Canada: The Family Law Implications Of Estate Planning Strategies: The Net Family Property Freeze, Alter Ego Trusts And Joint Partner Trusts

The House of Lords, in Inland Revenue Commissioners v. Westminster (Duke) established the following fundamental principle of tax law:

"Every man is entitled if he can to order his affairs so as that the tax attaching under the appropriate Acts is less than it otherwise would be."1

People over the age of 60 have generally amassed the maximum wealth to be had in their lifetime and have planned prudently for their retirement, and ultimately their passing. As noted by John-Paul Boyd and Anna Laing, "ours is an aging population" and more people over the age of 60 are divorced or separated than ever before.2 While estate planning is both a legitimate and encouraged practice in Ontario,3 it is imperative to acknowledge the family law implications of the various estate planning strategies for a client who seeks to order their affairs in an effort to undermine their family law obligations prior to or upon the breakdown of a relationship.

Here we will examine the more common estate planning practices, their respective advantages and disadvantages and the treatment of these strategies by the courts in the context of the equalization of net family property. Part I will provide the statutory framework, under which the entitlement to an equalization of net family property arises. Part II will investigate the net family property freeze and the reticence of judges to deem 'gifted' freeze shares as an exclusion from net family property. Part III will analyze the utility of alter ego and joint partner trusts and the treatment of trust assets by the judiciary when equalizing net family property. Part IV will conclude by offering some practice tips, which may bridge the exposure gap between estate planning and avoiding family law obligations.

PART I: THE EQUALIZATION OF NET FAMILY PROPERTY

In the eyes of the court, a relationship is at an end upon the earlier of the following events:

  1. The date the spouses separate and there is no reasonable prospect that they will resume cohabitation;
  2. The date a divorce is granted;
  3. The date the marriage is declared a nullity;
  4. The date that one of the spouses commences an application under subsection 5(3) (improvident depletion) that is subsequently granted; or
  5. The date before the date on which one of the spouses dies leaving the other spouse surviving.4

In Schreyer v. Schreyer, the Supreme Court of Canada succinctly described the legislative efforts to construct a regime for the division of property upon the breakdown of a relationship:

"Every Canadian province has tried to address in some way the inequities or difficulties arising out of the distribution of family assets after the breakdown of a marriage or of a common law relationship to which the same rules apply. Broadly speaking, the provincial legislatures have chosen between two different models: equalization and division of property."5

In Ontario, the Family Law Act (the "FLA") governs the division of property upon a breakdown of a relationship. The preamble of the FLA establishes its primary objectives as inter alia, the recognition of the equal position of spouses as individuals within marriage and of marriage as a form of partnership, and to provide in law for the orderly and equitable settlement of the affairs of spouses upon the breakdown of a relationship.6 In setting the intention for an equalization scheme, the FLA recognizes that

"child care, household management and financial provision are the joint responsibilities of the spouses and that inherent in the marital relationship there is equal contribution, whether financial or otherwise, by the spouses to the assumption of these responsibilities, entitling each souse to the equalization of net family properties."7

The equalization of net family property is calculated per section 5(1) of the FLA, which stipulates that the spouse whose net family property is the lesser of the two net family properties is entitled to one-half the difference between them.8

'Net Family Property' is defined at section 4(1) of the FLA as the value of all property, except excluded property, that a spouse owns on the valuation date, after deducting the spouse's debts and other liabilities and the value of property, other than a matrimonial home, that the spouse owned on the date of marriage, after deducting the spouse's debts and other liabilities, other than debts or liabilities related directly to the acquisition or significant improvement of a matrimonial home, calculated as at the date of marriage.9

The assets constituting "Excluded Property" that are relevant to our present purposes are set out in section 4(2) of the FLA as follows:

  1. property, other than a matrimonial home, that was acquired by gift or inheritance from a third person after the date of marriage;
  2. income from property referred in paragraph (a), if the donor or testator has expressly stated that it is to be excluded from the spouse's net family property; and
  3. property, other than a matrimonial home into which property referred to in paragraphs (a) and (b) can be traced.10

Pursuant to section 5(6) of the FLA, however, the court retains its discretion not to equalize net family properties in the event that the court is of the opinion that doing so would be unconscionable, having regard to the following equitable considerations:

  1. a spouse's failure to disclose to the other souse debts or other liabilities existing at the date of the marriage;
  2. the fact that debts or other liabilities claimed in reduction of a spouse's net family property were incurred recklessly or in bad faith;
  3. the part of a spouse's net family property that consists of gifts made by the other spouse;
  4. a spouse's intentional or reckless depletion of his or her net family property;
  5. the fact that the amount a spouse would otherwise receive under the equalization regime is disproportionately large in relation to a period of cohabitation that is less than five years;
  6. the fact that one spouse has incurred a disproportionately larger amount of debt or other liabilities than the other spouse for the support of the family;
  7. a written agreement between the spouses that is not a domestic contract; or
  8. any other circumstances relating to the acquisition, disposition, preservation, maintenance or improvement of property.11

In Ward v. Ward, the Ontario Court of Appeal emphasized that the discretion to order an unequal division of net family property pursuant to section 5(6) is strictly limited:

"The case law has made it clear that the intent of the section is not to alleviate every situation that may be viewed as in some ways unfair or inequitable, because equal sharing should occur in most cases. The Family Law Act creates a scheme for property sharing upon marriage breakdown that is intended to promote predictability and thereby discourage litigation. If courts were to deviate from the scheme of the Act wherever it gave rise to an unfair result, this would have the undesirable effect of encouraging parties to litigate their claims."12

Equalization of Net Family Property During Cohabitation

Section 5(3) of the FLA provides, that if during cohabitation there is a serious danger that one spouse may improvidently deplete his or her net family property, the other spouse may apply to have the difference between the net family properties divided as if the spouses were separated and there were no reasonable prospect that they would resume cohabitation.13

As interpreted by the Ontario Court of Appeal in the seminal case of Stone v. Stone, the effect of section 5(3) of the FLA is that where separation or death is certain, a spouse is under a duty not to deplete his or her net family property.14 Section 5(3) of the FLA therefore enables a souse in the face of such a threat to trigger the equalization scheme absent separation.

Equalization of Net Family Property Upon Death of a Spouse

When a spouse dies, if the net family property of the deceased exceeds the net family property of the surviving spouse, the surviving spouse is entitled to one-half the difference between them.15 Section 7 of the FLA further provides that on the application of a spouse, former spouse or deceased spouse's personal representative, the court may determine any matter respective the surviving spouse's entitlement to an equalization of net family property.16

Entitlement to an equalization of net family property is in personam as between the spouses, however, an application commenced before a spouse's death may be continued as against the deceased spouse's estate, and an application for an equalization of net family property may be made by or against the deceased spouse's estate, so long as the application is brought after the earliest of:

  1. two years after the day the marriage is terminated by divorce or judgment of nullity;
  2. six years after the day the spouses separate and there is no reasonable prospect that they will resume cohabitation; or
  3. six months after the spouse's death.17

Most importantly however, is section 6 of the FLA, which furnishes the surviving spouse with an option to take under the deceased spouse's will (or if the deceased spouse dies intestate, under Part II of the Succession Law Reform Act) or to elect an equalization of net family property.18 This availability is significant, as while the surviving spouse can pursue an equalization of net family property after the death of his or her spouse, the relief under section 5(3) of the FLA can only be pursued during the lifetime of the spouse.19

Fraudulent Conveyances Act

Section 2 of the Fraudulent Conveyance Act stipulates as follows:

"Every conveyance of real property or personal property and every bond, suit, judgment and execution heretofore or hereafter made with intent to defeat, hinder, delay or defraud creditors or others of their just and lawful actions, suits, debts, accounts, damages, penalties or forfeitures are void as against such persons and their assigns..."20

Thus, conveyances effected with the malintent indicated in section 2 of the Fraudulent Conveyances Act will be deemed invalid, unless pursuant to sections 3 and 4 of the Fraudulent Conveyances Act, the transferee can prove that the conveyance was effected for good consideration and in good faith without notice or knowledge of the intent to defeat, hinder, delay or defraud creditors or others.21 "Creditors or others" has been interpreted by the Supreme Court of Ontario to include judgment creditors, as well as persons who have actions pending against the transferor in which it is clear that they are certain to recover damages.22

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Footnotes

1 Inland Revenue Commissioners v. Westminster (Duke), [1936] A.C. 1 (H.L) at p. 19.

2 John-Paul Boyd and Anna Laing "The Boomers are Coming: Economic and Other Issues of Older Individuals" (Paper presented to the National Judicial Institute Family Law Seminar: Financial and Property Issues, 4-6 February, 2015) at p. 1 and 3.

3 As pointed out by Martin Rochwerg and Leela A. Hemmings in "Trusts, Trustees, Trusteeships III: Use of Trusts as Will Substitutes" (Paper, 23 September 2008) [unpublished] ("Trusts") at p.2, "courts in other provinces have been less planner-friendly".

4 Family Law Act, R.S.O. 1990, c. F.3 ("FLA") at s. 4(1) "valuation date".

5 Schreyer v. Schreyer, [2011] S.C.J. No. 35 (S.C.C.) at para. 14.

6 FLA, supra note 4 at "Preamble".

7 Ibid at s. 5(7).

8 Ibid at s. 5(1).

9 Ibid at s. 4(1).

10 Ibidat s. 4(2) (a)(b) and (e).

11 Ibid at s. 5(6).

12 Ward v. Ward, [2012] O.J. No. 3033 (ONCA) at para. 25.

13 FLA at s. 5(3).

14 Stone v. Stone, [1999] O.J. No. 3502 (ONCA) ("Stone v. Stone") at pp. 27.

15 FLA at s. 5(2).

16 Ibid at s. 7.

17 Ibid at s. 7(2).

18 Ibid at s. 6.

19 Kimberly Whaley and Debra Stephens "Estate Planning & Fraudulent Conveyance: When Does Estate Planning Cross the Line and Become a Fraudulent Preference"(Paper delivered at the B'nai Brith Canada CLE for Lawyers and Accountants: Fraud and Estate Litigation, 4 June 2013) [unpublished] at p. 4.

20 Fraudulent Conveyances Act, R.S.O. 1990, c. F.29 at s. 2.

21 Ibid at s.3 and 4.

22 Hopkinson v. Westerman, [1919] O.J. No. 127 (S.C. ON) at para. 9.

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