The treatment of Trusts on Divorce

 In Trusts

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Should trustees and those who advise on the use of trusts to protect assets from broken marriages be concerned about the recent case of Whaley v Whaley [2011] EWCA Civ 617? The Court of Appeal certainly criticised the obfuscation of the husband (whose parents created the relevant trusts) as to the nature of the trusts and the behaviour of the trustees. It is a lesson in how the matrimonial court deals with trust property on divorce.

Background

The Courts of the Family Division have a wide remit to adjust the wealth of the parties to a divorce. Classic strategies to protect wealth prior to divorce usually includes:

  • Pre-nuptial settlements
  • Specific provision in the articles, shareholders’ agreement or charter of a family company
  • The use of trusts

The Court must take into account a statutory set of factors when making financial orders on divorce which are contained in s.25 Matrimonial Causes Act 1973 each of which is open to interpretation by the Judge:

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a. 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, including in the case of earning capacity any increase in that capacity which is would in the opinion of the Court be reasonable to expect a party to the marriage to take steps to acquire;

b. The financial needs, obligations and responsibilities which each of the parties to the marriage has or is likely to have in the foreseeable future;

c. The standard of living enjoyed by the family before the breakdown of the marriage;

d. The age of each party to the marriage and the duration of the marriage;

e. Any physical or mental disability of either of the parties to the marriage;

f. The contributions which each of the parties has made or is likely in the foreseeable future to make to the welfare of the family, including any contribution by looking after the home or caring for the family;

g. The conduct of each of the parties, if that conduct is such that it would in the opinion of the Court be inequitable to disregard it; and

h. In the case of proceedings for divorce or nullity of marriage, the value to each of the parties to the marriage of any benefit (for example a pension) which by reason of the dissolution of the marriage, that party will lose the chance of acquiring.

Miller v Miller & McFarlane v McFarlane [2006] UKHL 24 saw the Law Lords confirm the principle that there was to be no discrimination between the breadwinner and homemaker and that each party is entitled to a fair share of the matrimonial assets, however long or short the marriage. The House of Lords identified three main strands to which the Court has to give consideration:

  • Financial needs
  • Compensation
  • The right to a share

Before Miller & McFarlane all assets whenever and however acquired formed part of the pool of assets which were available for distribution but how it was dealt with depended on the circumstances. In Miller & McFarlane it was said that it should be all property acquired during the marriage otherwise than by inheritance or gift. In short marriages the ‘yardstick of equality’ is unlikely to apply to non-matrimonial property. The longer the marriage the more likely it is that non-matrimonial property has to be taken into account particularly if it has been merged into the ‘marital acquest’.

So it is possible that all assets will be taken into account unless some are non-matrimonial property and the Judge thinks they should be disregarded in some way.

Where do trusts fit into the equation?

The Family Court has the power on divorce to vary nuptial settlements – s.24(1) (c) Matrimonial Causes Act 1973. There has to be a connection between the settlement and the marriage in order for that settlement to be regarded as nuptial. If it is nuptial then it can be regarded as a resource when deciding on the level of financial settlement.

The status of pre-nuptial agreements has been raised as a result of the Radmacher v Granatino [2010] UKSC 42 case and there is likely to be an increase in popularity. They are contractual arrangements which are at least for now highly persuasive to the English Courts and may yet have the force of law if:

  • Both parties make full financial disclosure;
  • They are entered into in good time before the marriage
  • Each party has received independent legal advice; and
  • Proper consideration is given to the arrival of children

For further consideration of Marital Property Agreements see the Law Commission Consultation paper no 198 issued on 11 January 2011 http://www.justice.gov.uk/lawcommission/areas/marital-property-agreements.htm

With trusts set up after the marriage it is harder to avoid ‘nuptial’ treatment but a fully discretionary trust for a wide class of beneficiaries, including several generations, without specific reference at all to the intended ‘primary’ beneficiary might succeed.

Generally, the following arguments might help in resisting a challenge that a trust is nuptial:

  • It was set up by a previous generation
  • The primary purpose was to benefit future generations
  • It was set up prior to the marriage
  • It was set up to avoid inheritance tax or other liabilities
  • It was not settled in contemplation of the marriage

However, despite pretty much all the above arguments being relevant in Whaley v Whaley the Court of Appeal dismissed the husband’s appeal against the financial settlement on divorce which DID take into account the family settlements. Why?

The facts

Mr & Mrs Whaley had been married for over 20 years and had four children together. Mr Whaley is 60 and Mrs Whaley is 47. The dispute was over the assets available for the Court’s consideration in making a financial order on their divorce. Mr W argued that the assets amounted to £3.173 million net after legal costs whereas Mrs W said £11.873 million net after legal costs. The main reason for the difference was their treatment of trust assets in which the husband had an interest.

The overall asset value was determined by the trial judge as £10.74 million but nearly £7 million of this was made up of the assets in two trusts:

  • The Farah Trust; and
  • The Yearling Trust

The non-trust assets included two properties in England in the wife’s name, one of which she lived in and the other she rented out and a property in Spain in the husband’s name which was his home and which despite being worth £1.19 million net of borrowing did not apparently have planning consent!

The husband owned shares in three Spanish companies which owned or managed hotels in Spain and also shares in a company which managed the business of a golf club; the club land and hotel premises on it being owned by the Yearling Trust.

Mr Whaley’s father was a builder who moved permanently to live in Spain in 1983. He put his company into the Farah Trust which was governed by the laws of Jersey. The beneficiaries were originally Mr Whaley’s parents, their children (i.e. Mr Whaley and his two older brothers) and remoter issue plus charities. Later on the parents were excluded. The trustees were to hold the fund on trust to pay the income as they might in their discretion think fit.

By November 1989 the funds had already been allocated to three separate funds in the names of the three sons. In the father’s last letter of wishes he said that he would expect the three sons to be consulted on the death of the parents with a view to a distribution of the whole fund and that he could see the allocated funds being used on various joint or individual projects over the next 8 to 10 years. The trust had not in fact been so deployed and continued to hold shares in companies owning hotels in Spain and in a company owning English potential development land (worth £1 million) and a small portfolio of shares.

The Yearling Trust was created by Deed of Appointment out of the Farah Trust in 2008. It retained all the powers of the Farah Trust but was for the grandchildren of the parents and Mr Whaley was not therefore a beneficiary although his four children were.

Because Mr Whaley was not a beneficiary of this trust it was contended that it should not be taken into account as part of the resources relevant to the ancillary relief exercise. The main reason put forward by Mr Whaley as to its creation was to ensure that a potential HMRC challenge as to Mr Whaley’s non-resident status might expose the assets transferred to the trust to the UK tax authorities unless they were held separately.

However, the Yearling Trust was included in the potential resources because it was possible to add Mr Whaley as a beneficiary at some future date and that since the HMRC challenge had been concluded it was merely convenient for the purposes of the divorce to continue to exclude Mr Whaley from benefit.

The Judge at first instance made findings about the attitude of the trustees and the trust protectors and criticised them for their incorrect presentation of the Farah Trust. Also she was satisfied that they were all accustomed to doing Mr Whaley’s bidding. She said there was no evidence of the trustees ever failing to provide funds for Mr Whaley’s needs whether in terms of business investments or assistance with the provision of homes. The Court of Appeal confirmed the Judge’s assessment and commented on the fact that one of the trustees was not available to give evidence despite being ordered to do so.

On behalf of Mr Whaley it was argued that the judge was not necessarily wrong to take into account of the assets in the Farah Trust but the nature of her order was to put undue pressure on the trustees and to make the assets in the trust subject to the ‘sharing principle’. Counsel argued the Yearling Trust assets should have been ignored altogether.

In the Court of Appeal the comment made by Wilson LJ in Charman v Charman [2005] EWCA Civ 1606 was referred to as the relevant principle:

“In principle, however, in the light of s.25(2)(a) of the 1973 Act, the question is surely whether the trustee would be likely to advance the capital immediately or in the foreseeable future.”

The decision of the trial Judge, that the trustees of both trusts would ensure that Mr Whaley would have the use of the funds whenever he wanted or needed then, was confirmed.

Counsel for Mr Whaley also made the argument that the court cannot go further in cases where the discretionary trust was set up before marriage by third parties for future generations than give judicious encouragement to the trustees to make funds available to a spouse. He argued that the order of the trial judge interfered with the trustees’ duties in administering the trust in particular the fiduciary duty owed to all the beneficiaries; not just one.

The decision

Unsurprisingly in the light of the above the Court of Appeal decided the trial Judge has come to the right decision in taking into account the assets in the Farah Trust and the Yearling Trust when making the order she did.

Lewison J explored the terms of the Farah Trust and therefore the Yearling Trust which contained a clause which said they may ignore entirely the interests of any person:

“Clause 6 (D) Provided Always that the Trustees are hereby expressly authorised in exercising any of the powers hereby conferred in favour of any particular person to ignore entirely the interests of any other person interested or who may become interested under these presents.”

The case also included arguments as to the nature of the orders actually made; the potentially incorrect valuation decisions and the incorrect balance between liquidity and risk in the ordering of certain assets to be transferred to Mrs Whaley or for the children.

There was criticism of the fact that the Trust documents were not included in the Court bundles and had to be requested. Lewison J reviewed all the documents and commented that the presence of Clause 6 (D) and the existence of the office of Protector distinguished these trusts from many discretionary trusts. He said:

“… a discretionary beneficiary has no proprietary interest in the fund. But under s.25 the court looks at resources; not just ownership. Thus whether a beneficiary under a discretionary trust has a proprietary interest is not relevant. The resource must be one that is ‘likely’ to be available. This is the origin of the ‘likelihood’ test. No judge can make a positive finding about the future: the best that can be done is to assess the likelihood. What is relevant is the likelihood of the trust fund or part of it being made available to him, either by income or capital distribution. If the husband were to ask the trustees to advance him capital would the trustees be likely to do so? ….The question is not one of control of resources: it is one of access to them.

In deciding that question the court must look at the facts realistically. The court will not put ‘undue pressure’ on trustees to exercise their discretion in a particular way, but it may frame an order which affords ‘judicious encouragement’ to provide one spouse with the means to comply with the court’s view of the justice of the case: Thomas v Thomas [1995] 2 FLR 668. The cases do not say what amounts to ‘undue pressure’, but in Thomas Glidewell LJ said what would not be undue pressure if

(a) The interests of other beneficiaries would not be appreciably damaged and

(b) The court decides that it would be reasonable for the husband to seek to persuade trustees to release more capital to enable him to make proper financial provision for his former wife

Even if the court makes such an order the trustees are not bound to comply with the husband’s request; but it is “plainly proper for the trustees to take it into account….and commonly it will be decisive”: Lewin on Trusts para 29-157.”

Practice points

From the above it is clear that family court will continue to assess whether the assets held in trusts can be regarded as resource in a particular matrimonial case and to what extent in appropriate cases judicious encouragement can be given to the trustees to comply with a party to the marriage’s request for funds from the trust in order to meet the financial settlement ordered.

How can we minimise the risk of a trust being treated as a resource?

  1. Make it wholly discretionary.
  2. Appoint trustees who think independently of the beneficiaries and do not always do their bidding.
  3. Ensure that it has a wide class of beneficiaries so if it is being made by parents for the benefit of all their children and families then do no allocated the fund to separate parts for each child and their respective spouse/civil partner and issue.
  4. As far as possible avoid it being a nuptial settlement.
  5. When administering the trust make distributions of income and capital to a mixture of beneficiaries not just one.
  6. Trustees should be willing to attend at court and provide information about the trust.
  7. Do not obfuscate about values, accounts and details of the trust as this is only likely to annoy the court and result in decisions being made which may be flawed for lack of appropriate data.
  8. Consider whether in the current context it might be better to set up a Family Investment Company as the family courts seem to be slightly less willing to ‘pierce the corporate veil’ than to take into account trust funds as a resource.
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