Trusts in divorce proceedings

This article was originally published in WealthBriefing.

It is not unusual that one or both parties of a divorce will be the beneficiary of a private trust. The question therefore arises in what circumstances trust assets can be taken into account in financial remedy proceedings arising upon divorce.

Settlors are often motivated to create trusts to protect family assets from being “attacked” in a divorce. However, many trusts have been successfully attacked in divorce proceedings in favour of the “non-beneficiary spouse” where the English Family Court considers it necessary to achieve a “fair” result. Often, the mere existence of a trust may be treated with some suspicion by the court.

In this article “spouse.” “marriage” and “divorce” should be taken to include civil partners and related terms.

Stress testing a trust against divorce

By the time divorce proceedings are issued, it is often too late to take steps to protect the trust assets. Many trustees, settlors and beneficiaries should therefore take heed of the risks and take detailed advice at an early stage on how a trust can be created and managed to minimise the risks, including considering the use of pre-nuptial and post-nuptial agreements.

The focus of this article is long-term stress testing of a trust. How to approach divorce proceedings is another question.

In order to bring trust assets within the scope of a financial order, those acting for the non-beneficiary spouse must demonstrate that a trust is either a nuptial settlement and/or a financial resource of the “beneficiary spouse” (though in practice these two concepts often overlap). In extreme cases, trust assets may be attacked on the basis that the trust is a sham.

1. Nuptial settlements

Despite the archaic name, the concept of a nuptial settlement is alive and kicking in modern divorce proceedings and catches a wide range of trusts.

The court has the power to vary nuptial settlements in divorce proceedings, so it may make express provision for a non-beneficiary spouse from trust assets where it considers this is necessary to achieve a fair outcome.

Is my trust nuptial?

A nuptial settlement includes trusts, whether made in lifetime or by a will, made for the benefit of one or both of the parties or their children, created because of the marriage, or referring to the marriage, whether made before the marriage or after it. The intentions and purposes of the settlor at the time a trust is created are key, and the definition of what constitutes a nuptial settlement is wide. Even when a spouse is not a beneficiary of the trust but may potentially become so in future, may be sufficient.

Nuptial settlements are often explained by distinguishing them from “dynastic settlements” (i.e. those designed for long-term inter-generational asset preservation) though the line between these categories is a blurred one.

What about offshore nuptial settlements?

The English Family Court is not shy of applying its powers to vary nuptial settlements to offshore trusts and will do so where the court was satisfied that a variation order would be enforced by an overseas court, or where the trust assets were in the jurisdiction of the court and were subject to its enforcement powers. Where enforceability is likely to be an issue, the court can make a “judicious encouragement” order (see below).

2. Trusts as a financial resource

All financial remedy proceedings arising upon divorce involve an examination of the “income, earning capacity, property and other financial resources which each of the parties to the marriage has or is likely to have in the foreseeable future.” Assets held in trust (even a non-nuptial trust) are often argued to be a financial resource of the beneficiary spouse despite not being owned by them personally.

The central question as to whether trust assets are a resource of the beneficiary spouse is: “would the trustee(s), if asked to do so by the beneficiary spouse, be likely to advance to that party the whole or all of the capital immediately or in the foreseeable future?”

Where the trust is a financial resource – “Judicial Encouragement” orders

The court does not have jurisdiction to vary non-nuptial trust assets directly. However, the court may give “judicial encouragement” to the trustee to provide funds in the following ways:

• “Backfill” case

The court may order an unbalanced division of personal assets in favour of the non-beneficiary spouse confident that the beneficiary spouse will draw on the trust to meet future needs.

• “Fresh money” cases

Where there are few personal assets available the court may even award a lump sum to the non-beneficiary spouse beyond the personal means of the beneficiary spouse, in the hope of persuading the trustee to provide funds.

What factors will the court take into account?

Recent cases emphasise the following key factors:

• the terms of the trust itself;
• the nature of the trust assets;
• how often and how recently the beneficiary spouse has benefitted from the trust;
• the existence of other beneficiaries with realistic expectations of benefiting from the trust; and
• the reality of the beneficiary’s relationship with the trustee(s) and protector(s).

The trustees may provide a statement to the court addressing these points. However, the court will place far greater weight on evidence of the past behaviour of the trustees in response to any such requests by the beneficiary over the whole history of the trust. A trustee may also be joined to financial remedy proceedings as a party (and thus subject to orders made by the court).

The fact that the beneficiary spouse is not the only beneficiary of the trust according to the trust deeds is largely irrelevant if this is not borne out by what is happening in practice (i.e. he or she has been the sole or primary beneficiary receiving distributions from the trust).

3. Sham trusts

A trust may be “looked through” by the court if it is shown that the trust deeds misrepresent the true intentions of the settlor (generally, because the settlor did not truly intend to dispose of beneficial ownership of the trust assets) and that the trustees knowingly participated in the sham. In practice, the high evidential burden required to succeed in such an argument make this a costly exercise rarely attempted.

• What steps can be taken now?
• The documentary position of a trust should be reviewed at an early stage:
• Who are the current beneficiaries?
• Is there a power to add or exclude beneficiaries?
• Who has received benefit from the trust and how recently?
• Are trustee decisions (and their consideration of the views and needs of other trust beneficiaries) fully documented?
• Are sub-trusts used for different beneficiaries?
• What does the settlor’s letter of wishes say?
• What is the nature of communications between the trustee/protector and the beneficiary spouse?

The governing law of offshore trusts is especially important in considering whether any variation order of the English Court would be enforceable against the trust directly.

Conclusion

Trusts should be subject to ongoing review and stress-testing, in tandem with other planning steps, including pre-nuptial or post-nuptial agreements, family constitutions/charters, and regularly reviewing the balance of personal versus trust wealth.