When trusts go wrong in divorce: lessons learned from real case studies
Laura Richards and Jennifer Williamson unpack some common mistakes with trust assets in divorce and when trustees should seek legal advice.
Once upon a time, there was a big house and a pot of money (the assets), to which some strict rules (terms) applied. The rules were written down in a document (the trust deed). Some people (the trustees) were put in charge of making sure those rules (terms of the trust) were followed.
There was a person, Riley (a beneficiary), who didn’t own the assets, but was allowed to use them because the rules said they could. Riley and their family didn’t own any property or money of their own, and for many years, they enjoyed living in the house, and the lifestyle that came with it. Riley didn’t entirely understand all of the rules, and neither did their spouse but that didn’t matter for most of the time. Everything was fine until Riley and their spouse decided to split up….
Fear paralysis
Things can get complicated if there’s a divorce in the family and most, or all, of the property and money belongs to a Trust. If neither spouse owns anything, perhaps there doesn’t seem to be anything to divide between them – it’s not surprising that the individuals involved are often worried about where they will live in the future, and how they will pay for it. Misunderstandings and poor communication are common, and understandable, in these circumstances.
Communication
In our example, it would be sensible for Riley to tell the trustees about the likely divorce. However, Riley might not do so if their head was in the sand, or they didn’t know it could be helpful for the trustees to know about this life development.
From Riley’s point of view, the trustees could answer any immediate questions Riley has and give them some information about the terms of the trust. In some trusts there are ‘triggering events’, such as a divorce, which can change the rules about how the trustees treat the family. It is important that Riley contacts the trustees early on so that they properly understand the implications of the divorce on how the trust now operates.
Early legal advice
The trustees would likely be concerned about balancing their duties to protect the trust assets for their intended purpose (which may include for future generations) whilst meeting Riley’s wishes so far as possible. The trustees likely have a duty to beneficiaries other than Riley and they are obliged to consider all the beneficiaries of the trust’s interests, not necessarily just Riley’s, which will inform what they can and cannot do. The trust rules could be very strict and they may not have much flexibility in how the trust operates as a result of the impending divorce. They might start to think about any risk the divorce could pose to the trust assets, and/or about how they might be able to help within the rules. They will also need to consider the tax position, as any changes to the trust assets or structures in the trust could trigger tax. It is important that this is fed into the consideration of how the trust can be used in the future. This would be a very good time for the trustees to take joined up advice from both trust, and family law, specialists so they can really understand the interplay between these two complicated areas.
Back to our story and, ideally, both Riley and their spouse would each go and see specialist family law solicitors and tell them as much about the trust situation as soon as possible. At the first meeting (and particularly without the trust deed) it is unlikely that the solicitor will know much about the trust or its terms. The solicitors will need information about the rules, and the identity and value of trust assets. Again, at this point the family law solicitor should engage with a trust solicitor, to make sure that they ask the right questions to obtain the information and documentation that is really required to clarify matters.
Riley’s solicitor and the trustees (and/or their solicitors) might be in touch at this early stage too. Ultimately, the early dissemination of accurate information can manage expectations and significantly reduce undue pressure upon individuals, beneficiaries and the trustees. It is important that the trustees take advice when any requests for information come in from a family solicitor to consider what information to provide to Riley and their spouse regarding the rules in the trust. They need to ensure that they are giving a true and accurate picture whilst ensuring confidential information is kept private. The person who sets up a trust often gives confidential guidance to the trustees and Riley and their spouse may not be entitled to see this.
Depending on the case, it can be that the family law solicitors themselves may not ask the right questions to obtain the information and documentation that is really required to clarify matters. What may seem to be straightforward on the surface of any documentation, may not always be as clear as it seems, as trust law and taxation is complex. It is important that where a trust exists as part of the context of a divorce, that any documentation and positions asserted by the divorcing parties is checked by a trust specialist to ensure that the interpretation of the rules in the trust being put forward to agree a financial settlement is accurate.
When things go wrong
Things can go wrong when people don’t communicate or take legal advice, at an early stage. Things are almost always considerably more complicated and expensive to rectify after the event. Our examples below overlay real case studies onto the characters in our story:
- Riley says nothing to the trustees: in this case the trust assets were cash (rather than a property), and Riley had a life interest, with their adult children being entitled to the remainder after Riley’s death. This means that Riley was only entitled to the income (interest in the bank account) but not the capital (the cash itself). Following the divorce, Riley and their children were no longer on speaking terms. The terms allowed the trustees to advance capital and to make loans, but only under very strict circumstances.
Riley completed their divorce without mentioning anything about it to the trustees, assuming that they would give them some money to buy a property with their new partner. Unfortunately, the children would not agree to Riley being given money so the trustees could only loan the money to Riley. If Riley dies before their new partner, their partner will have to sell the house to repay the loan.
Had the trustees been asked for financial information within the divorce, they could have explained that they would be unwilling to provide capital to Riley outright, and so this was not taken into account as part of the divorce.
- Trustees make funds available without conditions: in this case, trustees advanced monies to Riley before the marriage and didn’t consider the potential risk of Riley losing some or all of those monies if the marriage ended in divorce.
Riley assumed that their spouse would always acknowledge that Riley had owned the monies before the marriage, but when they were divorced that was not the case.
Here, depending on circumstances, the trustees could have asked Riley to take family law advice (for example about a nuptial agreement) before the marriage. Protective documentation could have been put in place and/or different decisions could have been made.
How to get the best outcome for all
In the worst cases, where there is a real mismatch of information and expectations, court proceedings may be issued with trustees being joined into the family law matter. This can be as emotionally painful and financially expensive as it sounds. The court can be a blunt instrument so the outcome may be perceived as sub-optimal by all.
Many of these pitfalls can be avoided by collaborative advice from family and private client solicitors working together, from the outset. The increased knowledge and information which is available as a result can enable more bespoke, suitable outcomes to be agreed which are more acceptable to beneficiaries, individuals and trustees.
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