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16 Sep 2006

Innocent third parties – how English freezing orders affect overseas trustees

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English Courts have the power to grant worldwide freezing orders. This is a powerful tool to prevent a party (the "Respondent") from dissipating their assets. Whilst the effect of a freezing order on the Respondent is usually quite clear, a question often arises about its effect on innocent third parties – for example, trustees, banks or directors of companies which the Respondent owns.

Breaching an English freezing order can have serious consequences, and not just for the Respondent. Third parties who knowingly assist in or permit a breach of the freezing order can be held in contempt of court and liable to imprisonment (for up to two years), a fine or having their assets seized.

Do English freezing orders apply to all trusts?

The English Courts' standard form freezing order states on its face that it applies to any assets which the Respondent has the power (directly or indirectly) to dispose of or deal with as if they were his own. This includes assets where a third party holds or controls the asset to the Respondent's instructions.

It follows that freezing orders should not in principle apply to trusts, as it is the trustee who controls the assets and not the beneficiary or settlor (this is the more the case for discretionary trusts). However, the position becomes complicated if trustees have not exercised their duty of independence in administering the trust (or if the independent exercise of their powers has not been properly documented). In these circumstances, the English Court might decide that the freezing order does in fact apply to the trust assets in question.

Furthermore, the standard form freezing order expressly freezes "any interest under any trust or similar entity". The difficulty with this paragraph is that, particularly under a discretionary trust, a beneficiary does not have an actual interest (but in most cases only a contingent interest).

Do English freezing orders apply to trusts overseas?

English freezing orders do not automatically have extraterritorial effect. Usually, an overseas trustee will only be subject to the terms of the order if:

  1. The trustee is the Respondent's officer or agent and has been appointed by a power of attorney. Normal trust arrangements do not include an appointment by power of attorney of the trustee;

  2. The trustee (i) is subject to the jurisdiction of the English Court; (ii) has been given notice of the order at their residence or place of business within the jurisdiction of the English Court; and (iii) is able to prevent acts or omissions outside the jurisdiction of the English Court which constitute or assist in a breach of the freezing order; or

  3. The freezing order has been declared enforceable or has been enforced by the local courts. The freezing order will then take effect under the laws of the local jurisdiction. It is usual for countries with a common law system (such as Cyprus and the British Virgin Islands) to recognise English freezing orders. The position in respect of civil law systems varies from country to country.

If any of the above scenarios apply, the trustee must comply with the freezing order and not permit the Respondent to breach the injunction.

A freezing order usually contains a caveat that, as far as overseas assets are concerned, a third party is not prevented from complying with its obligations under local laws or under the law of any contract between it and the Respondent. Therefore, insofar as the trustee is legally or contractually required to take steps, they may comply with those obligations. For example, it would not normally be objectionable for a corporate trustee to pay company filing fees, directors' salaries or indeed legal or accounting invoices.

What are the other risks for trustees?

In summary, provided a trustee is offshore without an English presence, a freezing order will not normally apply to them unless it is recognised in the local jurisdiction. However, there are other significant risks which are more difficult to guard against. It is extremely important to consider these risks in light of local laws regarding the trustee's duties, particularly the duty to safeguard the trust assets.

Local freezing order
If a claimant wants to specifically target the trust property, they might seek a parallel freezing injunction against the Respondent from the courts in the trustee's local jurisdiction. This is highly risky for a trustee in the context of corporate transactions relating to the trust assets, particularly if local orders can be obtained ex parte. Any transaction is at risk of having to be aborted if, during the course of the transaction, a local order is obtained. If a sale or purchase contract contains penalty clauses in the event of an aborted transaction, there is a serious risk to the trust assets in proceeding with the deal.

Actions by banks
Whilst English freezing orders have no effect on third parties abroad, some solicitors acting for claimants will write to banks abroad putting them on notice of the order. They should make clear in their letter that the order has no effect abroad, but do not always do so.

Banks will often act cautiously and refuse to permit transactions involving the trust account. Whether a bank can do this (notwithstanding the absence of extraterritorial effect of the freezing order) depends on local law. They may also make a report to criminal authorities. Even if the situation can be resolved consensually with the bank, there is a real risk that (at least for a period) the trust's bank accounts remain blocked, resulting again in risk to the trust assets.

Civil claims 
There is a risk to the trustee personally. The claimant might assert asset tracing claims against the assets held by the trustee. If the claimant can prove that its assets were in fact transferred to the trustee, these claims can be very difficult to defend. The main defence to such claims is to argue that the recipient of the assets is a bona fides purchaser for value. If the assets were gifted to the trust, this defence is unavailable. In the context of a tracing claim, it is therefore important for trustees to understand the origin of any monies or assets which were gifted to the trust. Trustees often have an indemnity against the trust assets to satisfy debts properly incurred under the trust (which might include the costs of litigation). However, in the event that a tracing claim is asserted, the assets will likely be frozen, leaving the trustee itself exposed to risk.

Finally, there is a risk that the claimant might bring a civil claim directly against the trustee. In JSC BTA Bank v (1) Mukhtar Ablyazov (2) Ilyas Khrapunov [2016] EWHC 230, the English Courts allowed the claimant (who had obtained a freezing order) to bring a civil claim for damages against a third party. The Court held that the claimant had an arguable case that the third party conspired with the Respondent to prevent the claimant from making any substantial recovery through breaching the freezing order. This decision is currently subject to appeal.

Practical points

The consequences of breaching an English freezing order are severe. It is therefore crucial that an overseas trustee who receives notice of a freezing order seeks English legal advice as to whether the order affects it. Even if it does not, the trustee should:

  • urgently seek local legal advice as to the prospects of the claimant obtaining recognition of the order (and the likely timing of recognition, if an application to recognise is made);
  • consider carefully any proposed dealings with the trust assets, and whether there is a risk to those assets in the context of the freezing order (for example, risks of abortive costs if the English freezing order is recognised locally); and
  • document carefully any dealings with the Respondent, with the assistance of the trustee's lawyers. Any such correspondence could become subject to disclosure obligations in subsequent litigation, and it is important that the trustee is able to demonstrate that they carried out their duties in accordance with local trust law (particularly with regards to exercising its independence and protecting the trust assets).
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