Are Discretionary Trusts Excluded Property in Divorce?

Is my ex entitled to my discretionary trust proceeds? Are discretionary trusts excluded property in divorce?

By Chantal M. Cattermole and Alison Carter

If you are contemplating separating from your partner or are in the midst of a divorce, you may be wondering what constitutes excluded property and what entitlement, if any, your ex may have to any discretionary trusts you may be a beneficiary of.

The BC Court of Appeal’s recent judgment on Cottrell v Cottrell, 2023 BCCA 471 grappled with this very question and provides some insights on how courts should approach discretionary trusts concerning excluded property in family law proceedings, and how it may go about valuing these trusts.

Our previous article, “A Certain Uncertainty – Discretionary Trusts and the Division of Family Property”, covers the initial proceedings of Cottrell v Cottrell, 2022 BCSC 1607, where the British Columbia Supreme Court determined that a husband could not have claim to a wife’s beneficial interest in a discretionary trust upon the breakdown of a marriage. The initial proceedings focused on the division of family property and spousal support, since the parties’ children were then adults and thus no issues of child support came into question.

The Property

Joanne and Paul Cottrell were married for 26 years and were granted their divorce in 2021. Paul was the primary income earner while Joanne cared for the family at home. When their relationship ended, Ms. Cottrell commenced a family law claim against Mr. Cottrell, seeking orders regarding property division and spousal support. Mr. Cottrell counterclaimed and sought an entitlement to the increase in value of Ms. Cottrell’s beneficial interest in her family’s trusts, companies and assets.

The disputed property that is central to these proceedings is a discretionary trust (the “Disputed Trust”). The Disputed Trust is one of two discretionary trusts that were created by Joanne’s parents, Robert and Patricia Muster (the “Muster Trusts”). The Muster Trusts hold assets that were accumulated by the Musters after they won a $5 million lottery in 1990, and are currently managed by Robert.

As these trusts are discretionary, the trustee has the power to decide how much a beneficiary will get from a trust and when they will get it. While someone may be a named beneficiary of a trust, this does not guarantee that they will ever receive any of the property.

As such, the assets in the trust are Mr. Muster’s property and can be used and distributed as desired by him during his lifetime. He has no obligation to disburse the funds in any particular way. Although Ms. Cottrell is an intended beneficiary of the Muster Trusts, she cannot unilaterally effect a distribution of the assets and her interest in the trusts can be defeated or rendered valueless before receiving any benefit.

Outcome of the Trial Decision

In the trial decision, which we have written of previously, the British Columbia Supreme Court determined that Mr. Cottrell would not have access to the discretionary trust.

The Court reached this conclusion because Mr. Cottrell was unable to establish that there was an increase in the value of Ms. Cottrell’s beneficial interest in the trust. Evidence gathered from witnesses at trial was not deemed reliable enough to assign a value to the wife’s beneficial interest.

The Court noted that if it was possible for a value to be assigned to the increase in the wife’s beneficial interest in the trust, a different outcome may be reached.

In light of the trial decision, the Court left the door open to the possibility that interests in a discretionary trust, or at least the increase in value of such interest, may be subject to division between spouses upon separation in certain circumstances.

The Legal Framework

The legal framework applicable to the division of family property and family debt is set out in Part 5 of the Family Law Act (“FLA”).

Section 81 of the FLA provides that upon separation, the spouses are each presumptively entitled to half an interest in all family property and family debt.

Section 84 of the FLA defines family property to include property owned by at least one spouse on the date of separation.

Section 85 of the FLA describes categories of excluded property which remain the sole property of the spouse who claims the exclusion. This includes property acquired by a spouse before the relationship began, gifts and inheritances received from others, and a spouse’s beneficial interest in property held in a discretionary trust.

Notably, Section 84(2)(g) of the FLA, provides that if there has been an increase in the value of excluded property during the spouses’ relationship, that appreciation is considered family property.

Fact-dependent Determination

Mr. Cottrell argued that the increase in value of Ms. Cottrell’s beneficial interest should be assessed by valuing the increase in the assets held in the Disputed Trust and then dividing this increase by three. By doing so he represented Ms. Cottrell’s interest in the Disputed Trust as equivalent to a fixed one-third direct interest in the assets held in the trust. This position was not accepted at trial.

The Court of Appeal found that this valuation was inappropriate given the terms of the Muster Trusts, the history of the trusts and their discretionary nature. Since the establishment of the Muster Trusts, there has been no indication from Ms. Cottrell’s parents that the trusts would be distributed evenly among the beneficiaries, or even at all.

The Muster Trusts held assets that included risky investments, the values of which fluctuated drastically from time to time. The Court noted that Mr. Muster’s pattern of managing the trusts since their inception could not be seen as creating any certainty as to what might happen in the future to potential distributions. He had not established a pattern of regular distributions to the beneficiaries and no evidence that suggested that Ms. Cottrell would receive any distributions in the near future.

As a result of this uncertainty and the discretionary nature of the trust, the Court of Appeal concluded that the trial decision was correct: Mr. Cottrell could not lay claim to the increase in value of Ms. Cottrell’s beneficial interest in the Disputed Trust.

Uncertainty Remains

In its decision, the Court of Appeal clarified that a spouse’s beneficial interest in property is not always equivalent to a direct proportionate interest in the property. However, uncertainty remains for future cases because the terms of the trust itself are paramount to determining the value of the spouse’s beneficial interest.

The door hasn’t shut yet. Cases may arise where the court can use evidence to determine the value of the beneficial interest in a discretionary trust at the time it was established and at the time of the dispute, effectively appraising the increase in value of the beneficial interest in question. But for now, this remains a mere uncertain possibility. This uncertainty has a significant impact on family law and the protection of property and the growth of excluded property during a marriage or marriage-like relationship.

Next Steps

If you or someone you know has questions about the nature of property disputes and what this case means for it, please feel free to contact Chantal Cattermole or anyone in our Family Law group for more information.