The complete guide to trusts on divorce
1. How do you protect your assets when you get married?
Trusts and nuptial agreements can both be used to protect a person’s wealth.
A nuptial agreement is entered into by the parties to a marriage, setting out what will happen in the event that they divorce. A nuptial agreement can be entered into before a marriage (prenuptial agreement) or after a marriage (postnuptial agreement). There are many advantages to nuptial agreements. If, for example, one party comes into the marriage with property, they can set out the nature and value of that property in a nuptial agreement. Should the parties later divorce, the court can refer to the nuptial agreement to demonstrate what was pre-acquired property and should not, therefore, be shared on divorce. Nuptial agreements are not, however, automatically binding. The court will attempt to give effect to the terms of a nuptial agreement, but only if it would produce a fair result, meet the basic needs of the parties, and was not made in unfair circumstances as a result of mistakes, misrepresentation, duress or undue influence.
Trusts can be established to serve a variety of purposes. A settlor spouse may wish to establish a trust in the hope that they can avoid making financial provision for the other spouse in the event of a divorce. The settlor spouse must, however, be aware that the other spouse may argue that the settlor spouse has wrongly dissipated assets. If the court agrees, it may declare the settlor’s disposition of funds into a trust as invalid, resulting in the assets placed in the trust reverting back to the spouse.
If a spouse is a beneficiary of a trust, the settlor of the trust will need to consider the potential implications if the beneficiary were to divorce. The other spouse who is not a beneficiary could, for example, argue that the trust is a financial resource of the beneficiary and so can be used to fund a financial award. Alternatively, if the trust has a nuptial element, the other spouse may make an application to the court for the trust to be varied.
Nuptial agreements and trusts both provide an opportunity to offer some degree of protection to a wealthy spouse. However, the economically weaker spouse can still challenge a nuptial agreement or the other spouse’s trust interest.
2. How will the courts assess trusts on divorce?
On divorce, where a spouse has a trust interest, there are several issues that the court may be asked to consider:
- 1. Is the trust a financial resource of the spouse?
- Is the trust a nuptial trust that is capable of variation by the court?
- Is the trust valid, a sham and/or should the placement of funds into the trust be reversed?
a. Are trusts a resource on divorce?
A spouse’s trust interests can be taken into account as a financial resource on divorce, which the court will then consider when determining how to arrive at a fair result.
If the trust in question is fixed, the beneficiary spouse’s interest is defined. The value of that interest will need to be obtained. The court will also need to consider when the beneficiary spouse will have access to the trust income and/or trust assets. The trust interest can only be taken into account by the court on divorce if the beneficiary spouse will have access to the trust assets at some point within the foreseeable future.
Where the court finds that a beneficiary spouse has an interest in a fixed trust that will soon be paid out to them, the court can make orders as if the spouse held the assets in question. This means that the court could, for example, award the other spouse a higher proportion of the non-trust assets on the basis that the beneficiary spouse would soon be receiving the trust assets.
The position in respect of discretionary trusts is more complex. If a spouse is within the class of beneficiaries in the discretionary trust, then, before the court can treat that interest as a financial resource, it must find that the trustees would be likely to advance trust assets to the spouse either immediately or in the foreseeable future. In answering this question, the court will consider the reality of the situation and take into account a wide range of evidence, including any statements made by the trustees.
Where the court finds that it should make an order in respect of a discretionary trust, it has several options. The court could make orders to provide judicial encouragement that the trustees act in a certain way (e.g. that the trustees should make a payment of capital to the beneficiary spouse). Alternatively, the court can offset any amount that it deems a beneficiary spouse may receive from the trust were he to make a request to the trustees against the non-trust assets. The other spouse would receive a greater proportion of the non-trust assets than they otherwise would do. In a more extreme scenario, the court can make an order against a beneficiary spouse that could only be funded if the trustees advanced funds to the spouse (though such an order would be highly unusual). Where the court finds that a beneficiary spouse has acted dishonestly, it can adjourn the financial claim until a later time so as to ensure that a fair result can be achieved. In making such orders, the court will consider the history of payments made by the trust and the likelihood of the trust coming to the aid of the spouse.
Alternatively, where the court finds that the trust has a nuptial element it can order a variation of the trust so that either the non-beneficiary spouse and/or the children of the family benefit from the trust.
b. What power do the courts have to vary nuptial trusts?
On divorce, the court has the power to vary a trust if it is found to have a nuptial element.
In a straightforward case, a trust will have a nuptial element if it is created to include a spouse as a beneficiary. A trust can still be found to have a nuptial element in more complex scenarios, such as where a trust provides loans to a business owned by a spouse. There is judicial disagreement about whether a trust that begins its life without a nuptial element can subsequently acquire one. Mr Justice Coleridge has held that a trust can do so, if at some point during the marriage the trust provided a financial or non-financial benefit to the parties to the marriage. However, Mr Justice Singer has disagreed with that proposition: he has said that a trust that is non-nuptial at its creation cannot subsequently obtain a nuptial element.
If a court finds that a trust is nuptial, it can vary it to provide a benefit to the spouses and/or the children of the family. The court has a broad discretion in ordering a variation so as to achieve a fair result. Orders for the variation of a nuptial trust can be made against both onshore and offshore trusts, but it may prove difficult to enforce any order made by the court against the latter.
3. What happens to inter-generational trusts on divorce?
An individual may establish a trust for the benefit of their family. Such trusts can be inter-generational, with the intention that the trust should exist for a long period of time.
The exact form of the family trust depends on the intention of the settlor. Discretionary trusts are often used as a family trust because they provide the trustees with great flexibility. A discretionary trust could be established with as narrow an intention as providing funding for education costs for the descendants of the settlor. If, however, a family member needed funds for another purpose, the trustees could in the right circumstances choose to advance funds to that individual.
There can be serious consequences for a family trust if a beneficiary divorces. On divorce, the spouse of the beneficiary could argue that the family trust should be treated as a financial resource of the beneficiary that can be used to fund a financial award. Alternatively, the spouse of the beneficiary might argue that the family trust is a nuptial trust that can be varied. Trustees of a family trust may be made to, or wish to become, involved in a beneficiary’s divorce proceedings, so as to best protect the position of all the beneficiaries of the trust.
Trust assets will not always be vulnerable to a successful attack by a non-beneficiary spouse. Where a family trust was established many generations ago, the trust assets will likely be characterised as non-matrimonial property. This means that the court will not seek to share the trust assets between the spouses on divorce, unless the needs of the non-beneficiary spouse or any of the children of the family cannot be met from the parties’ matrimonial property alone.
4. What happens to businesses with shares in trust on divorce?
Trusts can hold shares in businesses. When a beneficiary of such a trust gets divorced, there can be serious, or even terminal, implications for a business.
Where the court makes an order affecting a trust that holds shares in a business, this can pose unique problems. If, for example, a trust is taken into account as a financial resource that can be distributed on divorce and the same trust’s sole or primary assets are shares in a private company there may be difficulties. It may be impractical or impossible to sell the shares: they could, for example, be illiquid or one party may simply wish to retain the shares (e.g. if they possess and wish to continue to hold a controlling share in the business). In either scenario, the spouse who is to retain the shares may need to provide more of the parties’ liquid capital to the other spouse or raise the funds in another way (e.g. if the business is cash rich, a special dividend could be paid out to fund the award). In a more extreme scenario, it may prove impossible to fund an award in any way other than by selling a business. However the issues raised in each case can differ widely.
Settlors, trustees, protectors, and beneficiaries of trusts holding shares in businesses need to carefully consider their position should a settlor or beneficiary divorce.
5. Do trust interests need to be disclosed to the court?
Obtaining disclosure in respect of trust interests is vital. Disclosure should be obtained from both the spouse with a trust interest and from the trustees of the trust.
Spouses owe a duty to make full and frank disclosure of their financial position to the court. That duty includes disclosure of any interest under a trust. In cases involving complex trust interests, such as when the trust is located offshore, the court will expect the spouse to make disclosure that is sufficient to allow the other spouse to understand their trust interests. It must be remembered, however, that a spouse must only provide information which he possesses or is able to obtain. A spouse who is a beneficiary, for example, does not have a right to trust documentation; they can only request that the trustees provide them with the documentation or make an application to court for the same.
Unlike spouses, trustees do not owe a duty of full and frank disclosure to the court. Instead, trustees have a duty to act in the best interests of all the beneficiaries of the trust. Trustees can be asked to provide information about the trust. On receiving a request for disclosure, how the trustees respond varies depending on the facts of that particular trust. For example, the trustees of an offshore trust may first seek directions from the trust’s home court before it will make any disclosure. If trustees decide not to respond positively to a reasonable request for disclosure where a spouse has a significant link to or interest in the trust, then the other spouse may either request that the court draw an adverse inference against the trustees or, alternatively, make an application to court for disclosure from the trustees. Some jurisdictions, especially offshore ones, limit the amount of disclosure trustees can provide very strictly.
Trustees can also be joined to the financial remedy proceedings. Joinder can prove an effective method of obtaining the compliance of the trustees of onshore trusts. In respect of offshore trusts, however, joinder may prove ineffective if the trustees elect not to submit to the jurisdiction of the English court.
6. Can the court enforce orders involving trusts?
It is important to consider how an order involving a trust can be successfully enforced.
Where the court varies a nuptial trust, there may be enforcement problems. If the trust is located offshore, the trust’s home court may not have the power to order such a variation – it is particularly common for statutes in offshore jurisdictions to forbid the enforcement of foreign divorce orders against trusts. Alternatively, the same offshore court may not be minded to make the variation ordered in England. Pursuing enforcement in such a situation would likely involve the need to instruct foreign lawyers who may need to attend the foreign court. The time taken and costs involved in pursuing enforcement can, in many cases, prove prohibitive.
In financial remedy proceedings, the English court may find that a trust is a sham or is otherwise invalid. In such cases, it is usually found that the trust assets are held by the trustees for the settlor. Before complying with an order of this kind, offshore trustees are likely to seek guidance from their home court as to what they should do. It may prove necessary to instruct lawyers specialising in trusts disputes to assist and, if the trust is offshore, foreign lawyers.
If the English court finds that a trust is a financial resource of a spouse, enforcement is made directly against that spouse. The usual menu of enforcement options are open to the other spouse seeking to enforce an order, such as committal applications. The court can, however, make orders so as to provide judicial encouragement to the trustees to act in a particular way (e.g. to advance funds to a potential beneficiary under a discretionary trust). On receipt of such orders, trustees will need to determine whether it is in the best interests of all of the beneficiaries of the trust to comply with the request of the court. Trustees may be likely to comply, for example, where a spouse/beneficiary is at risk of committal for non-payment if funds are not advanced by the trustees.
There can be further difficulties with enforcement if the trustees of an offshore trust do not submit to the English jurisdiction. In practice, offshore trustees who do not wish to submit to the jurisdiction will be unlikely to engage at all with the financial remedy proceedings; they may not ask to see any documentation or have any other involvement with the case). Where offshore trustees succeed in not submitting to the English jurisdiction, the offshore court will retain the ability to consider matters afresh even if a decision is made in England. Submission to the English jurisdiction is not a prerequisite for an English order to be put into effect in an offshore court. However, in practice, the lack of submission to the English jurisdiction can often mean that the offshore court will decline to give effect to an English order. Even greater problems can arise where an offshore jurisdiction has so-called “firewall” legislation in place designed to protect offshore trusts from attack by other courts.
7. What is an invalid, or sham trust?
If a divorce involves a trust, a spouse may argue that the trust is invalid or a sham, or that the placement of assets made by the other spouse into the trust should be reversed.
Trusts are invalid if they fail to comply with any one of a number of formal requirements, such as if the settlor fails to sign the trust instrument. If a trust is invalid then the trustees will hold the trust assets on a new trust for the benefit of the settlor. However, a spouse arguing that a trust is invalid must think ahead: if the settlor is not the other spouse then the trust assets would be placed beyond the court’s reach on divorce.
Even if a trust appears to be valid, a spouse can argue that the trust is a sham. A trust is a sham if it is established by its purported settlor and trustees without the intention of actually creating a trust, but instead for the purpose of creating the appearance of a trust without the ensuing legal obligations. It is, however, notoriously difficult to successfully argue that a trust is a sham.
Finally, a spouse can apply to reverse the placement of assets into a trust by the other spouse. This type of application can only be made where the placement has been made to defeat the other spouse’s financial claim on divorce and, if the placement of assets were set aside, the financial award made on that claim would be different.
A spouse facing a divorce involving a trust should consider whether any of the routes set out above should be pursued, both in the early stages and throughout proceedings.