Is my trust protected if I get divorced?
Historically, wealthy clients have used trusts to protect family money from taxation and extravagance. Following a series of recent high profile divorce cases, clients are becoming equally anxious to protect their assets from financial claims made by a husband or wife on divorce. Some clients are now reviewing trust terms and letters of wishes with a view to protecting assets on divorce.
The Court’s attitude towards and powers in relation to trusts
When considering financial claims on divorce, the main objective of the Family Court is to ascertain what financial resources are available and, adopting a broad-brush approach, to divide these as fairly as possible considering all circumstances of the case. In doing so, the Court will consider and take into account all of the parties’ financial resources. These may and often do include a whole raft of assets and income including property, company shares, pensions and interests in trusts. Clients are often surprised at how much discretion the Family Court has to distribute financial resources in order to achieve ‘fairness’ on divorce. Generally, Judges will find what they think is the right solution for a divorcing couple and find an appropriate interpretation of the law to achieve this.
Under the Matrimonial Causes Act 1973, the Court has a range of powers available to it. Importantly, as far as trusts are concerned, the Court has the power to vary the terms of ante and post-nuptial settlements. Typically, a variation is made so that the husband or wife of a beneficiary under the trust is given income or capital from that trust. Establishing whether or not a trust is ‘nuptial’ is not always a straightforward exercise.
However, generally speaking, a nuptial trust must have been made with reference to the marriage and, in terms of timing, the trust will have been made either in contemplation of the marriage or after it. The relevant law provides a very wide definition of what may amount to a nuptial settlement and, therefore, this often applies to a broad range of trusts.
If the resources in a nuptial trust only represent some of the marital assets then, usually, the Court will try to achieve a fair division of the overall assets and income without interfering with a trust. If all or most of the assets are held within a trust then, assuming the Court has the power to vary the terms of the trust, it is likely to do so. Even where the Court does not have the power to vary its terms, any trust or settlement could still be taken into account by the Court upon divorce as a relevant resource of the marriage. If a husband or wife has benefited from a trust not found to be nuptial in nature, either before or during the marriage, the Court can assume that such benefits will continue in the future. In those circumstances, the Court may make an ‘Encouragement Order’. Such an order requires the paying party to make financial provision for the other party on the basis and assumption that the paying party will receive assistance from the trust.
When trust assets are located in England and Wales, it is normally straightforward to enforce an English Court Order against them. However, for tax reasons, trust assets are often based offshore. In these circumstances, the precise location of the trust becomes very important. Specifically, parties and their lawyers will need to establish, as early as possible in divorce proceedings, whether or not an Order of the English Court varying the trust will be enforceable within the country where the trust is located. Encouragement Orders are often particularly relevant where a paying party is resident in England and Wales but the trust in question is based offshore in a country which will not recognise or enforce an English Court Order.
Latest case law
In the recent case of Whaley and Whaley, the Court of Appeal was asked to consider when a family trust is to be treated as a ‘resource’ of a party. The main issue for the Court was in relation to the assets available for division. The husband argued the total assets were £3.17million. The wife believed they were £11.8million. The main reason for the difference was that the wife argued assets in a trust were effectively available to the husband and, therefore, should be treated as a resource available to him. The husband disputed this. The case was tried at first instance in the High Court in 2010. In the High Court, the Judge found that the trust assets (valued at approximately £7million) were assets which were likely to be made available to the husband and, therefore, should be taken into account within the overall division of the capital. Specifically, the Judge found that the husband ‘simply told the trustees how the funds were to be deployed and they followed his instruction’ and that ‘there is simply no evidence of the trustees ever failing to provide funds for the husband’s needs’. Including the capital in the trust, the Judge found that the total assets were £10.4million. The wife was awarded 36% of this including a substantial lump sum which, in order to pay, the husband would need recourse to the trust assets. The bulk of the trust capital had been brought into the marriage by the husband and, therefore this was reflected in an unequal division of the overall assets. The husband appealed on the basis that the Order would put improper pressure on the trustees, would require them to act against their stated intentions ignoring their duties to other beneficiaries and require them to realise assets at a time when it was not commercially prudent to do so. The Court of Appeal looked again at all of the evidence in relation to the trust, its structure and operation. In considering the husband’s appeal, the question for the Court was whether the trust assets were ‘likely’ to be available to the husband. Specifically, if the husband were to ask the trustees to advance him capital, would they be likely to do so? The Court of Appeal upheld the findings of the High Court that the trustees had acted in accordance with the husband’s wishes and were likely in the future to make available such resources as the husband requested. In those circumstances, the Court of Appeal confirmed it had no alternative but to treat the trust assets as part of the husband’s resources and, accordingly, his appeal failed.
Protecting trusts from divorce
It is clear the Court has and regularly uses its powers to make orders in relation to trusts on divorce. It is important settlors fully consider the potential impact which divorce may have on a trust.
There are a number of points and steps that settlors, trustees and beneficiaries should carefully consider in order to maximise the chances of a trust keeping assets out of the ‘matrimonial pot’:
Avoid creating the trust at the time of the marriage and ensure the class of beneficiaries is as wide as possible
Ensure the individual beneficiary who may divorce has no fixed interest in the trust assets and has no demonstrable control over the trustees
The trustees should be aware that, should a beneficiary divorce, the history of distributions from the trust will be looked at closely by the family courts
If any distributions are made, it is better these are made as formal loans to the beneficiary
Settlors should consider excluding themselves and their spouses as beneficiaries
Trustees should be aware that, should a beneficiary divorce, the files of communications and other records in relation to the trust are likely to be scrutinised by the Family Court. Hence, letters of wishes should be worded carefully and regularly reviewed to protect, as much as possible, against financial claims on divorce
Consideration needs to be given to beneficiaries being excluded from a trust if they fail to enter into a pre-nuptial agreement
The above is only a brief summary of the position. The Court’s treatment of trusts on divorce is, in itself, an evolving and complex area of matrimonial law. If you are concerned about the impact divorce may have on your trust assets or you are thinking of setting up trusts in order to protect assets, it is vital you obtain expert legal advice on these issues.
For further information please contact:
Caroline Penfold – Partner
Carina Smith – Assistant Solicitor
This briefing is for guidance purposes only. RadcliffesLeBrasseur accepts no responsibility or liability whatsoever for any action taken or not taken in relation to this note and recommends that appropriate legal advice be taken having regard to a client's own particular circumstances.