Protection of family wealth

The government recently conducted research into the use of trusts which indicated that many people would not feel comfortable with making a gift of capital for inheritance tax planning purposes without a trust being the recipient of the gift. This may be for a number of reasons, including the young age of the intended beneficiary or their perceived inability to deal with large amounts of capital; but according  to the research, protection is a key driver in utilising a trust structure rather than making an outright gift. For example, most parents would be dismayed to see hard earned family money pass to a child’s former spouse or civil partner on the breakdown of a relationship and may use a trust for this reason.

The potential use of trusts to achieve protection in these circumstances was illustrated in a recent High Court case. The husband (H) in a dissolved marriage, claimed a lump sum payment of between £1 million and £1.5 million from his former wife (W). The costs of the litigation between the couple had wiped out all the matrimonial assets, but H argued that the trustees of two discretionary trust funds which held assets of about £17.5 million should be encouraged to distribute funds to meet his claim. W was the settlor and a beneficiary of both trusts.

The background to this case

H and W were of Indian descent and had met at university. Their relationship lasted for 13 years but W’s wealthy parents did not approve of their daughter’s marriage. The couple had a son, aged six at the time of the hearing. They were both successful professionals and lived in a rented flat in London.

In 2015, W created two discretionary trusts both with identical terms, trustees and accompanying letters of wishes into which she transferred a nominal amount of cash, with the vast majority of the trust funds being provided by W’s father. The trust money did not belong to either W or H and was never a matrimonial asset.

The couple had good incomes (£130,000 net for H and £40,000 net for W). H had no capital assets, only debts incurred as a result of the litigation, while W had unrealisable assets in India valued at £2.6 million. The couple had enjoyed a comfortable, secure, but modest, standard of living. As there were no remaining matrimonial assets that could be shared, in order to substantiate his claim it was necessary for H to show that the capital was required to meet his financial needs.

The discretionary trusts

In considering whether or not recourse could be made to the trusts to fund H’s claim, the judge noted that the letters of wishes stated that the trust funds emanated from W’s father and that it was W’s wish that the trustees should act on her father’s advice concerning the trust, to the exclusion of every other person, including W.

In giving evidence to the court, W’s father stated that the trusts had never made a distribution and he intended that none should be made while he was alive. He also asserted that he would not direct the trustees to meet any order made against W, due to the need to be fair to all of his children.

In making his decision, the judge acknowledged that the value of trust funds could potentially be taken into account to make an award, and the court could give the trustees “judicious encouragement” to provide funds for this purpose. However, the court must not put undue pressure on the trustees; the other trust beneficiaries must not be “appreciably damaged”; and the court must decide that it is reasonable for the paying spouse to try to persuade the trustees to release capital for this purpose. The court found that in this case it would not be reasonable for W to try to persuade the trustees: she was the trusts’ settlor in name only; she had never received any benefit from the trust; and had excluded herself from giving any advice to the trustees.

Over-riding these considerations was the court’s view that if it were to make any order taking the trust funds into account, the court must be satisfied that the trustees would be likely to make the funds available. In the judge’s view it was “highly unlikely” in this case that the trustees would distribute funds for this purpose. In addition, it was held that H had no “objective, reasonable or justifiable” need for a lump sum from W as he had a very good income enabling him to sustain a good standard of living similar to that enjoyed during the marriage.

H’s claim was dismissed. The judge commented that “this tragic and destructive case should stand as a cautionary tale to those who… embark on expensive litigation….in the hope of prising money from a discretionary trust.”

Lessons to be learned

Each case of this nature will be decided on its own particular facts, but this judgment illustrates that trusts can potentially protect a gift from claims from former spouses.

Although not legally binding, the letters of wishes were clearly pivotal in persuading the court that the trustees were unlikely to make funds available. The manner in which a trust has been administered prior to the claim arising will be important, particularly whether or not distributions have been made to the couple and their children. It is likely that a trust with a wide class of beneficiaries, who might be “appreciably damaged” by a distribution to fund a court award, would provide a greater degree of protection and, arguably, it may be preferable to exclude the beneficiary’s spouse from benefit.