The Ultimate Guide to Trusts in Divorce

WHAT IS A TRUST?

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

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.

What are the different types of trust?

Trusts can be created expressly by the settlor (‘express trusts’). They can also be inferred from the way assets are held in certain circumstances. This document deals solely with express trusts.

There are two types of express trust:

• Fixed trusts: where the beneficiaries are identified.
• Discretionary trusts: where the choice of beneficiaries is left to the trustee(s), subject to the terms of the trust deed.

In a fixed trust, the settlor chooses the beneficiaries and determines what income or capital they can receive from the trust. For example, one beneficiary could be entitled to the income generated by the trust assets, whereas another beneficiary could be entitled to the capital of the trust assets.

In a discretionary trust, the trustee has the power to decide how the trust’s assets and income are distributed. They will be under a duty to exercise their discretion to apply the trust assets with reference to the trust instrument and any other relevant documentation. This could be a letter of intention created by the settlor, which sets out the matters he wishes the trustees to have in mind when they exercise their discretion. If a trustee, for example, breaches a duty, they can usually be sued by any of the beneficiaries of the trust.

Trusts can be revocable or irrevocable. Revocable trusts allow the settlor to alter the terms of the trust, or cancel it, within their lifetime. By contrast, the settlor of an irrevocable trust cannot alter or cancel the trust. These distinctions are important as, for example, the tax treatment of a trust differs depending on whether the trust is revocable or irrevocable.

What are 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?

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?
2. Is the trust a nuptial trust that is capable of variation by the court?
3. What power do the courts have to vary nuptial trusts?
4. Is the trust valid, a sham and/or should the placement of funds into the trust be reversed?

Is the trust a financial resource of the spouse?

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.

• Fixed trusts: 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.
• Discretionary trusts: 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.

Is the trust a nuptial trust that is capable of variation by the court?

On divorce, the court has the power to vary a trust if it is found to have a nuptial (also known as matrimonial) element. In financial remedies proceedings, disputes often arise as to whether certain assets can be considered matrimonial or non-matrimonial, and as such whether they can be included within the “matrimonial pot” to be shared.

Matrimonial assets are those built up by the parties during the marriage (generally from the date of cohabitation – insofar as that cohabitation led seamlessly to marriage – and until the date of separation). These assets have been built up during the parties’ marriage and the court would apply the sharing principle in the first instance.  

Premarital assets are a category of what are known as “non-matrimonial” assets and are assets either: 

• Brought into the marriage by a spouse 
• Having been owned prior to the relationship 
• Acquired unilaterally (including gifts and inheritance)

These assets were not built up during the marriage but owned prior to its inception or thereafter. Non-matrimonial assets will be examined to determine whether they have also become part of the matrimonial pot.  The importance of the source of premarital assets can diminish over time. There may be, for example, intermingling of premarital and marital assets, and this results in the premarital assets becoming “matrimonialised”. 

Further, if those premarital assets are required to meet the other spouse’s needs, for example their need to be re-housed, then the court is entitled to “invade” them, and they may well fall to be divided in the financial settlement. The court will usually take into consideration the standard of living enjoyed by the parties during the marriage when considering a spouse’s future needs. 

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. On the other hand, for example where the trust in question is a family trust that was established many generations ago, the trust assets may 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.

What power do the courts have to vary nuptial trusts?

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.

• Fixed trusts: 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.
• Discretionary trusts: here, the court 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). 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. 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.

Where the court varies a nuptial trust, however, 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.

Is the trust valid, a sham and/or should the placement of funds into the trust be reversed?

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.

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.

Finally

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. We offer a free consultation to qualifying individuals for divorce. Please call our confidential enquiry line on 020 3808 8100 or email us. Lines are staffed 24 hours.