Discretionary trusts prove problematic when it comes to dividing assets
Lawyers dealing with dilemma have been waiting for clarity, Laurie H. Pawlitza says.
Many Canadian families with a moderate degree of wealth create a family trust. A common type of trust names a parent or an adult child as a trustee, and names both adult and minor children as discretionary beneficiaries.
Family trusts can be created for several reasons, including to reduce taxes payable and to control the beneficiaries’ use of funds and the timing of the distribution of trust assets.
The trustees of a discretionary trust are usually directed to distribute income and capital from the trust in their “absolute discretion.”
The discretion includes the ability to decide which of the beneficiaries will receive income or capital from the trust and when a beneficiary receives it. If the trust is discretionary, the trustees are not required to treat the beneficiaries equally.
One of the most blurry property valuation issues in family law arises when a separating spouse has a discretionary interest in a family trust.
In Ontario, separating spouses “equalize” their property. The regime requires that they value their assets and debts at marriage and at separation, with any rise in their net worths between those two dates (“net family property”) being equalized.
“Property” is broadly defined under the Ontario Family Law Act, and includes a “contingent” interest in property. A discretionary interest in a family trust has been determined to be a contingent interest in property.
While a discretionary beneficial interest in a trust created during a marriage is usually excluded from that spouse’s net family property as a gift, a trust that predates the marriage and that still exists at the time of separation gets a different treatment. In that case, the value of the trust interest must be determined at both dates, a difficult valuation problem.
Courts have wrestled with this issue for over 20 years. The leading case of Sagl v. Sagl, decided that Mr. Sagl’s interest in the trust would be determined by valuing the trust property at the date of marriage and at separation, and dividing that value by the number of beneficiaries of the trust at each date.
Since that time, the Courts have decided the issue differently, causing considerable confusion for family lawyers and clients alike. In Dillon v Dillon, a decision of Justice Gordon, one of the central issues was whether a marriage contract and an amending agreement were valid, given the disclosure the husband made of his interest in a discretionary family trust. There was contradictory evidence as to whether the husband’s interest in the discretionary trust was provided when the marriage contract was signed. However, when the parties signed an amendment to the marriage contract, the financial information provided by Mr. Dillon included: “Dillon Family Trust, Amount Unknown” with a note that Mr. Dillon was a “discretionary beneficiary.”
The wife took the position that the husband’s trust interest could be valued and therefore, the husband ought to have disclosed this during the negotiations. As there had been no value provided, she said the agreements should be set aside.
Justice Gordon held that “the interest in a discretionary trust cannot be valued.” Citing one of the authorities on trusts, His Honour said, “if the person is a beneficiary … under a discretionary trust, his interest may be incapable of clear valuation (since it is a mere hope).” As a result, he determined that the wife had received adequate disclosure and refused to set aside the marriage contract and the amending agreement.
The case of Mudronja v. Mudronja, another 2014 case, demonstrates the importance of the roles ascribed to each spouse in the trust settlement document.
In Mudronja, the husband had the sole power of appointment, meaning that he could appoint himself as a beneficiary and also had the discretion to distribute trust assets to himself alone. The wife was a discretionary beneficiary of the same trust.
At trial, much of the case focused on the value of the each spouse’s interest. Justice Seppi valued the husband’s interest in the trust as equal to the value of the shares it held, because the husband had the sole power of appointment over the trust. She decided that the husband’s interest was equal to the value of the shares that the trust held, because, “In the circumstances of this case, the entire discretionary, unfettered power in relation to the distribution and all dealings with the Trust’s assets rests with the (husband).
With respect to the value of the wife’s shares, however, Justice Seppi said, “(the husband) is (the wife’s) adversary now and was also adverse in interest when the parties separated. I find therefore that the (date of separation) value of the (wife’s) interest in the trust is nominal …. A value of $1.00 is therefore attributed to the (wife’s) interest in the Mudronja Family Trust for the purposes of the equalization calculation.”
Family lawyers dealing with the value of discretionary trusts have been waiting for appellate intervention to give clearer guidance since Sagl was decided in 1997. Meanwhile, family lawyers with clients who are discretionary beneficiaries continue to be unable to give clear advice about their client’s obligations on separation.