When is a company a trust?

When is a company a trust?

The principle of separate legal personality of a company has been affirmed in yesterday’s Supreme Court case of Prest v. Petrodel Resources Limited, and the principles upon which the court will act to “pierce the corporate veil” have been clarified, but it remains the case that upon divorce, the court will look carefully at the reality of the structure to achieve a fair distribution of assets. The decision has important implications for all those engaged in the trusts and corporate services business.

A unanimous Supreme Court overturned the decision of the Court of Appeal yesterday in the case of Prest v. Petrodel Resources Limited and others [2013] UKSC 34 (400 KB PDF). At stake was the issue of whether it is open to the court, in an application for ancillary relief in divorce proceedings, to treat assets of a company of which one spouse is the sole controller as being assets to which that spouse is “entitled” for the purposes of Section 24(1)(a) of the Matrimonial Causes Act 1973. Lying at the heart of the matter are the competing objectives of the commercial and family law divisions, the former of which seeks adherence to established legal principles to ensure commercial certainty for parties dealing at arm’s length, while the latter aims to achieve a “fair result” in circumstances where the parties are dealing at anything but arm’s length.

In October 2011, High Court judge, Mr. Justice Moylan ordered the transfer of certain UK residential properties to Yasmin Prest, former wife of Michael Prest, as part of a £17.4 million divorce settlement. The properties (at stake) were owned by a number of Isle of Man companies over which Mr. Prest, a successful oil trader, exercised sole control and in respect of which he enjoyed an exclusive beneficial interest. Evidence showed that Mr. Prest had unrestricted access to the assets of the companies, so that the companies were, to all intents and purposes, his “money box”. He ran all his household expenses through the companies and all directors of the companies answered to him, to the extent that none could be said to be independent. Mr. Justice Moylan order the transfer of the properties, legally owned by the companies, on the basis that there is a wider jurisdiction conferred by Section 24(1)(a) of the Matrimonial Causes Act 1973 to pierce the corporate veil. The decision was overturned in the Court of Appeal.

There has been something of a practice in the family division of using Section 24(1)(a), to order distribution of assets held by a company, substantially owned by one spouse, to the other spouse, in the interests of justice, provided the remaining corporate assets are sufficient to satisfy the company’s creditors. Usually, it has been done without specifically addressing the issue of the “corporate veil”. This position was supported by Lord Justice Thorpe in Prest, but not, however, by the two commercial judges sitting with him. In a 2-1 decision the court, while noting that Mr. Prest’s failure to disclose financial information was “deceitful and shambolic”, nevertheless affirmed the principle that a company is a separate legal entity and that the assets of the companies concerned did not belong to Mr. Prest. In the majority view, it is beyond the court’s authority to order transfer of company assets unless the corporate personality of the company is being abused for a purpose which is improper in some relevant respect, or in a particular case, where it can be shown that assets legally owned by a company are, in fact, held in trust for the spouse. Neither requirement was found in this case. According to Lord Justice Patton, the family division has developed “an approach to company owned assets in ancillary relief applications which amounts almost to a separate legal system of legal rules unaffected by the relevant principles of English property and company law”. This practice, he asserted, “must now cease”. In his dissenting judgment, Lord Justice Thorpe, made the argument that allowing the companies to retain the properties in the circumstances would defeat the court’s “overriding duty to achieve a fair result” in divorce proceedings.

“I conclude that there is a limited principle of English law which applies when a person is under a legal obligation or liability or subject to an existing legal restriction which he deliberately evades or whose enforcement he deliberately frustrates by interposing a company under his control. The court may then pierce the corporate veil for the purpose, and only for the purpose, of depriving the company or its controllers of the advantage that they would otherwise have obtained by the company’s separate legal personality.”

And later:

“If there is no justification as a matter of general legal principle for piercing the corporate veil, I find it impossible to say that a special and wider principle applies in matrimonial proceedings by virtue of Section 24(1)(a) of the Matrimonial Causes Act 1973.”

On the facts of Prest, however, the Supreme Court found that Mr. Prest clearly used his own money to purchase the relevant properties and simply registered them in the names of the companies, there having been no separate and considered board decision to make the acquisitions. Indeed, Mr. Prest’s concerted efforts to conceal evidence arguably gave rise to an inference that full disclosure would have revealed the true nature of his interest. In the circumstances, the properties, were found to belong beneficially to Mr. Prest, and were thus held on resulting trust for his benefit. That being the case, the requirements of Section 24(1) (a) were met, the properties being assets to which Mr. Prest was “entitled either in possession or reversion”. Furthermore, because the properties were found to be held on resulting trust, the court did not have to establish impropriety as a means of piercing the corporate veil.

The decision in Prest has shown the court to be taking a pragmatic stance, finding its way to reaching what most would consider on the facts to be a “fair” result, while not eroding the fundamental legal principles around which the commercial world revolves. In the words of Lord Mance: “What can be said with confidence is that the strength of the principle in Salomon’s case and the number of other tools which the law has available mean that, if there are other situations in which piercing the veil may be relevant as a final fall-back, they are likely to be novel and very rare.” The court will be looking to facts, and the question of whether or not assets legally vested in a company are beneficially owned by its controller will be highly case-specific. It is of interest that the Supreme Court hearing this matter was comprised of 5 commercial division judges and 2 family division judges.

There will be many cases in which trust and corporate structures are established for legitimate purposes and properly administered, leaving a disadvantaged spouse unable to demonstrate impropriety. There will almost certainly be future abuses of such structures by those savvy enough to arrange their affairs on the basis of what has been tried, tested and found to succeed. In the wake of the 2010 Supreme Court decision in Radmacher v Granatino, pre-nuptial contracts are no longer void as a rule, and unromantic though it may be, seeking advance protection in the event of divorce may be the most certain way forward. Without a crystal ball, it can be almost impossible to conceive of the potential rise and fall of financial and marital fortunes and to plan accordingly. What is clear, however, as expressed by Lady Hale, is that:

“There is a public interest in spouses making proper provision for one another, both during and after their marriage, in particular when there are children to be cared for and educated….This means that the court’s role is an inquisitorial one….the court is entitled to draw such inferences as can properly be drawn from all the available material, including what has been disclosed, judicial experience of what is likely to be being concealed and the inherent probabilities, in deciding what the facts are.”

It is as well for all those involved in advising on estate plans, managing family business structures and those who act as trustees, or provide trust and corporate administration services, to have regard to the wider implications of the Prest decision. The facts of the case were extreme so that it was open to the Supreme Court to use conventional trust principles to achieve the “right” result. In ordinary companies where a trust and/or corporate structure is used to manage family wealth, proper records are kept of decisions to invest and manage assets, with clear financial records of the sources and use of funds, it would be virtually impossible to make the same argument. In such a situation, the structure may remain vulnerable to a challenge that in reality the assets are held on resulting trust for the person whose will, or directing mind, is seen to control the activities of the entities concerned.

Finally, in closing, it is as well to remember that Mrs. Prest’s victory may not avail her much actual financial benefit, as the assets held by the companies were encumbered by mortgages, meaning the rights of third party creditors will prevail.