Divorce-proofing trusts

Structures crave stability. You wouldn’t choose to build in an earthquake zone. If you had no choice but to do so, you would ensure your structure had sufficient flexibility to withstand a powerful shock.

Divorce is a major source of instability for a family wealth-holding structure because it exposes the structure to scrutiny by a powerful and potentially hostile external body – the family court.

Following the earthquake analogy, in an ideal world, wealth-holding structures would be created in such a way that they are outside the reach of the family court. Failing that, they should be created in such a way that they can adapt and, if necessary, absorb a certain amount of damage without compromising their structural integrity.

This article is based on English law, but the points raised are very much applicable to divorce proofing trusts in most common law jurisdictions.

Jurisdiction

The family court’s powers

Family courts often have extensive powers in relation to trustees and trust assets:

1. Power to compel disclosure. Parties to financial remedy proceedings on divorce are subject to a “duty of full and frank disclosure” in relation to their financial affairs. That requires parties not merely to provide information that is in their knowledge or possession. A beneficiary will be expected to request information from trustees regarding the extent of trust assets and the likelihood that a request for assistance will be agreed to.
2. If the court feels a beneficiary is being deliberately obstructive, the court has power to join the trustees as a party to the proceedings and to require them to provide information regarding trust assets. Trustees are then faced with difficult decisions about whether to submit to the court’s jurisdiction or to refuse and risk potentially adverse publicity if the judgment is published. Joinder can also lead to expensive satellite litigation in the trust’s home jurisdiction as guidance is sought from the local court.
3. Power to vary the terms of a trust if that trust is found to be a “nuptial settlement”, which can be defined as “a settlement for the benefit of one or both of the parties or their children, created because of the marriage, or referring to the marriage, whether made before the marriage (ante-nuptial settlement) or after it (post-nuptial settlement)”. The court often has the power to vary such a settlement by, for instance, reinstating a spouse who has been removed from the class of beneficiaries, or requiring the trustees to make a distribution to a beneficiary to pay off his or her spouse.
4. The court sometimes has resorted to “judicious encouragement” in cases where a beneficiary professes that they are unable to receive a benefit from a trust once the divorce has concluded. In such cases, the court would award the beneficiary spouse a smaller proportion of the matrimonial assets on the basis that the court expected that the trustees would make up the shortfall once the case was concluded, either directly or through a “forced” distribution to the beneficiary.
5. The power, in appropriate circumstances to “pierce the corporate veil” as the court seeks to establish the underlying beneficial ownership of assets held in complex structures. (Prest v Petrodel Resources Ltd & Ors ).
6. In the great majority of cases, where adequate disclosure is made, the family court will understand and respect the trustees’ role. However, the court will look beyond the terms of the trust deed and will examine the extent to which the beneficiary has in fact benefited and the extent to which they can expect to do so in future. So established patterns of benefitting can be detrimental in such circumstances.
7. Dynastic Trusts: a trust that is dynastic in nature is far less likely to suffer adverse consequences than a trust which is clearly primarily for a beneficiary who is divorcing. The court is generally reluctant to interfere with the potential benefits of future generations.
8. Reserved Powers: Settlors reserving powers of revocation, and/or other reserved powers, such as the power to determine distributions and certain extensive investment powers, may find that the courts order them to exercise those powers to bring back the assets into their hands for the purposes of the divorce.
9. Letters of Wishes: Courts are very likely to want to see Letters of Wishes, as they often reveal the real intended beneficiaries and how they will benefit. It is essential to draft them carefully, and with this in mind. They should not be changed when a marriage break-up is in prospect.
10. Is it a trust at all? The very recent La Dolce Vita case in Singapore is a timely reminder that if the trust is, in reality, the settlor’s “alter ego”, then divorce courts will look straight through the trust and regards the assets as those of the settlor.

Nuptial agreements – pre- and post

A nuptial agreement can perform a number of useful tasks in an asset-protection context:

1. Fixing jurisdiction. A nuptial agreement will typically contain clauses in which the parties agree to submit to a particular jurisdiction. They provide powerful evidence of the parties’ intentions at the time they signed the agreement and can be helpful if jurisdiction becomes contested.
2. Fixing choice of law. In addition, a nuptial agreement will typically contain a choice of law clause. This will specify the law which is to be applied when interpreting and giving effect to the agreement, regardless of where the divorce takes place.
3. Arbitration. It is common for nuptial agreements to contain an arbitration clause. Arbitration frequently provides a swifter, less costly and more confidential form of dispute resolution, as compared to court proceedings.
4. Punitive costs. Agreements will frequently contain a clause specifying that a party who seeks to challenge a nuptial agreement in court should be required to pay the other party’s costs.
5. Confidentiality. Nuptial agreements will typically contain extensive confidentiality clauses. In addition to the above, the principal purpose of a nuptial agreement is to set out the terms on which the couple agree their financial claims should be resolved in the event of divorce.

For international couples, care should be taken, wherever possible, to ensure the nuptial agreement will be upheld in each state which could potentially have jurisdiction to hear the divorce.

In England, the Supreme Court considered whether nuptial agreements should be upheld in the landmark case of Radmacher v Granatino . Their conclusion was that they should, subject to some important provisos (neither party should be under undue pressure to sign, both should provide a reasonable level of disclosure of assets, each should have independent specialist legal advice, and the agreement should not be unfair).

For those seeking to mitigate the risk of divorce to structures, therefore, the first step is to ensure beneficiaries enter into a nuptial agreement. We often recommend a clause in the trust deed obliging a beneficiary marrying to enter into a pre-nuptial agreement, unless that provision is waived because the trustees are satisfied that it might be disadvantageous. Failure to do so could mean the beneficiary being excluded or receiving less than they otherwise would.

The Family Court always retains oversight. A pre-nuptial agreement cannot therefore be enforced in the same way as a contract, since the court will always retain the ability to decide whether it would be fair to hold the parties to the terms of the agreement. Even if a nuptial agreement is challenged, however, it is likely that it will result in a far more restricted award than if there were no agreement.

Governance considerations:

1. Selecting jurisdiction for structures and investments (there is little point in setting up a Cook Islands structure if the underlying asset is a UK residential property).
2. Considering carefully the class of beneficiaries.
3. Considering carefully whether a new or existing structure risks being considered a “nuptial settlement”.
4. Considering whether to create a separate trust or sub-trust for a beneficiary perceived to be exposed to divorce risk, so as to limit the potential damage to wider structures.
5. As part of wider family governance conversations, consider a requirement that all beneficiaries are expected to enter into nuptial agreements to protect the trusts, and granting trustees the power to treat those who fail to do so less generously (or to exclude them altogether).
6. Focus on making trusts dynastic in nature.
7. Take great care over reserved powers and revocation powers.
8. Draft Letters of Wishes very carefully, and on the assumption that the divorce court will see it.