I have recently noticed a potential new trend in the overlap between trust and family law which I thought was worth mentioning, being the use of an estate freeze immediately prior to marriage as a form of imposing a “unilateral marriage contract” to insulate assets against the equalization of net family property on the breakdown of marriage. The concept of an “estate freeze” itself is not new as a potential tax planning strategy (I have previously blogged about estate freezes more generally here). What does appear to be a new trend however is the intentional use of an estate freeze not only for the potential tax benefits, but also for insulating the individual against equalization claims even when no marriage contract is signed.
An estate freeze at its most basic accomplishes what the name implies, insofar as it “freezes” the value of an individual’s assets at a particular date and time prior to their death, with any future “growth” on the assets being attributed to someone or something else. The use of an estate freeze is typically done as a tax planning tool, with the underlying rationale being an attempt to reduce the potential capital gains associated with the deemed disposition of their assets upon their death. Although the structure that is required to accomplish this is somewhat complicated and will require the involvement of professionals, it is most typically accomplished by having the individual create a new holding company which acquires the individual’s assets, with two classes of shares being created for the holding company, the first of which is retained by the individual implementing the freeze and fixed at the value of the assets on the day the of the freeze, with the second class of shares being attributed any future “gain” in value after the freeze and given to someone or something else (often a trust for the benefit of the individual’s family). As the gain in value after the freeze is not attributed to the individual who implemented the freeze, the capital gains which may otherwise be payable on the deemed disposition of their assets on their death under the Income Tax Act is correspondingly reduced.
One potential unexpected but significant impact of “freezing” the value of an individual’s assets in an estate freeze could be to alter what may be payable in the equalization of net family property upon the breakdown of a marriage under the Family Law Act. The calculation of net family properly typically involves determining the value of each spouse’s assets on the date of marriage and the date of separation, with the gain between these two values being used to calculate any equalization payment. If, however, one of the spouses “froze” the value of their assets prior to the marriage as part of an estate freeze, and otherwise did not have any additional assets which gained in value during the duration of their marriage, you could be faced with a situation where the spouse had no “gain” in net family property over the duration of their marriage, such that no equalization could ever be owed by them.
Take for example the hypothetical of an individual who is worth $500 million who is about to marry their third spouse who has personal assets totalling $100,000. No marriage contract is signed between the spouses prior to their marriage, however the spouse who is worth $500 million implements an estate freeze the day prior to their marriage without their soon-to-be spouse’s knowledge, attributing any future growth on their assets to a family trust for the benefit of their children from a prior relationship. The couple lives an extravagant lifestyle during their marriage, however after 10 years of marriage they separate and file for divorce. In the context of the divorce the existence of the estate freeze is revealed to the other spouse, with the spouse who had been worth $500 million indicating that not only was there no gain in the value of their assets during their marriage because of the freeze, but as they had redeemed $100 million of the “frozen” shares they were in fact worth less than they were on the date of the marriage. As the other spouse’s assets had increased from $100,000 to $150,000 during the marriage they are now faced with the potential scenario of having to make an equalization payment to their spouse who is now worth $400 million notwithstanding the fact the trust which acquired the “growth” shares as part of the estate freeze was itself now worth more than $200 million.
To the best of my knowledge the use of an estate freeze immediately prior to marriage as a form of “unilateral marriage contract” has not been considered by the court in Ontario, such that it is unclear whether it is a tool which will ultimately be effective. I have heard it suggested the situation is akin to that the Ontario Court of Appeal considered in Stone v. Stone, (2001) 55 O.R. (3d) 491, where the court confirmed the Fraudulent Conveyances Act was available between married spouses to undo a transfer designed to defeat the interests of the other spouse on equalization. The transfer in Stone v. Stone perhaps notably occurred after the parties were married and equalization appeared imminent however, and the Ontario Court of Appeal in Reisman v. Reisman, 2014 ONCA 109, confirmed that spouses are not always in a “debtor-creditor” relationship as required by the Fraudulent Conveyances Act, with such a status only arising after marriage when equalization appears imminent. As the “transfer” in the situation of an estate freeze implemented immediately prior to marriage would occur before there could be any equalization claim, it is at least questionable whether the Fraudulent Conveyances Act as applied in Stone v. Stone could be applicable to the transfer, or whether the court’s rational in Reisman v. Reisman would result in the Fraudulent Conveyances Act not being available. Should this be the case, although other options such as challenging the validity of the trust which holds the growth shares on grounds including it was a “sham” may be available, it may be more difficult to undo the estate freeze to the point the growth in value after the estate freeze would again be included for equalizing net family property.
Thank you for reading.