UK: A Family Affair

Last Updated: 10 October 2016
Article by Jenny Cutts and Rosie Schumm

With 42 per cent of marriages ending in divorce, it is important when advising wealthy clients to put mechanisms in place to protect family assets. Jenny Cutts and Rosie Schumm provide a guide.

According to the latest figures from the Office for National Statistics, 42 per cent of all marriages end in divorce. It is important when advising clients on wealth planning to factor in the possibility that they and their children will not necessarily have long happy marriages, and to put in place mechanisms to protect family assets.

In this article, we will review the fictional scenario of a married couple, Simon and Sarah, with their four adult children, Edward, Emma, Eve and Ethan. Edward, Emma and Eve are children from Simon's first marriage, and Ethan from his marriage with Sarah. Edward has two children and is divorcing; Emma is on her second marriage and has one child and two stepchildren; Eve is engaged to be married; and Ethan is 10 years old.

We consider the estate planning Simon and Sarah can undertake to protect each other and the family wealth, while also balancing the complex family dynamics through solutions available to them and the use of wills, trusts, different asset strategies, nuptial agreements, divorce settlements, separation agreements and lifetime giving.

Wills

Wills are the starting point for Simon and Sarah to protect the assets they want to pass to their children.

They should consider creating wills with an immediate post-death interest (IPDI) trust in each other's favour, with discretionary trusts arising on the second death. The IPDI should contain overriding powers to allow the trustees to distribute capital to the survivor and to any of the class of discretionary beneficiaries during the survivor's lifetime. These trusts would achieve the following.

  • Protection of Simon and Sarah's financial positions: they will be entitled to the trust income and the trustees will have the power to loan or distribute capital to the survivor. This means neither Simon nor Sarah need worry about the survivor redirecting the family money to a new partner.
  • Third party claims: the discretionary trust will provide a layer of protection for any of their children (or grandchildren) who are at risk of a third party claim (such as a divorcing spouse) on their assets. The trustees will be able to make smart distribution decisions based on the beneficiaries' personal circumstances at the time.
  • Protect minor children: there will be sufficient flexibility to protect Ethan and any minor grandchildren. It will also be important for Simon and Sarah to choose guardians to look after Ethan's wellbeing.

A solid letter of wishes will leave the trustees with no doubt about how Simon and Sarah want the IPDI and discretionary trusts to be administered. It can set out:

  • how income and capital is to be distributed, in what circumstances, and to whom
  • any concerns about family money being dissipated, perhaps by an 'evil ex' or because of general financial irresponsibility in the family
  • how the trusts can be used for long-term wealth planning for the current generation and onwards
  • tax planning objectives and the weight to be given to these.

The importance of choosing the right trustees cannot be underestimated. They will need to be financially responsible and have the diplomatic ability and strength of character to act impartially, and to navigate the complexities of family bonds and disagreements.

Family estate planning

Simon and Sarah should be encouraged to discuss their succession plans with their children and encourage them to make wills themselves. Edward (who is divorcing) is a good example: any will he has already should be reviewed. After divorce, a will takes effect as if the former spouse had died, unless there is contrary intention in the will (sections 18A and 18C of the Wills Act 1837). However, this does not take effect until the divorce is finalised with a decree absolute, meaning the former spouse could still inherit in the interim.

Advising any client with complex family and/or asset structures is not straightforward and there are numerous risks you need to be on top of as their adviser

Emma should consider creating a trust in her will to mitigate the possibility of challenges under the Inheritance (Provisions for Family and Dependants) Act 1975 (IPFDA 1975). Her stepchildren could make a claim under the IPFDA 1975 if she is treating them as 'a child of the family' (section 1(d) and in any event, if she is financially maintaining them (section 1(e) of the IPFDA 1975). A trust will help the trustees negotiate a settlement with the stepchildren, potentially avoiding the need for costly court proceedings.

Pre- and post-nuptial agreements

Eve is engaged to be married, so should consider a pre-nuptial agreement, which should be signed at least 28 days before the wedding. This is to protect any wealth her parents may have passed to her before marriage, but can also cover inheritance received during marriage.

If Emma has not made a pre-nuptial agreement, she could consider making a post-nuptial agreement (an agreement signed after the marriage). If Edward did not make such an agreement and divorce is on the cards, it is too late now to make a post-nuptial agreement.

All of the children should be aware that nuptial agreements are still not completely binding in England and Wales. The English court retains discretion as to whether or not to hold the parties to the terms of the agreement. The current law is as stated in the landmark case of Radmacher v Granatino [2010] UKSC 42: 'The Court should give effect to a nuptial agreement that is freely entered into by each party with a full appreciation of its implications unless in the circumstances prevailing it would not be fair to hold the parties to the agreement.' This judgment means that the court is more likely to give weight to pre-nups than was previously the case.

To try to ensure that Eve's pre-nuptial and Emma's post-nuptial agreements are upheld, the following steps should be taken.

The agreements should be freely entered into by each party – there must be no element of pressure, coercion or undue influence.

Specialist family lawyers should advise each party independently, and material financial disclosure should be given.

The agreements must be fair in the circumstances at the time of the divorce – this is a very difficult element to assess and it really depends on the facts of the particular case. In Radmacher, if at the time of the breakdown of the marriage Mr Granatino had been unable to work through illness, it may have been unfair for the court to hold him to the agreement.

Although some say that nuptial agreements are unromantic and unattractive, they are now commonplace, and an essential wealth-protection step for wealthy families; they encourage a healthy and open dialogue about finances, so that everyone knows where they stand if the worst were to happen, and should form part of a 'family constitution' in many families.

Cohabitation agreements

If there is no date set for the marriage and it is a long way off, Eve should think about entering into a cohabitation agreement with her fiancé if she is living with him or plans to.

Although cohabiting couples in the UK have doubled in number in the last 20 years, the law for cohabiting couples remains deficient. If unmarried couples separate, there is no clear legal apparatus to determine what will happen to assets: rather, a patchwork of speculative, complex and costly claims. This could be a headache for Eve and for Simon and Sarah, particularly if Eve and her fiancé have been together for many years without marrying and have intermingled their assets.

If Eve has a cohabitation agreement, drafted before she and her fiancé were living together or while they have been, then assets should generally be divided in accordance with the agreement. To give the agreement the best chance of being upheld, both Eve and her fiancé should be independently represented in negotiations, material financial disclosure of their respective situations should be given, and there should be no pressure / undue influence exerted.

Separation agreements and divorce settlements

It would be advisable for Edward to negotiate a separation agreement with his wife. Although not legally binding, this is a legal agreement setting out the financial arrangements during the period of separation and how the couple's finances should be divided in the event of divorce. It can seek to protect inherited wealth or gifts received from a third party, and can be cited in later divorce proceedings as evidence of the parties' intentions.

Edward should be aware of how the courts approach finances on divorce. He must be upfront and transparent, as his duty is to provide full and frank disclosure to his wife and the court. This is vital. He cannot fail to disclose trust assets or inheritance which he considers he will receive in the foreseeable future. He also cannot do anything to try to defeat his wife's claims. If he does try to dissipate assets, the court has preventative powers to prevent a disposition (for example, his wife could obtain a freezing order to stop him doing so).

There is no standard formula for calculating appropriate financial provision on divorce. Instead, the court has a duty to consider all the circumstances of the case and to take into account the following specific statutory factors, set out in section 25 of the Matrimonial Causes Act 1973 (MCA 1973):

  • the capital and income available to the parties
  • details of the financial needs of the parties
  • the respective contributions of each party
  • the conduct of each party (although only in exceptional cases)
  • any benefit either party will lose as a result of the divorce (such as a spouse's pension).

However, before considering these factors, the court first considers the welfare of a child if the child is under 18.

The starting point is that assets accrued during a marriage are divided equally, and the guiding principles applied are 'equal sharing', 'needs' and 'compensation' (the latter is the principle applied for relationship-generated disadvantage, for example, if one party has given up work to care for the children and has therefore damaged their ability to earn money). The matrimonial home is normally considered a matrimonial asset, so is divided equally between the parties, even if it was owned by one of them before the marriage.

A lot depends on the financial position of Edward's wife. Where her needs and the needs of their child cannot be met by an equal division of the assets, an unequal division of resources may be appropriate. The court may invade inherited assets, or assets introduced by Edward during the marriage (such as trust assets), to meet his wife's and children's needs.

Lifetime giving and trusts

Lifetime giving is an important theme in any advice on wealth protection. This is dealt with in detail in Lesley King's Back to basics on lifetime giving in the July 2016 edition of PS magazine, but we have highlighted here the key points in relation to divorce and remarriage.

It is simple and straightforward to make outright gifts, but such gifts will not benefit from asset protection. For small gifts, this may not be a concern, but where an extra layer of protection and control is required for more significant transfers, trusts are hard to beat. A discretionary trust will give the trustees complete flexibility to decide when, how much and to whom distributions are to be made. They can manage the trust assets and distributions to protect the family wealth over the long term, assisting beneficiaries through turbulent emotional and financial times and keeping the wealth in the family bloodline.

However, be aware that while assets are better protected in a trust than if owned outright, trusts are still vulnerable on divorce. Under section 25(2)(a) of the MCA 1973, the court must look beyond the strict property interests of the parties to the 'other financial resources which each of the parties to the marriage has or is likely to have in the foreseeable future'. Beneficial interests under a trust are considered a financial resource. The significance given to a beneficial interest depends on the extent of the underlying assets, their value and the likelihood that they will be received in the foreseeable future.

The court looks at the reality of the situation. For example, in Thomas v Thomas [1995] 2 FLR 668, the husband had trust assets which were not readily available to him, but they were still considered to be a substantial financial resource and the court made an order on the basis of the potential availability of wealth. In deciding whether trust assets are a financial resource, in G v G [2012] EWHC 167 (Fam), the court considered whether there was a likelihood of receiving income immediately or in the foreseeable future. Edward (who is divorcing) should be mindful that the availability of external resources means he is vulnerable to a more generous order in his spouse's favour, particularly where there is a 'safety net' of third party support.

The terms of any trust or settlement are susceptible to variation by the court on divorce, and this is a real danger to the family's wealth. To be capable of variation, there must be a 'nuptial' element to the settlement and this is fact-specific, although the courts have given it a broad meaning. The clearest definition was given in Brooks v Brooks [1996] AC 375. A 'nuptial settlement' is one:

  • made on the parties to the marriage
  • making some form of continuing provision for both or either of the parties to the marriage with or without provision for their children.

A settlement which is non-nuptial when created could later obtain a nuptial character if there is a flow of benefit to the parties during the marriage (Quan v Bray [2014] EWHC 3340 (Fam)). However, the case law is not clear in this area.

If Sarah and Simon set up lifetime trusts for their children, they should bear in mind the above vulnerabilities of trusts upon divorce. A discretionary trust for all of the children with no pattern or expectancy of distributions for any child will stand a better chance of protection than one where a child has clear and regular distributions, or the settlement has a 'nuptial' character. Trustees need to be alert to this and act accordingly.

Practical points

Advising any client with complex family and/or asset structures is not straightforward and there are numerous risks you need to be on top of as their adviser. Here are a few practical points to be aware of when taking instructions and giving advice.

  • Do a full asset review: find out what assets will fall under the jurisdiction of the will and those that do not, and advise accordingly.
  • Do not fall into the trap of giving financial advice: always work with a good financial adviser.
  • Make sure that your retainer and letter of engagement are clear on confidentiality when taking joint instructions from couples: we all have clients who in a joint meeting profess to be singing from the same hymn sheet, and then one telephones you later with a different agenda.

Finally, never forget the importance of clear attendance notes and written advice. When navigating the complexities of divorces, multiple marriages, half siblings and stepchildren, this will protect them (and you) in the case of any vindictive claims against their estates, which will be beyond your and your client's control. 

This article first appeared in the September edition of PS, the magazine of the Law Society's Private Client Section.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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