Saturday, May 21, 2016

What Happens to Funds Inherited by a Spouse on the Breakdown of the Marriage?

Some of my estate-planning clients have asked me what would happen to the money they intend to leave to their children if one of their children’s marriages breaks down.  In some cases, there may be concern that a marriage breakdown is imminent, while in others it’s a more general, “what if?” question.

When family law was reformed a few years ago in British Columbia, I thought that my answers would be a little more straightforward than they had been in the past. The Family Law Act, which came into effect in March 2013, overhauled the law governing divisions of property in a marriage breakdown. The basic rule is that family property and family debt is shared equally. The parties may agree on a different division, or if an equal division would be “significantly unfair” the court may order a different division, but the basic rule is a 50/50 split. One key aspect of the new property-division regime is that some property is excluded from the divisible family property. The “excluded property” includes inheritances or gifts received by one of the spouses.

At first glance, the answer to the question what happens to my child’s inheritance if her marriage breaks down appears simple:  “don’t worry; it is excluded from the property that she would have to divide equally with her former spouse.”

Alas, if the law were that simple, I might be out of a job.

Section 84 (2) of the Family Law Act includes among the divisible family property,
“(g) the amount by which the value of excluded property has increased since the later of the date
(i) the relationship between the spouses began, or
(ii) the excluded property was acquired.”

Still, this probably conforms to most people’s sense of what is fair. If I (the hypothetical  me) leave an inheritance to my daughter of say $400,000, she invests it and it grows to $500,000 during her marriage, then on the breakdown of the marriage, she keeps the full $400,000 on the breakdown of her marriage, and shares the $100,000 growth with her former spouse.

But it gets murkier (otherwise this would be a much shorter post). Supposing my daughter inherits $400,000 from me, but then uses the funds to purchase a house with her spouse, with the title registered in the spouse’s sole name. On a subsequent breakdown of the marriage, is the house (or at $400,000 of the value of it) remain excluded property that my daughter retains? Or is the full value of the house now equally divided between my daughter and her spouse?

The British Columbia Court of Appeal considered this issue in V.J.F v. S.K.W., 2016 BCCA 186. Mr. F. inherited $2 million (it was not from parents or other family, but nothing turns on that). He used most of it to purchase land in Vancouver on which he and Ms. W planned to build a new family home. The title was registered in Ms. W’s sole name. The trial judge found that he did this for creditor protection. It should be noted that there was no finding that he acted fraudulently to defeat current creditors, but rather that he did this because of risks of claims associated with his business. At trial, the trail judge found that Mr. F conferred a gift on Ms. W when he used the funds to buy the property in her name, and held that when he did so, the funds were no longer excluded property. Accordingly, the land was equally divided between Mr. F. and Ms. W.

Madam Justice Newbury, writing for the Court of Appeal, in upholding the trial judge’s decision, held that the trial judge did not err in finding that Mr. F conferred a gift on Ms. W. He could not protect the property from potential future creditors without conferring an absolute interest in Ms. W. She also held that the presumption of advancement—that is the presumption that when a married spouse transfers property to the other spouse gratuitously, he or she intends to make a gift—continues to apply to transfers between married spouse in the province of British Columbia (in some provinces in has been abolished). In this case the onus was on Mr. F to rebut the presumption that he made a gift, and he did not meet the onus.

Madam Justice Newbury also rejected the view expressed in some of the Supreme Court of British Columbia cases that the Family Law Act regime is a complete code, which supersedes common law property rights. In this view, property that was excluded remains excluded despite the fact that title may be transferred between the spouses. She wrote at paragraphs 74 and 75,

[74]         With all due respect to the contrary view, I conclude that the new FLA scheme does not constitute a “complete code” that “descends as between the spouses” and eliminates common law and equitable principles relating to property. Rather, the scheme builds on those principles, preserving concepts such as gifts and trusts, and evidentiary presumptions such as the presumption of advancement between spouses. Thus I find that the gift of (slightly less than) $2 million made by Mr. F. to Ms. W. became her property and was “property owned by at least one spouse” under s. 84, as opposed to “property derived from the disposition of [excluded] property” within the meaning of s. 85. At the time the definitions are applied – the date of separation – the fact Mr. F. had originally received the $2 million as a gift was no longer relevant. He lost the exclusion when he voluntarily and unreservedly directed that the West 33rd property be transferred to Ms. W. and ‘derived’ no property from that disposition.
[75]         I do not interpret the FLA as reversing the gift or requiring that it be ignored because of the spouses’ separation. Nor do I agree that the FLA effectively ‘prohibits’ gifts between spouses, as Mr. F. suggested. (See para. 56.) Gifts between spouses can continue as they have through the ages. It would take much clearer wording to render them suddenly revocable or null or illegal. (See the comments of Chief Justice Farris in a slightly different context in Duncan v. Duncan (No. 2) [1950] B.C.J. No. 50 at para. 13 (S.C.),aff’d [1950] B.C.J. No. 41. (C.A.).)

This case raises a couple of questions.

First, does this mean that whenever a spouse transfers funds from an inheritance to the other spouse, those funds lose their status as “excluded property?” I suggest that the answer is “not necessarily.” In V.J.F. the trial judge found that Mr. F intended to make a gift, and that the presumption of advancement had not been rebutted. In other cases, the courts may find that a spouse did not intend to confer a gift, and there may be evidence rebutting the presumption of advancement. In such a case, the spouse to whom title is transferred may hold the property as a trustee for the spouse who inherited the funds. In that event, the funds should still be excluded.

Secondly, what about a case where the spouse who receives the inheritance buys a house and the title is held in both names as joint tenants. This is likely a more common event. The beneficiary of the inheritance may want her spouse on title as a joint tenant for estate planning so that if she dies first, her spouse will receive the house by right of survivorship. Although the concept of joint tenancy is nuanced, arguably in that case half of the beneficiary of the inheritance should be able to exclude one half of the funds, and the other half divided equally, on the basis that each spouse has a notional half-interest.

If this is correct, then in my example of my daughter receiving a $400,000 inheritance, if she uses the funds to buy a house to be held in a joint tenancy with her spouse, $200,000 would remain excluded, and $200,000 divided equally between her and her spouse on the breakdown of the marriage. She ends up with $300,000, and he with $100,000 from the inherited funds.

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