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Divorce and Trusts: A Guide to Asset Protection

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Divorce and Trusts: A Guide to Asset Protection

Trusts

One of the questions that may emerge during divorce litigation is whether assets held in Trust should be included or omitted in establishing a party’s estate.

The law states that a trustee does not acquire ownership of trust property but instead holds it for the benefit of the designated beneficiaries. Consequently, the Trust property is typically not included as part of a person’s estate when determining the value of an estate in divorce proceedings.

Divorce and Trusts: A Guide to Asset Protection

Protecting trust assets during divorce: Learn relevant laws and diverse techniques to safeguard trust assets or defend against a sham trust claim, effectively communication with trustees, and avoid frequent blunders.

When Trust Property May Be Included

However, this does not mean that trust property is immaterial or should permanently be excluded in divorce proceedings. Considerations may apply in some circumstances to imply the reverse.

A court may evaluate whether the Trust is being utilised as a “alter ego” of one of the parties.

In the 2006 case of Badenhorst v Badenhorst, the court ruled that if it can be established that the Trust is being used as the “alter ego” of a party, the assets held in the Trust must be included in determining that party’s means.

It must also be demonstrated that the trust assets were, in fact, controlled.

In this case, the court found that, although the assets were technically held in Trust, they were effectively under the control of Mr. Badenhorst, who was also a trustee and made all decisions about the Trust, despite the presence of other trustees.”

The court outlined two critical components that must be proven by a spouse who alleges that a trust is being utilised as a “alter ego” of their spouse:

The court established two key factors that must be proven for a trust to be considered an “alter ego” of a spouse in a divorce: that the spouse had control over the Trust, regardless of the terms of the trust deed, and that evidence of how the Trust’s affairs were managed during the marriage should be taken into account; and that the spouse would have acquired and owned assets in their own name, even if the Trust did not exist.

In this case, the court determined that Mr Badenhorst individually owned all of the assets, which had to be shared with his wife during their divorce.

Identifying True Ownership of Trust Assets

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The following factors should be examined when determining the genuine ownership of trust assets:

Is the Trust real or merely a “corporate veil”?

If trust funds were misappropriated or abused, a court might breach the corporate veil to determine whether the Trust was simply a person’s alter ego.

When did the Trust begin?

Suppose a party transfers assets into a trust to deceive their marriage partner of their potential rights in an upcoming divorce action. In that case, the Trust’s legitimacy may be questioned due to the absence of bona fides on the part of the Trust’s founder/donor or trustees.

What was the founder/donor of the Trust’s intention?

For instance, if parties who married in community of property decide to transfer assets from their joint estate into a trust for the benefit of themselves and their children, one party may apply to have the Trust set aside in the event of divorce. The assets may then be considered part of the communal estate.

Is there a conflict of interest? A conflict of interest may develop in a divorce proceeding when one spouse is a trustee, and the other spouse is a beneficiary.

The latter spouse may petition the court for an order dissolving the Trust or substituting trustees.

The court must be convinced that granting such relief is in the best interests of all beneficiaries.

Transfer of Assets into a Trust

When the property is put into a trust, the cause for the transfer is usually either a donation or a sale.

If the transfer of assets into a trust is a donation, donation taxes must be paid accordingly.

In the event of a sale, the purchase is frequently reported as a loan account in favour of the seller.

In actuality, assets are frequently transferred into trusts with little explanation.

Without proof of a donation or purchase consideration, such a transfer would constitute a loan account, which is an asset in the transferor’s estate.

What is a Sham Trust?

A sham trust is a trust in which the person who creates the Trust, known as the founder or donor, and/or the trustees who chose to run the Trust do not intend the Trust to be true.

If a court rules that a trust is a sham trust, it is because it fails to meet the critical requirements for establishing a lawful trust.

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Court Factors Considered

The court will consider many considerations when determining whether a trust is a sham trust, including:

  • Possession of trust property: Whether the trust assets are managed apart from the trustee’s or donor’s personal estate or if the Trust does not function independently from them. 
  • De facto Trust asset management and administration: Whether trust assets are managed and administered as if they were part of the donor’s or trustee’s personal estate.
  • The Trust’s purpose: Whether the Trust’s goal is ambiguous or unlawful.
  • Whether the Trust is unilaterally vested in the name of the spouse: Whether or whether the Trust is only in the name of one spouse.
  • Trustees’ authority: Whether the trustees have the power to act independently.
  • Whether any activities made are consistent or contradictory with the terms of the trust deed.

The donor’s authority to change trustees or beneficiaries: If the donor has sole authority to replace co-trustees or modify beneficiaries.

Each case is unique, and whether a trust is deemed a sham trust depends on the facts of the case.

The Value of a Declaratory Order

It is vital to remember that before the divorce processes begin, either party, whether plaintiff or defendant, can seek a declaration order from the court saying that the Trust is a sham trust.

This is because assessing whether a trust is a sham trust and splitting assets in a divorce lawsuit are two independent legal proceedings.

Suppose a trust is discovered to be a sham trust. In that case, the assets of the Trust will be handled as if there was no trust, and the assets will be regarded as part of the donor’s or trustee’s personal estate.

These assets will subsequently be considered when the spouses’ assets are divided according to the applicable marital property system.

In WT and Others v KT, a husband and wife married in community of property, and the husband afterwards put assets into a trust.

The wife claimed that the asset transfer was a hoax and that the Trust was utilised as the husband’s alter ego.

The court determined that the asset transfer was not a fraud but that the spouse neglected to disclose the existence of the Trust and the assets held in it.

Conclusion

Finally, in divorce situations, assets held in Trust may be included or excluded when evaluating an estate’s worth.

According to the law, the trust property is not considered part of a person’s estate for these purposes, but there may be exceptions.

A court may assess whether the Trust is being utilised as a “alter ego” of one of the parties and if the trust assets are under de facto control.

Factors such as the period of the Trust’s formation, the founder’s objectives, and conflicts of interest may all be considered.

It is vital to discover the underlying ownership of trust assets and to examine whether the Trust is real or simply a “corporate veil”.

A trust may be established sometimes, or trustees may be substituted.

 

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