This blog has been written by Darren Lund, Partner at Fasken LLP
I previously blogged about the trial level decision Newlands: A New Interpretation of Estate Freezes in the Family Courts? and a subsequent motion Newlands Revisited: Moving to the Appeal in Lang-Newlands v. Newlands, a family law case that dealt extensively with equalization claims in the context of intergenerational wealth planning involving multiple estate freeze transactions.
The Ontario Court of Appeal recently released its decision in the appeal. My fellow blogger, Karen Watters, recently blogged about the appellate decision Estate Freezes and Calculation of Net Family Property: Lang-Newlands v. Newlands. Her blog provides an excellent review of the decision and is recommended reading. You can also find links to the full text of both the trial level and appellate level decisions in her blog.
In this blog I want to focus on the core of the Court’s analysis, which provides an excellent example of how a transaction – the estate freeze – that has become relatively common as part of intergenerational wealth planning, can be understood quite differently depending on the particular legal lens that is used.
The facts of the Newlands case are complex, but the core issue for our purposes involves an estate freeze implemented by Barbara, the wife, during her marriage. The private company shares that were the subject matter of the freeze were traceable to a discretionary family trust that Barbara’s father had settled for her benefit before her marriage to Ian, the husband. There was no dispute that Barbara acquired her interest in the pre-marriage trust as a gift and, being a gift received before marriage, her interest in that trust did not qualify as excluded property under the Family Law Act.[1] Accordingly, her interest in the pre-marriage trust formed part of her net worth on the date of marriage (for which she was entitled to a date of marriage deduction).
During the marriage, the pre-marriage trust distributed the private company shares it held to Barabara, who, as a result of the distribution, became a direct shareholder. Again, there was no dispute that the distribution of the shares to Barbara did not constitute a new gift to her during the marriage; rather, the shares were traceable to her interest in the pre-marriage trust, which existed on the date of marriage and was not excluded property. Accordingly, the shares now owned by Barbara directly also did not qualify as excluded property.
At the time of the freeze that was the subject matter of litigation, the shares Barbara received from the pre-marriage trust had undergone reorganizations. However, this did not change the central fact in the case, i.e. that the asset being frozen was not excluded property at the time of the freeze.
In terms of the structure of the freeze, Barbara’s father settled a new discretionary family trust, known as the NFT. The father used $100 to settle the trust, and (unfortunately) the trustees used the same $100 to subscribe for new common shares of the frozen company. Barbara held the frozen shares of that company, with a redemption value equal to the fair market value of the company at the time of the freeze. From a strictly formal perspective, the new common shares held by the trust ought to be considered substitute property for the $100 the father used to settle the trust. They are not the same shares that Barbara owned prior the freeze. Also from a strictly formal perspective, Barbara did acquire something new as a result of the transaction – an income and capital interest in the NFT, which interest was derived from the $100 contributed by her father, which was then used to subscribe for the new common shares.
Form, however, did not carry the day in Newlands. The appellate decision contains many statements such as the following:
…the only property Barbara’s father gave her after her marriage to Ian, was the $100 fee he paid to effect the estate freeze (at par. 81).
The $100 from Barbara’s father was a de minimus contribution that does not change the facts of this case: the value of the NFT derives entirely from the 702 shares that Barbara beneficially owned at the date of marriage (at par. 82).
…Barbara’s father did not give Barbara new property after the marriage that she did not already possess, nor did he divest himself of anything beyond $100 (at par. 84).
Looking at the transaction in terms of form only, one could take issue with the above statements. However, the key to understanding the Court’s perspective is set out in the following statement:
Characterizing Barbara’s entire interest in the NFT as a “gift after marriage” solely because the trust was initially seeded with $100 from her father would allow form to overwhelm function [emphasis added] (at par. 84).
In short, the Court’s analysis focused on, and gave priority to, the substance of the estate freeze rather than the legal form of the transaction.
Prior to the freeze, Barabara owned common shares that would continue to increase in value if the value of the company increased. She voluntarily entered into a transaction whereby she exchanged those participating shares for shares with a fixed value, in substance transferring the future growth to the NFT, of which she was a discretionary beneficiary, along with her issue. If Barbara’s interest in the NFT was treated as excluded property because, formally, it derived from her father’s $100 gift to the trustees of the NFT, then Barbara would, effectively, have converted the future growth in value of her original common shares from non-excluded property to excluded property, to the extent of her interest in the NFT. That is something the family courts do not like.
It is interesting to consider what could have been done to avoid the litigation in this case.
Would the outcome have been different if Ian had received independent legal advice (ILA) at the time of the freeze? If the purpose of the ILA was simply to ensure the husband was fully informed of the nature and consequences of the freeze, and consented to the freeze, then it is hard to see how that would change the outcome. Whether Ian had had knowledge of, or consented to, the transaction was irrelevant to the determination of whether Barbara’s interest in the NFT was excluded property. Indeed, Ian did have knowledge of, participated in, and presumably supported the freeze when it was implemented. To change the status of Barbara’s interest in the NFT to excluded property, it would have been necessary to enter into a marriage contract to expressly exclude it – or better still, the long process that resulted in the Newlands decision may have been avoided if the pre-marriage trust had been excluded from net family property through a marriage contract when Barbara and Ian were married.
A factor that would almost certainly have changed the trajectory of the case, or even avoided the dispute altogether, is the decision to include Barbara, the freezor, as a beneficiary of the NFT. There are of course many reasons why a freezor would want to be a beneficiary of a freeze trust, and freezes are often structured to permit that. However, if the freezor is not a beneficiary, then the issue the Court took exception to in Newlands – the conversion of non-excluded property of the freezor to excluded property of the freezor – does not arise. Rather, the freeze is, in substance, on the family law analysis at least, a gift to specified individuals other than the freezor.[2] Newlands highlights why the decision to include or exclude the freezor as a beneficiary of a family trust in the context of a freeze must be made thoughtfully and, in appropriate circumstances, consider what additional steps, such as a marriage contract, may need to be included.
Newlands is an important decision not only for family lawyers, but for all professionals who advise clients on estate planning and wealth management matters. Transactions that are formally and technically appropriate in the estate planning context may be viewed very differently through a family law lens, which may consider whether the substance of the transaction is consistent with core principles of matrimonial property law. Indeed, Newlands highlights with particular clarity why spousal claims must always be a central consideration in every wealth plan.
[1] To qualify as excluded property, a gift must be received during marriage and the gift cannot be a matrimonial home. I note that it is beyond the scope of this blog to outline the steps that must be taken to preserve excluded property status for a gift received during marriage, once it is received.
[2] A spouse may assert other claims, such as reckless depletion of net family property or fraudulent conveyance, on appropriate facts, but that is beyond the scope of this blog.
