Protecting Trusts on Divorce

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 available to 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.

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”.

In the 2023 case of HO v TL [2023] EWFC 215, the courts provided further clarity on the test set out in Charman, and provided a list of factors that would be taken into account by the court when deciding if trust resources are a financial resource available to one of the parties:

1. The nature and purpose of the trusts. Trust documents will be informative, as will evidence within the family as to the working of the trust, and their expectations.
2. Whether the spouse is a main or principal beneficiary, or just one among many minor beneficiaries of similar standing.
3. Whether distributions to a party would appreciably damage other beneficiaries.
4. The history of distributions or loans to a party, including how often they have been made, for what purpose, and whether requests for funds have been turned down. Where loans have been made, the terms of repayment and security may require scrutiny.
5. The value of the overall trust funds, and the quantum of monies sought to be provided from that source.
6. Whether the trust funds are fully liquid (e.g. in investment portfolios) or tied up in private businesses and potentially difficult to realise.
7. Whether the beneficiary has a close relationship with the trustees (or, protector, should there be one).
8. The extent of explanation, information and documentation provided by the trustees, and whether they declined to attend court in a witness capacity.

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.

Additionally or alternatively, the court may 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, however, for a trust to be nuptial, it must be made in contemplation of marriage and make continuing provision for one or both parties to a marriage. Each case must be considered on its own facts. Even if a settlement does not appear nuptial in nature, 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. There are a number of steps which can be taken by settlors and trustees in order to afford better protection to trust assets in the context of divorce and financial remedy proceedings. Examples include:

• Not having spouses as a beneficiaries;
• Explicitly stating in the letter of wishes that spouses should not benefit from it;
• Limiting settlor’s powers. 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;
• Consider the timing of settlement and if it is established around marriage or not (to try and avoid arguments the trust is nuptial);
• Establishing sub-trusts in order to limit what is capable of being attacked by the spouse, however consider that if it is a sub-trust for just one beneficiary, that may have the opposite effect and make it more susceptible to being attacked because the sub-trust assets are effectively ring-fenced;
• Having more beneficiaries so that the trustees have a duty to consider a wider pool of beneficiaries and the court cannot assume the trust assets are solely available to the party getting divorced. Dynastic family trusts to provide for future generations may help;
• Consider making loans to beneficiaries as opposed to capital distributions, so that it can be argued these have to be repaid and are not a resource available to the beneficiary. Ideally, there should be evidence of the loan being repaid or the court may say it is not commercial in nature and the trust will not enforce it;
• Consider whether 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” and with assets offshore. 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.

Putting in place a prenuptial agreement to ring-fence trust assets may offer the best protection as it should seek to limit claims on divorce. The parties’ needs will still need to be met, which could involve the use of some trust assets if there are insufficient non-trust assets, although needs can be defined in an agreement and limited to some extent thus reducing claims. Trustees (or settlors) could also insist on pre-nuptial or post-nuptial agreements being entered into before distributions or loans are made.

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 trustees on trust issues arising in the context of divorce.

Article written by Mike Finnegan and Richard Handel.