way and to call his own evidence. Any defence and evidence put forward by another defendant should only bind the defendant in the proceedings if that decision is fairly and truly said to be, in substance, a decision against him as well. In the absence of such a principle, it would enable a plaintiff to litigate against the frailest of defendants and use any victory in proceedings to bind other possible defendants who were not party to the proceedings.

The Court of Appeal also referred to a principle from Lord Denning’s UK Privy Council judgment in Nana Ofori Atta II v Nana Abus Bonsra II,^[10] in circumstances where a defendant stands by and merely watches proceedings. In House of Spring Gardens, all three defendants were joint tortfeasors (i.e., responsible for causing the same damage through the same act) and the judgment against them was joint and several. If the Waites’ action to set aside the judgment on the grounds of fraud had succeeded, the judgment would have been set aside in its entirety, which would have benefited McLeod. McLeod was happy to let the Waites fight his battle at no expense to himself, which the Court of Appeal held was sufficient to establish an estoppel binding him under privity of interest.

Miharo: privity of interest

Having determined that the English Court had no jurisdiction over Miharo under Rule 43 of Dicey, Jack J considered the application of privity of interest in Mezhprom. The BVI Court concluded that Miharo (as trustee) and the beneficiaries shared a common interest in establishing that the Trust was a proper discretionary trust and in defeating the claimants’ assertion that the Trust assets were held on bare trust for Pugachev. Jack J’s view was that this was a quintessential example of privity of interest, as Miharo was happy to allow the minor beneficiaries argue the case. It was, therefore, common sense that they should stand and fall together.

This analysis allowed Jack J to conclude that the BVI Court should recognise the jurisdiction of the English Court. The effect of the English Court’s judgment was that Miharo held the share in Lenux on bare trust for Mezhprom and the DIA, and that the register of members should be rectified to reflect this.

Firewall provisions

As the Trust in Mezhprom was a New Zealand trust, the BVI Court did not consider how the firewall legislation would have applied. Nonetheless, the Mezhprom BVI judgment has alerted practitioners to future issues with enforcing foreign judgments in offshore jurisdictions that have implemented firewall legislation. Jurisdictions with firewalls now include the Bahamas, Bermuda, the BVI, the Cayman Islands, Dubai International Financial Centre (DIFC), Gibraltar, Guernsey, Hong Kong, the Isle of Man, Jersey and Singapore.

This is legislation that protects local trusts by modifying the choice-of-law rules that would otherwise apply, so that certain potential challenges to the validity or effect of trusts, or to dispositions of property into trust, are to be governed only by their domestic law and challenges under foreign law are prevented.^[11] That is to say, Rule 43 of Dicey and the decision in House of Spring Gardens would not determine whether, as a matter of local law, a foreign court has jurisdiction under each firewalled jurisdiction’s international private laws. This would be determined by the local firewall legislation.

By way of example, if the Trust were a BVI‑law trust, the English Court would not have had jurisdiction to consider the validity of the Trust in a manner that would be binding in the BVI, unless the BVI Court had previously ruled that the foreign court was the appropriate forum to determine such issues under BVI law. The question of validity of a BVI-law trust would be determined only by the BVI Court. In the absence of an order of the BVI Court, the BVI Court would not recognise a foreign judgment that purportedly finds a BVI-law trust invalid.

Lack of firewall legislation

There now appears to be an issue for offshore trustees who do not have the protection of firewall legislation. If they are a party to foreign proceedings and do nothing, then they may be subject to a judgment that is binding on the trustees in jurisdictions where the trust assets are situated, if other parties to the litigation take part. Given that many trusts are created for asset-protection reasons, settlors and trustees may now seek the comfort of establishing and administering trusts within legislative regimes that benefit from firewall protections.

From a practitioners’ perspective, the Mezhprom trusts were ostensibly discretionary trusts. Pugachev obtained professional advice in New Zealand from a solicitor, Bill Patterson, on the establishment of the trusts that were held on discretionary trusts for Pugachev, his partner and his children. The trustees were private trust companies and Patterson and his wife were initially directors of the companies that acted as trustees. Pugachev was the protector of each trust and his son, Viktor, was named as successor protector.

Prior to the action in the English Court, the High Court of New Zealand had approved a change of trustees and the approach taken indicates that they considered the trusts to be legitimate.^[12] The English Court distinguished their findings on the basis that the facts before the New Zealand court were insufficient.

This begs the question of the possible outcome in Mezhprom, had New Zealand firewall provisions been in place. The New Zealand courts would likely have been solely responsible for considering whether the trusts were illusory or sham structures. Given the indication in the trustee action that the trusts were valid, there is a strong chance that the New Zealand courts would have upheld the trusts as valid discretionary trusts and the assets would be out of reach from the claimants in Mezhprom.

Participation in proceedings

The Mezhprom case illustrates that the estoppel of privity of interest may bind defendants to judgments in other jurisdictions, even in circumstances where they did not actively participate and expressly reserved their right to challenge the jurisdiction. As such, trustees may no longer be able to sit back while another party submits to the jurisdiction and defends the action. Trustees may now be faced with a decision to actively participate in proceedings if a co-defendant has submitted to the jurisdiction in question.

This highlights the need for parties interested in a trust to be on the same page when approaching foreign proceedings. Had the minor beneficiaries (via their litigation friend) not sought to defend the proceedings, the BVI Court would have concluded that Rule 43 in Dicey did not apply and the English Court did not have jurisdiction as a matter of BVI international private law, as the estoppel in House of Spring Garden would not apply.

Where parties interested in a trust do not share a common interest, the trustees may wish to actively participate in the proceedings. Megarry VC’s conclusions regarding privity of interest in Gleeson^[13] were formed on the grounds that ‘a defendant ought to be able to put his own defence in his own way, and to call his own evidence’.

In the absence of protection or an agreed approach between parties, trustees may have no viable alternative but to put forward their defence and call their own evidence. A likely consequence of the Mezhprom decision is that we will see an increase in parties challenging the authority of the England and Wales courts’ jurisdiction, or refusing to submit to the jurisdiction with a view to protecting their offshore assets. This question should be borne in mind by practitioners when setting up offshore trust structures to ensure that their clients’ interests are sufficiently protected.