Property prices in Hong Kong have always been eye-watering and they are very much on the rise elsewhere. The younger generation are, more than ever, struggling to invest, and consequently there has been a trend in recent years, perhaps accelerated by the current economic climate, to look to the “Bank of Mum and Dad”. Also, the older generation is generally sitting on wealth which they do not require for themselves and are keen to transfer to their children and grandchildren.
There is a general wish with such families to keep the wealth within the family and to “pass the torch” of their family business to the younger generation within their own family. This has been dubbed “The Great Wealth Transfer” which refers to the titanic shift of wealth transferring between generations, particularly with affluent families in Asia, giving rise to more and more second or even third generation wealth.
Such generosity however does not come without significant potential problems. Divorce is an unfortunate contingency which, if happens, can easily mean losing at least half of an individual’s assets particularly if the marriage is a long one. And if the individual is a second generation and his/her assets mainly comprise of inherited or gifted wealth, that family is at risk of losing a substantial amount of their hard-earned family wealth to a divorcing spouse outside the family. In a modern society where divorce is sadly increasing, it is high time for both the old and young generation to be wary of the risks that a marriage turned sour may pose to their family wealth.
Gifts from parents at risk of being shared in a divorce?
A lot of people have the misconception that whoever has paid more into the marital asset pool, means that that person would have a greater share when it comes to a divorce. However, it does not work like that under the law in Hong Kong. The Courts will not go through a minute retrospective investigation of who paid more or less. The Courts look at what the assets are (no matter under sole or joint names) and the values of those assets. Whoever paid more into the asset is not relevant, even if the divorcing person’s parents were the ones who contributed to or paid for the asset, unless if the parents (a) claims that they have a beneficial interest in the asset and intervene in the divorce proceeding to stake their claim; or (b) claims that the monies paid were not a gift to their son/daughter but a loan, and successfully convinces the Court of their case. This means that a parent who has generously bought a property for their child, or paid for the down payment of their child’s first property, will have to accept that their generosity will very likely extend to and benefit their child’s divorcing spouse in the future. By the same token, shareholdings in family businesses will also be at risk.
Inheritance from parents at risk of being shared in a divorce?
Another common scenario particularly among Chinese families is the possibility of inheritance being taken into account as marital assets to be shared in the event of a divorce. Again, if the marriage is fairly long and if the inherited assets has been intermingled with other marital assets or used for the divorcing couple’s family lifestyle (such as an inherited property being used by the couple as their matrimonial home, or the rental income of an inherited property being used to pay for the couple’s living expenses), it would be very difficult to exclude the inherited asset from being shared by the spouse in a divorce situation. If it is certain that an individual is about to inherit substantial wealth from an ailing parent, that inheritance may also be taken into consideration as a financial resource in the Court’s overall analysis of a “fair settlement” if there is a need for it to be taken into account, even though the inheritance has not been passed down to the individual yet.
It is natural for many parents to want to transfer their assets to their children earlier in their lifetimes rather than wait until after they pass away. However, with divorces being an unfortunate but possible occurrence in one out of three marriages, it may be sensible for the older generation to plan ahead for such contingencies and consider the timing and the way in which they should transfer their wealth to their children. Tools such as a prenuptial agreement, postnuptial agreement, and holding wealth under trust structures (such as a “dynasty trust”) may be a good start to mitigating some of these risks.
Prenuptial Agreements to ringfence assets gifted/inherited by parents
It may not be romantic, but a prenuptial agreement is a good idea where wealth has been transferred before a marriage because it can successfully ringfence such assets.
It may not be romantic, but a prenuptial agreement is a good idea where wealth has been transferred before a marriage because it can successfully ringfence such assets. It works as an insurance policy, something which can be agreed and then hopefully filed away without the need to use it. Prenuptial agreements in Hong Kong are increasingly enforceable, but certain factors must be complied with in order to do so. Importantly, both parties must fully understand what the agreement means and must agree to be bound by its terms. In order to prove that the parties were not in any way forced into agreeing, independent legal advice is important, and the agreement should take place well in advance (at least 28 days) before the wedding so that a party cannot allege that she or he were coerced into signing it – or else no wedding.
One of the important elements of understanding what the parties are agreeing to will include some financial disclosure so that the parties are making an informed decision, or at least a waiver of such disclosure. The agreement must also be fair and not leave either party in a ‘predicament of real need’.
Prenuptial agreements will hold decreasing weight the older they become. As with most premarital assets, if there has been intermingling of the assets over time, it becomes less reasonable to hold a party to the agreement. Also, things change during a marriage, and what may have been agreed before a wedding, may no longer be appropriate 10, 15 or 20 years later. Therefore, it is important to include a review clause in the agreement, and better still, prepare postnuptial agreements to update the agreement from time to time. Postnuptial agreements are useful not only to refresh a prenup, but also where gifts and inheritances have been made after the marriage.
Even with a prenuptial agreement and a couple of postnuptial agreements, the court may still have recourse to all the marital funds should one party be left with nothing. The court retains a discretion to produce a fair result to both parties, but fairness will be determined by needs and intention. Therefore, for parties wishing to enter into a nuptial agreement, make sure that it is fair to both parties and that, when the agreement is made, it was clear that both parties fully understood what they were agreeing to.
Trusts as wealth planning tool against contingency of a divorce
Trusts are popular with dynastic families to ensure wealth is passed down through the generations and they appeal to many Asian families for that reason.
Trusts have also been used as a wealth planning tool to protect a family from the consequences of divorce. Trusts are popular with dynastic families to ensure wealth is passed down through the generations and they appeal to many Asian families for that reason. With a trust, the settlor will give his wealth to the trust which is generally managed by trustees. Therefore, he is no longer the legal owner of the assets, as legal ownership has transferred to the trustees. The beneficiaries, normally himself, his wife, children and grandchildren, are also not the legal owners and therefore, technically, the assets in the trust are not in the marital pot for division.
However, it is not as simple as that. The courts in Hong Kong will look behind the trust if the settlor is in fact still ‘in charge’. This happened in a famous Court of Final Appeal case where the settlor, who was the husband, set up his trust and placed all his valuable company assets into it. The company prospered and he continued to operate it within the trust. The beneficiaries were himself, his wife and their daughter. On the wife’s application for a divorce after over 40 years of marriage, and her application for an equal division of all the assets, including those in the trust (which was the majority of their wealth) the court found that the settlor had retained sufficient influence over the trustees, and that should he ask them to pay out a dividend, they would do so. Hence, the assets in the trust could be considered to be a resource for the purposes of asset division in divorce. In addition to this, the court found that the assets should be divided 50:50 and that the daughter’s entitlement under the trust would not be taken into account. The husband in that case was informed that, should he wish to provide for his daughter, he would have to do so out of his half share.
The key, therefore, is to ensure that, once assets have been placed into trust, the settlor relinquishes his right to those assets, and he becomes a beneficiary like anyone else. The fact that the husband in the aforementioned case retained operational control of his company within the trust was fatal to his case before the Court of Final Appeal. Careful drafting of the trust deeds and set-up of the trusts by experts in the field will be crucial to prevent spouse’s trust interests to be taken into account as a financial resource on divorce.
Regular support to children at risk of being seen as ongoing financial resource
The other sort of gifting that parents should watch out for is the giving of regular contributions. It may well be very tempting for wealthy parents to supplement their children’s general expenses in order to ensure a comparable lifestyle as adults that they enjoyed as children. It is not uncommon for parents to pay for grandchildren’s education, holidays, or monthly maintenance. While the court cannot make orders against a third party in a divorce, the court has found that, if parents had provided regular financial support for their adult child, such support may be deemed to be something the party could rely on as a resource and, even if the husband could not afford to pay maintenance to the wife sufficient to maintain the lifestyle which they had enjoyed during the marriage, the court may well make an assumption that such support would continue. In one case before the Court of Final Appeal, the husband’s potential earning capacity, and the fact that his parents had supported him and his wife during the marriage, led to an award of maintenance to the wife well in excess of the husband’s current income.
The courts will not readily look to the parents to maintain adult children even if their assistance is ongoing, but it is wise to be aware that, in certain circumstances, they may be vulnerable. A historical pattern of giving should be avoided or at least well documented. Gifts for children’s education can be put into an education trust as a one-off gift. And for parents who have already helped pay for their children’s property by a soft loan or provided their property for their children’s family to use as a matrimonial home, they should consider whether they have the evidence necessary to protect their interests in case of a future divorce. If loans can be made more formal, with some sort of repayment and interest element, this could help to ringfence them.
It is natural for parents to want to help their children and legal advice from a family lawyer with wealth planning experience could save a good deal of anxiety further down the road.
For further information, please contact:
Jocelyn Tsao, Partner, Withersworldwide
jocelyn.tsao@withersworldwide.com
