How do the courts treat trusts and foundations on divorce?

What is a trust?

A trust refers to a legal relationship created when assets have been placed by a person (the settlor) in the control of a third party (the trustee) for the benefit of another person (the beneficiary) or for a specified purpose. This separates the control of the assets from the right to the value of the assets.

A trust may be revocable or irrevocable. A revocable trust is known as a living trust and can be changed at any time. In contrast, an irrevocable trust cannot be changed, except in extremely rare circumstances.

Trusts are often used to protect wealth. They are complex to deal with upon divorce, and in some cases, a party may seek to hide marital assets in complicated trust structures.

Who are the people involved in a trust

The settlor creates the trust. A settlor can create a trust either by declaring that they hold certain assets on trust for the beneficiaries or by transferring the legal title to assets to trustees for them to hold for the beneficiaries.

Trustees are the third party who hold the legal title to the trust assets. Trustees have both powers and duties to deal with the trust assets in accordance with the terms of the document which creates the trust. The exact way in which trustees are expected to deal with the assets depends on the type of trust. For large trusts, trustees will often be professionals, such as wealth managers or lawyers.

Trustees hold assets for the beneficiaries of the trust. The interest that a beneficiary has in the trust will depend on the type of trust that has been established. For example, a beneficiary may be entitled to income and/or capital from the trust assets.

Protectors may be appointed to oversee the administration of a trust. The settlor determines the exact role the protector will hold. A protector could, for example, be given the power to appoint and/or remove trustees. In practice, protectors are often appointed in offshore trusts. Whether a protector can be appointed will depend on the rules governing where the trust is based.

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The Different types of trusts

There are many types of trusts, some more simple than others. The most common are:

• Bare Trusts: This is where assets are held in the name of a trustee, but the beneficiary has the right to all of the capital and income of the trust at any time if they’re 18 or over
• Life Interest Trusts: These provide for a specified person (the life tenant) to receive income from property or enjoy any property in the trust e.g. reside in a property fortheir lifetime, and thereafter, upon the life tenant’s death or other trigger event, for the property to be distributed to the ultimate beneficiaries; and
• Discretionary Trusts: These allow the trustees of the trust to make certain decisions as to how the trust income and sometimes capital should be distributed and to which beneficiary.

Settlors and beneficiaries often mistakenly believe that assets held in trust are fully protected in the event of divorce, however this is not in fact the case as several recent cases have indicated.

Offshore trusts and foundations

Offshore trusts and private foundations are complex structures used to hold wealth.

Offshore trusts are located in a no or low-tax jurisdictions (e.g. Bermuda, the British Virgin Islands, or the Isle of Man). With offshore trusts, there can be difficulty with obtaining disclosure from the trustees or enforcing any order made by the English court.

Private foundations are legal entities established for the benefit of their founders. A council or board will run the private foundation. Unlike a trust and more akin to a company, a private foundation can hold assets in its own name. Some features are common to all private foundations, they can all last for an unlimited duration, for example. The exact nature of a foundation will, however, differ depending on the jurisdiction within which it is located.

The court is growing increasingly accustomed to dealing with such structures. In certain circumstances on divorce, both offshore trusts and private foundations can be taken into account by the court when assessing the nature and extent of the parties’ wealth. Whether or not an order resulting from this exercise can be enforced is, of course, another matter.

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.

How are trusts dealt with by the courts on divorce?

There are two main ways in which the courts will treat trust assets on divorce:

• Find the trust assets as a financial resource of one or both parties, or
• Less commonly, find that the trust is a nuptial settlement which gives the court wide discretion in relation to the trust.

If the court considers trust assets to be marital, they will be included in the matrimonial pot and subject to the principle of equal sharing. However, in some cases, trust assets may be considered non-marital – if, for example, it is an intergenerational trust.

The trust as a financial resource:

An interest in assets held in trusts may be regarded as a financial resource, available to the beneficiary or beneficiary’s spouse. There are several considerations that will influence the decision to classify the trust as a financial resource, including the conditions of the trust and any records proving the beneficiary is receiving benefits from the trust. A trust is far more likely to be seen as a financial resource if, for instance, the beneficiary has a life interest in a trust that pays out on a quarterly basis, than if they belong to a class of beneficiaries in a discretionary trust and have never received any benefits.

This is significant because, should the trust be determined to be a source of funds, the court may impose enforceable financial obligations on a beneficiary, with the understanding that the trustees will assist the beneficiary in meeting the requirements.

The trust as a nuptial settlement:

Determining whether a trust is a nuptial settlement is fact-specific. There is no statutory definition of a nuptial settlement, but the court will look at whether the trust was settled for the benefit of one or both of the parties to the marriage and makes some form of continuing provision for one or both of the parties to the marriage. It is necessary to find evidence of the trust being connected to the parties in their capacity as husband and wife.

At this point, if the court does find that the trust is a nuptial settlement, then it has wide and far-reaching powers to vary the trust. For example, it can add or exclude beneficiaries, change the terms of the trust, remove or replace trustees and protectors, and order the trustees to make a payment from trust assets. As a result, the belief that trust assets are protected in the event of a divorce is a mistaken one.

Sham trusts:

A sham trust is one where the parties do not, in fact, intend to create a trust and rather intend to create the impression of one, by purportedly transferring legal title of an asset to trustees to manage for beneficiaries. Yet, in reality, the settlor retains ownership and control of the asset.

Sham trusts will typically be void, with the asset reverting to the person who set up the trust.

What happens to businesses with shares in Trusts 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.

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.