Trusts in Divorce: Navigating Complex Financial Settlements

It is not unusual for Trust assets to be in the mix when looking at the make-up of a couple’s assets on divorce. Often advice is sort as to whether they will form part of any financial settlement, or if they will be exempt from division on divorce.

Are Trusts financial resources on divorce?

If they exist, it is open to the court to treat Trust assets as a financial resource available to the parties immediately, or in the foreseeable future. What the court will do with those assets, is likely to depend on whether the Trustee or Trustees, if asked, would be likely to advance all or part of the capital to the husband or wife who is a beneficiary of the Trust immediately or in the foreseeable future.

If a court is looking at dividing Trust assets it will look at a number factors:

• how the Trust came into existence;
• who the Beneficiaries are;
• what duties the Trustees have; and
• how the Trust has been administered to date.

The court will look at what has happened on the ground with the Trust to decide whether or not the assets within the Trusts are actually available to the spouse who is a Beneficiary.  The position is usually clearer if a party has an absolute right to Trust income or capital. It is more difficult to make an assessment in circumstances where distributions from the Trust are discretionary. In those circumstances a court is likely to look at:

• if anyone involved in the proceedings was the Settlor of a Trust;
• whether there are other Beneficiaries who have an interest in the Trust;
• whether there is any pattern to the previous distributions from the Trust;
• the content of any letter of wishes dealing with how the Trustees should exercise their; discretion; and
• what the Trust deed actually says.

Once it has been established that the Trust assets are a resource available to the parties, when deciding how to distribute them, the court will consider the section 25 factors to make sure,

1. any distribution is fair in the circumstances;
2. it takes into account both parties needs; and
3. where relevant it takes into account any claims the parties have made for compensation or sharing.

What orders can a court make in relation to Trust assets?

The court can make orders against the spouse who is a Beneficiary of the Trust to:

• meet any order it makes in favour of the other spouse, e.g. to pay a lump sum (though this is rare as usually the court will only make orders based on what it knows is available to the parties); or
• replenish the beneficiary spouse’s assets after the order it makes is satisfied.

The court will make such orders only if accepts the Trustees will make the Trust assets available to the Beneficiary spouse to meet them. The court cannot make orders against the Trustees themselves, as they are third parties and not parties to the divorce proceedings.

Often where Trust assets are involved the Beneficiary will consider them to be ‘non-matrimonial’. Arguments as to whether Trust assets are non-matrimonial are likely to arise. As in the case with all other classes of assets the origin will be important, but ultimately any argument that the asset is non-matrimonial in origin will be trumped by needs, and the need to divide it in order to meet needs.

What is a nuptial settlement?

During a marriage, it is not unusual for Trusts to be created for the benefit of one or both of the parties of a marriage or their children. This is known as a nuptial settlement. For a Trust to be considered a nuptial settlement it must have a connection with the marriage.

On divorce in the court can use its discretion to make a variation of settlement order (a type of property adjustment order) in respect of a nuptial settlement, but before doing so the court will consider:

• whether there are the required characteristics of a nuptial settlement;
• if so, what the property in that settlement is; and
• how it should exercise its discretion.

If the court does decide to use its discretion to vary a nuptial settlement, then it has the ability to:

• order for an income to be paid to one or both of the spouses or to their children;
• order that one of the spouses is no longer a Beneficiary of the Trust, or their interest in it should be reduced;
• order that a new Trust should be formed using the assets in the old Trust;
• transfer one or more assets comprised in the Trust to someone who is not a Beneficiary of Trust;
• make orders in relation any powers of appointment of the Trustees; and
• make orders regarding the removal of Trustees.

Challenging Trusts on divorce

Sometimes on divorce or in contemplation of it, Trusts are created to make it appear as if the assets within them are no longer owned by one of the spouses. These are known as ‘sham’ Trusts. A sham Trust is an arrangement in which the settlor and Trustee or Trustees purport to establish a Trust with the goal of misrepresenting the beneficial ownership of assets.

Proving a Trust is a sham is not an insignificant undertaking, as it will usually involve allegations of fraud, which carry a high evidential burden of proof. If one of the parties choose to run a sham Trust case, often it will be determined as a preliminary issue in the financial remedy proceedings. This means the usual rules as to costs in family proceedings do not apply do not apply (each party bears their own) and if unsuccessful a costs order can be made against the party running that case.

It can also be the case that someone may create a Trust with the intention of putting assets out of reach from the other party. A further circumstance in which Trusts may also be challenged if the court is satisfied that an asset was placed in a Trust with the intention of defeating the other party’s claims on divorce, then it has the power to set that transaction aside. In law there is also a presumption that any disposal into a Trust made within the three years preceding the application for financial relief on divorce was made with the intention to defeat the other party’s claims, provided it is the case the disposal would in fact have that consequence.

The position of the Trustees when Beneficiaries divorce

The general duties and obligations of Trustees are set out in legislation and can be onerous.

Scott Clayton is the Managing Director of Renaissance Trust, a Trust company which advises individuals, families, companies and existing Trustees on the creation of Trusts, ongoing management, administration and compliance.

He explains what happens upon divorce from the perspective of Trustees:

Where Beneficiaries of the Trust decide to divorce, the Trustees must take additional care to consider the position and it is prudent for them to take independent legal advice. The cost of such advice can be paid from the Trust assets.

Consideration needs to be taken as to the Beneficiary’s entitlement to the Trust assets, or the income those assets generate, and whether a claim for those assets on divorce is valid (as described above).

A Trustee can be placed under immense pressure from both parties in the divorce to release funds, receive formal approaches from legal representatives and face criticism from other Beneficiaries who are trying to ensure that the Trust funds are not diminished. It is important to note that where a Beneficiary considers that by making a payment the Trustees have committed a breach of Trust the beneficiary may choose to take legal action against the Trustees to recover the funds. The primary liability for a breach of Trust lies with the Trustees personally. This is one reason why it can be beneficial to consider appointing a Trust Corporation as Trustee to remove any chance of personal liability.

Generally, the courts will take a pragmatic approach to the predicament such circumstances can place on Trustees. Obtaining good legal advice and understanding their powers and obligations will stand Trustees in good stead to act properly and in the interests of all parties concerned.

About

Amanda Phillips-Wylds is a Director, Solicitor & Mediator in our Ascot office.

Scott Clayton advises individuals, families and professional clients and works with a network of business referrers and contacts based all over the UK. He has particular specialism in UK resident trusts, Trusts for children, asset protection and the outsourcing of trust administration.

Scott is a member of STEP and the Institute of Financial Accountants. He is also the current Chief Executive of TACT – The Association of Corporate Trustees.