Settlors and beneficiaries often mistakenly believe that assets held in trust are fully protected in the event of divorce. This is not in fact the case as a number of recent cases indicate. However, there are practical steps that trustees, settlors and beneficiaries can take to protect the trust assets in such circumstances.
When determining financial claims on divorce, the court must look at all the resources available to the parties and seek to achieve a settlement that is fair in all the circumstances.
If one or both parties have a beneficial interest in a trust, the beneficial interests will be taken into account by the court. The weight given to the interest, and the impact on the outcome, will depend on a number of factors, which are considered below.
There are two main ways in which the courts will treat trust assets on divorce. The court will either:
- 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 a wide range of powers in relation to the trust.
The trust as a financial resource
An interest in assets held in trust may be regarded as a financial resource available to the beneficiary or the beneficiary’s spouse. The decision to treat the trust assets as a financial resource will depend on a number of factors, including the terms of the trust, and the track record of the beneficiary receiving benefits from the trust. For example, if a beneficiary has a life interest in a trust which makes quarterly distributions of income to the beneficiary, this is much more likely to be viewed as a financial resource than in the situation where a beneficiary is one of a class of beneficiaries of a discretionary trust and has never received any benefit.
If a trust is held to be a financial resource, the court may make financial orders against a beneficiary which are enforceable on the basis that the trustees will come to the beneficiary’s rescue to enable him or her to meet the financial orders. This is often referred to as the court giving ‘judicious encouragement’ to the trustees.
Lord Justice Wilson in Charman [2007] EWCA Civ 503 set out the test the court should apply as follows:
'Can the claimant spouse demonstrate, that if asked, the trustees would be likely, immediately or in the foreseeable future, to exercise their powers in favour of or in some way for the benefit of the other spouse'.
A recent example of the court adopting this approach is the case of Ipecki v McConnell [2019] EWFC 19. In that case the wife was the great-granddaughter of the Avon cosmetics founder and the beneficiary of a number of discretionary trusts worth many millions of dollars. Under the terms of one of the trusts, income from that trust could be accumulated and separated into a separate fund solely for the wife’s benefit. By November 2017 the fund had a value of c$4.45m. The wife had received income and capital advances from the fund, and no other person had benefitted from it. The court found that the trustees were likely to make funds available to the wife, so that she could comply with any order it made against her.
Ipecki can be contrasted to that of Daga v Bangur [2018] EWFC 91 where the court, based on the facts before it, took the opposite view. In this case the wife was the settlor and beneficiary of two discretionary trusts which had assets of about £17m. The wife’s father had been behind the creation of the trusts and funded them, albeit via the wife. He remained heavily involved in the trusts and gave evidence to the court that no distributions would be made to the wife, or any other family member, in the foreseeable future. The husband’s claims against the trusts were dismissed upon the court finding that the wife had not received, and had no expectation of receiving any benefit from the trusts. As such, making an order against the wife based on ‘judicious encouragement’ would not work as the trustees were unlikely to make funds available to the wife to enable her to comply with any order.
In addition to making awards against a party on the basis that the trustees will come to the aid of the beneficiary, the court may, additionally or alternatively award the non-beneficiary party a greater share of non-trust assets on the basis that the trustees will make provision to the beneficiary from trust assets.
Nuptial settlements
The court has wider, and far reaching powers, if it finds that a trust is a nuptial settlement. In determining whether a trust is a nuptial settlement the court will have to consider whether the trust was settled by one or both, or 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. If the court finds this is the case, then the court’s powers are broad, 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 to a spouse, whether or not they are a beneficiary.
There is judicial debate as to whether a trust which is not regarded as a nuptial settlement at the outset can become a nuptial settlement at a later date. In Quan v Bray [2014] EWHC 3340 the court was of the view that a trust can become a nuptial settlement, whereas in Joy v Joy-Marancho [2015] EWHC 2507 the court found that a trust cannot become nuptial if it wasn’t nuptial from the outset. This was on the basis that, otherwise, any family or dynastic trust which was not nuptial at the outset, but which provided benefits to an individual, would become nuptial upon the individual marrying and benefits continuing to be given. Clarity on this point will need to be provided by further case law from a superior court.
However, the courts are more consistent in the view that a transaction, or one aspect of a trust, can be nuptial in isolation. The obvious example being where a trust purchases a property for the benefit of the parties as their family home. Having found that a transaction, or aspect of a trust, is nuptial, the court can then use its powers of variation in relation to that transaction or aspect.
The courts are mindful of not simply ignoring the fact that assets are held in trust, and are reluctant to interfere more than is necessary. Further, the courts recognise that they should be slow to deprive other beneficiaries of their rights under trust. In other words, the impact on other beneficiaries is a factor the court will take into account.
Practical steps to consider
As can be seen from the case law, the treatment of trusts on divorce is fact specific and each case will be dealt with on its own merits.
Careful consideration needs to be given to the drafting and structuring of a trust, the letter of wishes and the narrative used in the trust accounts as a court is likely to wish to see those documents in deciding whether to treat the trust as a financial resource or nuptial settlement.
In addition, it may be beneficial for a trust not to be governed by English law, and for it to be administered by offshore trustees, perhaps in a jurisdiction with robust 'firewall legislation'. These factors may offer an additional line of protection against an attack of a trust in divorce proceedings, and against the enforceability of an English court order.
In terms of drafting, if one party to the marriage has certain powers under the trust deed, such as the power to add and exclude beneficiaries, change trustees, or consent to distributions (which is common in offshore jurisdictions), this could make the trust more susceptible to attack in the event of a divorce.
In light of the complexities, it is crucial to obtain advice at an early stage, ideally before assets are put into trust, especially if such a structure is being considered in the context of an upcoming wedding. In the event that a trust becomes involved in litigation, the trustees should take advice as early as possible to understand how best to protect their beneficiaries as a whole, and to understand to what extent they need to participate in any litigation.
We are able to advise beneficiaries/settlors, and/or trustees on trust issues arising in the context of divorce.
This article was written by Michael Finnegan.