Trusts and protecting assets on divorce from creditors - part II

The basic principle is that a beneficiary’s interest under a trust can be relevant in divorce proceedings if either the beneficiary has a vested right to trust assets and/or income, or the trustees operate in any way consistent with the conclusion that, as a matter of fact, they treat the trust assets as the beneficiary's and use them for his or her benefit. This is true regardless of the nature of the trust assets. 

Generally speaking, a divorcing spouse, who is aware that the other spouse has either created a settlement or is a beneficiary of a settlement created by another person, may have three ways to "attack" such a settlement with a view to having the trust assets included for the purpose of the divorce proceedings. First, they can try to challenge the validity of the trust itself, in effect claiming that the arrangement is a sham. The Courts are not keen to challenge the validity of a trust. However, there are a number of cases when a trust was deemed to be a sham, the most famous being that of Rahman v Chase Bank (CI) Trust Co Ltd [1991] JLR 103. We have looked at sham trusts in past articles. 

To prove a sham it must be shown that both the settlor and the trustees intended the trust to be a sham when the trust was created and that is not likely to be easy. 

The second way to challenge a trust on divorce is to seek to vary the terms of the trust as a "nuptial settlement". We covered this in more detail in the last month's article. 

The third method available to a divorcing spouse is to argue that the trust assets are a financial resource available for division in the matrimonial proceedings. The next case we consider involved an argument of this kind. 

As previously stated, Matrimonial Courts tend to refuse to be bound by the technicalities of trust law and they look through trustees’ discretions to the substance of how the trust operates.

If a spouse is entitled as of right to income from a trust, that is clearly going to impact on whether or how much maintenance is payable; but discretionary trusts are not immune from attack either. The Court will look at the reality of the situation: where a spouse is the settlor and main beneficiary, and can simply ask the trustees to get money out of trust, he or she is likely to be on a sticky wicket. The Court will look at the pattern of payments to a beneficiary and the reasons for them. Letters of wishes and minutes of trust meetings will be disclosable, and orders may be made in the expectation that trustees will exercise their powers to enable the beneficiary to comply. 

Daga v Bangur [2018] EWFC 91

This case is particularly interesting as it involved two settlor-interested discretionary trusts into which the father of the settlor had also made substantial additions and which had combined assets of the equivalent of about £17.5 million.

The facts in the case of V Ankul Daga (AD) v Aparna Bangur (AB) were as follows.

The couple met when they were both university students aged 20. Their relationship started in 2003, they married in 2007 and the final breakdown was in 2016. According to the judgment AB’s parents never approved of the match and always regretted that their daughter had married this particular husband. The couple had one child.

Throughout the marriage the parties lived in rented accommodation in London paying the rent out of their joint income. They were both successful, professional earners but they never owned their own home. AB did, however, acquire some property and other assets in India, funded by her father. It was agreed that there were no marital assets and AD based his claim on ‘need’ – he wanted to buy a home for £2.5 million (later reduced to £1-1.5 million).

In 2015 AB, as settlor, created the two offshore discretionary trusts. The trusts were in identical terms and the trustees were the same. The beneficiaries were ‘family members of the settlor, including the settlor’. Initially only nominal amounts were settled into each trust but in early 2016 AB’s father gifted substantial sums to AB and by mid-June 2016 the total sum settled in the two trusts was about US$23 million. No distributions to any beneficiary had ever been made by the trustees from the trusts.

By the time of the Court hearing the couple had already spent between them over £1m on legal costs; £380,000 related to litigation about their son and about £650,000 on finances. Savings built up during the marriage had been wiped out. There were no liquid matrimonial assets and each party had considerable debts. AD argued that the judge should make a lump sum order designed to give ‘judicious encouragement’ to the trustees to distribute funds with which the wife could make the payment to him.

AD’s pleas fell on deaf ears. The judge was not prepared to accept either that AD had the need he claimed or that the trusts were a ‘resource’ available to AB.

The judge found that what AD needed was to clear his debts but these were entirely referable to the costs he had incurred and a lump sum for that purpose would be the same as making a costs order in his favour which could not be justifiable.

On the ‘resource’ point the judge was clear that the trust funds were not an available resource. The judge determined that, whilst AD (as the husband) fell within the class of discretionary beneficiaries prior to the decree absolute, he was no longer a beneficiary post the decree absolute. The judge also referred to letters of wishes signed by AB in which she indicated that it was her ‘irrevocable wish that the trustees act on the advice of my Father in regards to all matters concerning the Trust…’ The judge therefore proceeded on the basis that, even if a lump sum order was made, the father would advise the trustees not to distribute funds to the wife. The Court must not put undue pressure on the trustees and the judge concluded that the trustees were highly unlikely to make funds available in any event. There were various reasons to support this conclusion. The trustees (being offshore) were not within the jurisdiction of the Court; they had never made any distributions to the wife or her son; there were very strong letters of wishes and it was highly likely that the father’s attitude would determine the trustees’ attitude.

The judge therefore ordered a clean break between the parties and refused AD’s claim.

Although the next case we consider is not divorce-related, it deals with the protection of trust assets from creditors where a trust was created for tax planning purposes and so it is convenient to mention it here (and also because the individual concerned worked in financial services).

Robin Farrell (a bankrupt) sub nom (1) Andrew Tate (2) James Hopkirk (Joint Trustees in Bankruptcy of Robin Farrell) V (1) Barbara Maria Farrell (2) Andrzej Leslaw Swiatkowski (3) Penntrust Ltd (2019) [2019] EWHC 119 (Ch) 

The facts of this case were as follows: Robin Farrell (RF) , an investment manager, ran the Arch Group of companies which provided investment and other financial services. Relevant to the case is that the Group's products, performance and record keeping were first investigated by the FSA in 2007 and that the 2008 financial crisis created liquidity problems for the Group. 

In 2009 RF made various large gifts of cash from his own bank account totalling £855,000 and transferred 47% of his 50% interest in the family home to his wife and to trusts set up in favour of his children. 

In 2011 claims for mismanagement were brought against the Arch Group and RF personally. In 2014 damages of £24.2 million were ordered in relation to the mismanagement claims and as a result RF was declared bankrupt in late 2015. 

Under section 423 of the Insolvency Act 1986 (Transactions defrauding creditors), the Court has the power to unwind gifts made by a person if the gifts are for the purpose of either putting assets beyond the reach of a person who is making, or may at some time make, a claim against them, or otherwise prejudicing a claim. 

The person applying to Court must prove that the purpose of the gifts was to put assets beyond the reach of, or to prejudice, a third party claimant, on the balance of probabilities. RF's trustees in bankruptcy applied for an order under section 423 to unwind the gifts and return the gifted assets to the bankruptcy estate saying they were transactions defrauding creditors. 

The High Court ruled that the primary purpose of the gifts was tax planning and therefore the gifts were not transactions defrauding creditors. All the gifts and trusts were therefore safe. 

RF had received tax advice and was motivated by his desire to provide for his family in the future and to pay for household expenses. The tax planning advice he had received included equalising his assets with those of his wife. Having examined the circumstances at the time of the gifts, the Court also took the view that the liquidity problems faced by RF's business and the FSA investigations were not sufficiently troubling as regards his personal assets at the time of the gifts for him to have potential third party claims in mind, and in fact RF's state of mind regarding his personal finances appeared optimistic at the time of the gifts. 

The judge made a point that this was very much a borderline case and that he was very close to finding in favour of the trustees. Obviously each case will depend on its own facts but this decision illustrates that it is very difficult to argue (let alone prove) an intention to defraud. 

We should add that had the gifts been made within the 5 year period prior to the bankruptcy, there would have been no need to prove the intention to defraud as such gifts (s 339 -441 Insolvency Act 1986) would be brought back into account as transactions at undervalue and this applies regardless of the motives.

Conclusions

Clearly, the mere existence of a trust does not by itself offer any protection from claims on divorce or from creditors. If there is an argument then the reality of the situation will be of paramount importance and the Courts will carefully examine all the evidence.

However, in particular the first case mentioned above offers some comfort that even if the party to a divorce is a settlor and a beneficiary of a trust, it does not follow that trust assets will be available to the other party. The judge's comments about the importance of the letter of wishes and the history of the trustees not actually making any distributions are also very useful. Many settlors do need reminding about the importance of the letter of wishes and the importance of keeping it up to date ( a potential reason to revisit trust clients?). 

The second case is also useful in confirming that the standard of proof in cases of fraud is extremely high although, when it comes to implementing tax planning strategies, the sooner any action is taken the better. RF only just got away from falling into the 5 year trap.