The valuation of third party discretionary trusts on separation has sparked disputes between family lawyers and trust lawyers, and even more so for separating family law clients. A blockbuster BC Court of Appeal case of Cottrell was released at the end of December 2023. Cottrell v Cottrell provides guidance for family law clients and their lawyers related to the vexing issue valuation and division of third party created discretionary trusts. Hiring family law lawyers like the experienced trust lawyers at MacLean Law, such Lorne MacLean, KC and Fraser MacLean who know how to get proper disclosure, proper valuation evidence and who can analyze the exact terms and historical operation of third party discretionary trusts is critical. Interest in discretionary family trusts can impact child support, spousal support not just division of family property.
As one of the few lawyers to win on a third party discretionary trust claim, where we persuaded the court to take an “if and when” approach, imposing a constructive trust on any property distributed to the beneficiary spouse: Fulton v. Gunn, 2008 BCSC 1159, we know how these cases work.
ALERT: Completely different rules apply to discretionary trusts that are created by a spouse before, or during the relationship with property jointly created by the spouses during marriage or a marriage like relationship.
Valuation Of Third Party Discretionary Trusts On Separation – Executive Summary Call Us at 604 602 9000
The key issues relating to valuation and division of these discretionary trust interests is the level of certainty that a separating beneficiary of such trusts will receive their share and when. Issues related to certainty affecting division and valuation may involve the history of distributions to that spouse, the level of control the spouse has over receiving their interest, the number of beneficiaries, the final distribution date of the trust and the fairness of a spouse receiving an uncertain trust interest that they may never receive causing them to lose most or all of the other family property such as a home, investments and a business. Issues of fairness arise when one spouse could receive all the family property while the other gets nothing up front at the end of the marriage and only a hope of money coming to them down the road that they have no way of obtaining payment of. Even unequal division may be in play when a discretionary trust interest is involved.
Valuing a discretionary trust interest requires expert evidence and even the approach to valuation matters. Most experts would say a beneficial interest in a trust has no value as no third party would pay money to buy a separating spouse’s uncertain interest that may never be received by the buyer. A failure to provide expert evidence on valuation of a beneficial interest in a third party created discretionary trust will be fatal to any claim for division. The FLA says you must start with a “fair market value” analysis but other methods such as value to owner can potentially be argued.
The BC Appeal Court Summarized the Cottrell case as follows:
The appellant former husband appeals from an order dismissing his claim to his former wife’s beneficial interest in property held in a discretionary trust established by her parents. The wife’s father settled the trust while the couple was married, and she was listed as one of the beneficiaries. [Neither divorcing spouse contributed to the trust.] The husband submits that the trial judge erred in failing to divide the trust’s increase in value. Held: Appeal dismissed. The trial judge did not err in interpreting the Family Law Act [FLA] as entitling the husband to the increase in value of the wife’s “beneficial interest” in the property held in trust. The trial judge correctly concluded that the husband had failed to demonstrate the value of the interest had increased during the marriage.
The Law On Valuation Of Third Party Discretionary Trusts On Separation
Sections 84(2)(g) and 85(1)(f) of the Family Law Act, S.B.C. 2011, c. 25 [FLA] establish what property is included and excluded from the division of family property and family debt upon separation. Section 85(1)(f) treats a spouse’s beneficial interest in property held in a discretionary trust as excluded family property, but any increase in value of that beneficial interest during the relationship is included as family property pursuant to s. 84(2)(g).
The Muster Family Trust at issue in Cottrell had both parents and their children as beneficiaries with the parents’ siblings as backups if all primary beneficiaries died. While the divorcing wife and her brother were trustees, they did not manage the trust , which at all times was controlled and managed by the divorcing wife’s father, Robert Muster.
Notably, Third party created trusts do not include money or assets created by the joint effort of parties who are married or in a marriage like relationship and these trusts are treated differently than trusts set up during a relationship by spouses who jointly created the assets in these trusts.
Key Facts On Valuation Of Third Party Discretionary Trusts On Separation:
- Neither spouse contributed to the Muster Trust;
- The wife did not receive any distributions from the trust during marriage;
- The wife did not exercise control over the trust set up by he parents with their own money;
- The Trust’s final distribution date was September 2031;
- The wife borrowed some money from her father after separation;
- Critically, there was a complete absence of expert valuation evidence concerning the nature and value of the trust assets and any gain that may have occurred on the wife’s beneficial interest since the start of the relationship up to the date of trial;
- The judge noted that under s. 85(1)(f) of the FLA discretionary trusts were excluded from the definition of family property; however, any increases in value of excluded property were family property pursuant to s. 84(2)(g).
- The judge rejected the husband’s proposed method of valuing the assets (by using the starting and ending property assessments on the trust’s commercial land assets and divided this difference by the number of beneficiaries resulting in a 1/3 share of the increase to the wife) and found Mr. Cottrell had failed to show an increase in value of Ms. Cottrell’s beneficial interest in the trusts.
- Further, the judge considered Mr. Cottrell’s arguments that his obligation to pay spousal support should cease in the year 2031, which would be the year he would turn 65 and Ms. Cottrell could receive assets from the Family Trust. The judge declined to make this order, consistent with his findings that the future was too uncertain in this regard: at para. 65. However, he acknowledged that if Ms. Cottrell were to receive assets in the future from the Muster Trusts or from her father, Mr. Cottrell would have the right to apply for a variation of his spousal support obligation on the basis of a material change in circumstances.
- The court reviewed the importance of considering a variety of factors affecting valuation and what the chances of any distribution down the road were and how fairness played a role in deciding how to divide such a beneficial interest which is not the same as valuing the property in the trust.
How Are Third Party Created Discretionary Trusts Valued? Tel: 604 602 9000
The BC Court of Appeal explained:
[48] The mere fact that the future interest in a trust was a contingent interest, with several uncertainties as to when, if, and how much the spouse might receive in the future, did not preclude a finding that the spouse had a type of property interest capable of valuation or division for purposes of the FRA. This was a finding of fact that required looking at the terms of the trust and the pattern of use of the property in the trust: see Purtzki at para. 68.
[50] The present case involves a discretionary trust established by a parent of a spouse, where the parent retains control of the trust and there are multiple beneficiaries. These kinds of trusts are not unusual, and problems regarding their division or valuation arose under the FRA. Under the FRA, several authorities avoided the problem of valuing a contingent interest in a trust such as this by finding that the spouse’s contingent interest was a family asset, and ordering that the interest would be divided in the future “if and when” the spouse who was the beneficiary received their interest:…
[52] The parties have not referred the Court to any authority which applies the “if and when” approach to these kinds of interests in discretionary trusts under the FLA. This may be because, unlike the former Act which considered the entire interest in a discretionary trust owned by the spouse, the FLA regime only applies to the increase in value of the interest for the relevant time period, and therefore a valuation of that increase must still occur even if the parties are directed to wait until a final distribution.
[53] The parties also have not provided the Court with any authority in which a court has determined the valuation of the increase of a beneficial interest in a discretionary trust under the FLA. In S.L.M.W. v. M.R.G.W., 2016 BCSC 272, the court found that the claimant was entitled to the increase in value of the respondent’s beneficial interest in a discretionary trust that the respondent contributed to before the relationship began. However, the court directed the parties to provide further submissions addressing the nature of the family interest in that trust: at paras. 104–105. Ultimately the valuation issue was resolved out of court: S.L.M.W. v. M.R.G.W., 2016 BCSC 919 at para. 2.
[58] I agree with the trial judge that what is being valued under s. 84(2)(g) of the FLA is the growth in value of the spouse’s “beneficial interest in” the property held in the discretionary trust during the relationship, which is not the same as the growth in value of the property in the trust. The spouse’s beneficial interest is not equivalent to a direct proportionate interest in the property. Sometimes there may be a close relationship between the two values, but not necessarily always. The terms of the trust itself are therefore highly relevant in determining the value of the spouse’s beneficial interest.
[59] Focussing on the nature of the beneficial interest does not render the FLA provisions regarding discretionary trusts inoperative, but rather gives effect to the wide variety of potential circumstances that might affect such interests. Therefore, contrary to Mr. Cottrell’s submissions, Robert Muster and Ms. Cottrell’s evidence regarding the degree of knowledge and control Ms. Cottrell had and has over the Family Trust is not an irrelevant consideration for the trial judge.
[60] Rather than achieve certainty, Mr. Cottrell’s proposed method of valuing a beneficial interest in a discretionary trust simply raises more questions. Mr. Cottrell’s method requires the court to pay no heed to the terms of the trust or the relationship between the trustees and the beneficiaries. Although he considers that Ms. Cottrell’s chance of receiving assets under the Family Trust is virtually certain given her apparently good relationship with her father, he chooses to ignore situations where the relationship between the trustee(s) and the beneficiary spouse might be quite distant, or even strained and where other beneficiaries have priority in receiving trust assets. He also does not propose a clear method for determining how many beneficiaries should be counted, as shown by the fact that at trial he proposed that the assets be divided by the number of three beneficiaries, yet on appeal he concedes the number should be five because the parties’ adult children are also beneficiaries. He says nothing about the situation where the beneficiaries may have additional children in the future who could then become beneficiaries.
[61] Contrary to Mr. Cottrell’s submissions, there is nothing in the language of the FLA that suggests there should be a one-size-fits-all formulaic approach to valuing a spouse’s beneficial interest in property held in a discretionary trust. Perhaps the legislature recognized the rather infinite creativity of lawyers in drafting trust instruments, and the wide variety of potential circumstances that might affect the value of a beneficiary’s interest. Thus, despite the variety of complex factual disputes that arose under the FRA when considering the valuation of beneficial interests in trusts, when enacting the FLA, the legislature chose not to direct any particular method of valuation of these kinds of interests.
[62] It is also important to bear in mind if there was a rigid approach to valuation that applied, it would mean the legislature considered such an approach to be presumptively fair under the FLA, leaving the spouse with the beneficial interest in a discretionary trust to meet a high burden of showing that such an approach is “significantly unfair”.
[63] I do not accept that taking Mr. Cottrell’s formulaic approach to valuing Ms. Cottrell’s beneficial interest in the property in the Family Trust was a scenario the legislature implicitly deemed “fair”, as a starting point for all discretionary trusts when interpreting s. 84(2)(g) and s. 85(1)(f).
Problems With Giving One Spouse An Uncertain Possibility of Receiving Their Beneficial Interest While Giving All The Other Family Property To Their Spouse
Serious issues of fairness can arise when valuing and dividing beneficial interests in third party created trusts. The Court of Appeal points out:
[64] Here Ms. Cottrell points out that she gave up her career and took care of the children and home, allowing Mr. Cottrell to advance in his career. At the end of their relationship, their major asset is the family home. If Mr. Cottrell’s arguments were accepted, she would be required to notionally pay Mr. Cottrell one-half of his valuation of the growth of her beneficial interest in the trust, determined by treating her interest as though it is a fixed direct interest in real estate. In order to manage this, she would be required to trade off all of her interest in the one major asset they did accumulate during the marriage, the family home.
[65] In other words, if Mr. Cottrell’s arguments were accepted, Ms. Cottrell would be starting out after a lengthy marriage, trying to establish a new career, with next to no assets and nothing but a possibility of receiving some assets from the Family Trust in 2031, if her father does not otherwise distribute them or suffer a poor investment result or change the terms of the trust. Mr. Cottrell, on the other hand, would have no uncertainty about his financial future, having received all of the equity in the family home in compensation for Ms. Cottrell’s uncertain future distribution from the trust. The obvious unfairness of this result explains why Ms. Cottrell argued in the alternative that if the court was to conclude that there was an increase in value of her beneficial interest in the Family Trust, it would be significantly unfair not to reapportion that interest entirely to her, pursuant to s. 95.
[66] In short, as I read ss. 84(2)(g) and 85(1)(f) of the FLA, the judge’s task was to determine as a matter of fact whether Ms. Cottrell’s beneficial interest in the property held in the discretionary trust had increased in value during the parties’ spousal relationship and by what amount. This required some consideration of the terms of the discretionary trust and circumstances regarding the management and distributions from that trust. That is exactly how the judge approached it: see para. 42.
Should Fair Market Value Of The Gain On A Third Party Trust Beneficial Interest Be Used? Tel: 604 602 9000
The importance of expert valuation evidence in valuation of third party discretionary trusts on separation was emphasized by the Court of Appeal:
[73] The FLA states at s. 87(a) that family property must be based on its “fair market value”. I agree that it is difficult to apply the concept of there being an open market for a contingent, beneficial interest such as in a true discretionary trust. However, in such a case, the fair market value is the starting point and the court can go from there to reach a different conclusion: Stober v. Stober, 2015 BCSC 2505 at para. 35. As indicated in Stober at para. 27, it is conceivable that a chartered business valuator might be able to value Ms. Cottrell’s beneficial interest in the Family Trust.
It seems the Court of Appeal has opened the door to arguments for a valuation approach based on value to owner which avoids the concept of no third party being willing to pay anything for the beneficial interest of a separating spouse. The concept of fairness might dictate a court would reject a finding of zero value when the act says a beneficial interest can be divided.
What key factors Must You Show When Valuing An Interest In A Third Party Created Discretionary Trust?
Looking at the trust deed and how a trust operates is critical.
[74] Further, as already indicated, I do not accept Mr. Cottrell’s approach of ignoring the terms of the Family Trust, when valuing Ms. Cottrell’s beneficial interest.
[75] In the present case, unlike in Purtzki, Ms. Cottrell does not control the Family Trust, her father does, and Ms. Cottrell is not the only beneficiary, there are currently five beneficiaries including her two children. There are a large number of uncertainties as to when, if, and how much Ms. Cottrell might receive a property distribution from the Family Trust, including: the life expectancy of Robert Muster; Robert Muster’s future investment decisions managing the trust; the potential that the investments might decline in value due to market conditions or unsuccessful investment decisions, prior to any anticipated distribution of the same to beneficiaries; the potential future needs of Robert and Bruce Muster, including whether they might have special medical needs when they age that are not provided for by other means; any special needs of Ms. Cottrell’s children, now and in the future; Ms. Cottrell’s own future needs and life expectancy; and whether Robert Muster might change the terms of the trust or beneficiaries in the future.
[76] These uncertainties existed at the formation of the Family Trust, and had not diminished during the time of the parties’ marriage. Robert Muster’s pattern of dealing with the trust over time could be seen as not creating any greater certainty as to what might happen in the future in terms of potential distributions to Ms. Cottrell, than the uncertainty that existed when the trust was established. He had not, for example, established a pattern of regularly distributing assets of the trust to Ms. Cottrell over those years. There was no evidence to suggest that Ms. Cottrell could expect a distribution of assets in the Family Trust in the near future.
[77] Two values must be determined under s. 84(2)(g): the value of the spouse’s beneficial interest at the later of the time the relationship began or the property was acquired; and the present value of the spouse’s beneficial interest at the time of trial. The two values then need to be compared to determine if there has been growth in value of that beneficial interest. A number of factors could potentially affect these starting and end values, including the uncertainties just mentioned.
[78] In Stober, the court cited a party’s submission and reliance on academic commentary regarding the types of factors that may be relevant to valuing beneficial interests in discretionary trusts:
[32] The claimant notes, again, that there is no existing judicial consideration of the relevant provisions of the FLA and correspondingly, no established approach or methodology to valuing beneficial interests in discretionary trusts. She cites a number of cases from other jurisdictions where the courts have taken different approaches. She also notes that there has been considerable academic commentary and debate on this issue and she refers, as an example, to Freedman and White, Financial Principles of Family Law, where the authors identify a number of factors that may be relevant to the valuation of an interest in a discretionary trust as follows:
a) the circumstances of the owner-spouse, the trust, and the other beneficiaries;
b) the number and ages of the various beneficiaries;
c) the obligations of the trustee(s) under the terms of the trust;
d) the owner-spouse’s overall estate planning;
e) the trustee’s possible plans for the underlying assets of the trust;
f) the obligation of the trustee(s) to maintain an even hand when dealing with all beneficiaries;
g) the fair market value of the underlying assets of the trust; and
h) the expectations and legal rights of the other beneficiaries (at 28-13-28-14).
[79] These factors recognize that valuating a beneficial interest in a discretionary trust is a fact-specific inquiry, based on both the language of the trust instrument and the various circumstances affecting that interest.
[80] The judge was not wrong to conclude that:
[43] … I agree with the submissions of Joanne’s counsel that the uncertain nature of Joanne’s contingent beneficial interest in the Muster Trusts is such that it cannot be said that, at the time of the trial, there has been an “increase in value” of this interest. This uncertainty stems from the fact that Joanne has never had the actual or even an apparent ability to compel a distribution of the Muster Trusts, and has no reliable assurance regarding the specific extent to which she may receive such a distribution in the future. In these circumstances, the Court cannot find that Joanne’s beneficial interest in the property held in the Muster Trusts is greater now than it was when the trusts were settled. In the absence of such a finding, there is no “increase in value of excluded property” to which a s. 84(2)(g) FLA claim can be asserted. Paul’s request for a remedy in relation to such a claim must therefore be dismissed.
…
[47] Before completing my consideration of this issue, however, I wish to be clear that my finding that Paul has not established that there has been an increase in value of Joanne’s beneficial interest in the Muster Trusts should not be taken as a conclusion of law that it is impossible to make a family property claim in respect of a spouse’s beneficial interest in a discretionary trust under the FLA. My finding is based on the evidence presented in this case, particularly the terms of the Muster Trusts instruments, as well as Mr. Muster and Joanne’s testimony about their intentions and expectations regarding these trusts. That evidence does not justify a conclusion that Paul is entitled to a remedy in relation to Joanne’s beneficial interest in the Muster Trusts. A different conclusion could well be reached in another case involving different trusts, trustees, beneficiaries, and spouses.
[Emphasis added.]
[81] In short, this case involves a true discretionary trust with no established pattern of distributions providing predictability about the future, and very little evidence of the value of Ms. Cottrell’s beneficial interest at the time the trust was established versus at the time of trial. On the spectrum between certain pending receipt of trust property, and uncertain future receipt, Ms. Cottrell’s interest fell closer to an uncertain future receipt of property. In my view, it cannot be said that the judge made a palpable and overriding error in concluding that there was no increase in the value of Ms. Cottrell’s beneficial interest in the Family Trust during the relationship.
In the end result the husband lost but was free to come back to court on spousal support if and when his ex wife received her share of the Muster Trust.
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