Trust Interests And Family Law Rights – What Estate Planners Need To Know After Tremblay And Mudronja

Introduction

Since the enactment of the Family Law Act ("FLA"), Courts have struggled with determining, firstly, if and when the interest of a spouse in a discretionary trust qualifies as "property" as defined in the FLA for purposes of equalization of net family property ("NFP") and secondly, how that property interest is valued.

Family law legislation varies from province to province, but it has been difficult to find any significant body of law in Canada addressing how to deal with interests in trusts. Other jurisdictions such as the U.K., Australia and New Zealand have extensive jurisprudence on the issue and legislation that addresses the accountability of a spouse for a trust interest, both as a beneficiary and in terms of the bundle of rights that are reserved, whether as a Trustee, as a protector or as holder of a power to appoint.

Estate planners need to know when the rights reserved will result in the value of the trust property being included in a spouse's NFP under the FLA.

Trust Interests as Property

In Ontario, the problem arises from the remedial nature of the legislation and the very broad definition of "property." Subsection 4(1) of the FLA defines "property", in part, as follows:

"property" means any interest, present or future, vested or contingent, in real or personal property and includes,

property over which a spouse has, alone or in conjunction with another person, a power of appointment exercisable in favour of himself or herself, and property disposed of by a spouse but over which the spouse has, alone or in conjunction with another person, a power to revoke the disposition or a power to consume or dispose of the property. The first part of the definition includes the interest of a beneficiary under a Trust, but paragraphs (a) and (b) relate not to the rights of a beneficiary, but rather to the bundle of rights by which a spouse has the power to control the disposition or consumption of the trust property, whether as a Trustee, protector or holder of a power to appoint.

Trust practitioners believe the definition is overly broad for several reasons.1 There is no doubt that an individual who has a general power of appointment has a right that is tantamount to ownership of the property.2 But paragraph 4(1)(a) extends to a power of appointment which a spouse has "alone or in conjunction with another person." The FLA does not provide any guidance as to the identity of the other person, but presumably the intention was that the other persons might be individuals whose compliance the spouse had either the ability or the expectation to compel.3

There does not appear to be any reported Canadian cases which have analysed the identity of the co-trustees or whether or not they are truly independent, although Tremblay v. Tremblay4 makes conclusions on the issue. U.K. Courts have dealt with the issue of control of the trust property by examining the independence of the other trustees, the likelihood of the other trustees exercising independent authority and any correspondence between the parties such as letters of wishes and patterns of distributions of trust property.5

In a number of recent decisions of Commonwealth Supreme Courts and Courts of Appeal,6 the approach taken by the Courts support a "substance over form" approach to the problem of division of assets in the context of a divorce. The analysis of the Courts involves bringing "a judicious mixture of worldly realism and a respect for the legal affairs of Trusts, the legal duties of Trustees..."7

In Charman v. Charman (No. 4), [8] the U.K. Court of Appeal considered whether assets held in an offshore trust over which the husband had de facto control (even though there was a nominally independent Trustee) were "financial resources" of the husband. The Court applied the test of "whether the Trustee would be likely to advance the capital immediately or in the future to the relevant spouse."9

Subsection 4(1)(b) is also directed to a power which the spouse does not possess alone. It is directed to a revocable Trust or to an act which commences with the disposition of property. It is not arguable that a power of revocation held alone should result in the inclusion of the value of the trust property in the NFP of the holder. In Tasarruf Mevduati Sigorta Phonu v. Merryl Lynch Bank and Trust Co. (Cayman) Ltd.,10 the Privy Council concluded:

The powers of revocation are such that in equity... Mr. Demirel can be regarded as having rights tantamount to ownership... There is no invariable rule that a power is distinct from ownership.

However, subsection 4(1)(b) does not require that such a power be held alone. The particular mischief with paragraph (b) is that it is vague and the word "consume" is not particularly instructive in assessing the use of trust property, as the power to "dispose" of the trust property is clearly included in every trust indenture. Finally, because of the breadth of the definition, neither the legislation nor the jurisprudence appears to have taken into account the fact that if these powers are held in a fiduciary capacity, equitable principles would require that the Trustees, in exercising their discretion or these powers, must act in a fiduciary fashion.

The result of such broad definitions is to permit the value of a trust interest held for the benefit of persons other than the two spouses to be included in the NFP of one spouse. Specifically, paragraph (b) is broad enough to include a power to resettle a Trust made in favour of, for example, the children of the marriage. In that instance, if such property is included in the NFP of one spouse, he or she would be required to make a payment to the other spouse even though neither is a beneficiary of the Trust.11 Further, despite the fact that the FLA grants significant discretionary powers to the Court, it does not grant to the Court the power to vary Trusts to permit any one or more of the spouses to become a beneficiary of such a Trust.12

Tremblay is the latest in a series of Ontario cases that have considered the inclusion of an interest in a trust property in NFP under the FLA.

Practitioners have found the ruling troubling and somewhat opaque. The decision is currently under appeal. It is important for estate planning practitioners to understand how trust assets are likely to be treated in matrimonial litigation when advising clients on the settlement of family trusts, including: the type of powers to be reserved to an individual, the extent to which Trustee duties are limited, and the identity of Co-Trustees. Frequently, clients will wish to retain as much control as is possible, restraining that wish only to avoid income tax rules that restrict benefits if an individual retains rights that would trigger one of the attribution rules. However, the rights retained in Tremblay are not unusual and do not go so far as other more aggressive trust designs. Estate planners will need to examine more carefully the details that will be considered in determining whether or not a specific bundle of rights will qualify as "property" within the meaning of subsection 4(1).

Before reviewing Tremblay, it is helpful to review an Ontario case decided...