Interests in discretionary trusts under the new Family Law Act


The new Family Law Act (the “FLA”) received royal assent on November 24, 2011 and is scheduled to come into effect in March of 2013.

The FLA introduces significant changes to the rules surrounding property division upon a marital breakdown. Under the FLA, “family property” is divided equally between the spouses, and includes all real and personal property owned by one or both spouses at the date of separation, unless the property fits within the definition of “excluded property”.

The definition of “excluded property” includes, among other things, gifts and inheritances, property acquired by a spouse before the relationship began, and property held in certain discretionary trusts. Despite the definition, this property isn’t exactly “excluded” as a family asset because any increase in the value of excluded property during the relationship is still shared equally between the spouses on a breakdown.

This scheme raises some potential issues in the context of discretionary trusts. If a spouse is a beneficiary of a discretionary trust, any growth in the value of the trust property during the relationship may be subject to division, despite the fact that the spouse’s interest in the trust is only discretionary and there is no guarantee the spouse will even benefit from the trust property.

The following example of a typical estate freeze might help illustrate the issue:

A and B are owners of a family business (“AB Co.”) and implement an estate freeze by exchanging their common shares of AB Co. for fixed-value preferred shares. A new family trust then subscribes for common shares of AB Co. for $100. The beneficiaries of the trust are A, B and their two children, X and Y (who is married at the time). Ten years later, the value of the common shares of AB Co. grows to $10 million and Y’s relationship breaks down.

According to the current provisions of the FLA, on the breakdown of Y’s marriage, Y would be required to make a payment of $5 million to his or her spouse in respect of the trust property, even though all of the trust property may in the future be distributed to the other beneficiaries of the trust, to the exclusion of Y.

As demonstrated by the example above, the provisions in the FLA relating to discretionary trusts are problematic, and the fact that the FLA will apply to common law relationships as well as marriages makes these issues all the more troubling. It will be interesting to see whether the FLA will be amended before it comes into effect in order to address these concerns.