In divorce, not engaging a family lawyer is a counter-active trap many separating couples can fall into to try to save costs.
Take for example, ‘Peter’ and ‘Amanda’, who have recently separated.
They have two children. During the relationship Peter handled the finances. Amanda was the primary carer. The parties own the following main property:
- Jointly owned principal place of residence.
- Jointly owned investment property.
- Family vehicle registered in the name of Peter which is subject to finance. A chattel mortgage is registered over the title to the vehicle on the PPSR.
- A Family Discretionary Trust through which Peter operates his business. Peter and Amanda are directors and shareholders of the corporate trustee and are Appointors of the Trust. Both parties are beneficiaries of the Trust. Peter and Amanda have debit loan accounts with the Trust. They have also given a personal guarantee to a bank as security for a loan facility for the Trust.
Managing to remain amicable after their split, Peter and Amanda reach an agreement for the care of their children and property settlement.
The children will live with Amanda and spend time with Peter each alternate weekend and during school holidays.
Amanda will retain the principal place of residence, the family vehicle on the understanding that Peter will continue to pay the finance payments and all other property in her sole name.
Peter will retain the investment property, the Family Discretionary Trust and all other property in his sole name.
To effect the settlement transfers of real property are signed with Amanda and Peter sharing the cost of the transfer duty.
Peter transfers the title to the family vehicle to Amanda.
Amanda resigns as a director and transfers her shares to Peter in the corporate trustee of the Family Discretionary Trust. The divorce settlement is now complete.
Why would Peter and Amanda ‘waste’ money on lawyers?
By not consulting a lawyer to discuss the divorce settlement and not formalising the settlement in a legally binding way under the Family Law Act 1975 (Cth), Peter and Amanda may be faced with several unintended consequences.
Another bite of the cherry
As Peter and Amanda have chosen to informally resolve property settlement matters, their divorce settlement agreement is not legally binding.
If Peter’s business were to take off and become more valuable he is exposed to Amanda making a further claim against his property in the future (subject to the expiration of any limitation period).
For a property settlement to be legally binding upon the parties to the agreement and thus enforceable, the settlement must be formalised under the Family Law Act by way of a Court Order or the parties entering into a Financial Agreement.
If the settlement agreement is not formalised in either of those ways, then the parties involved are exposed to their former partner making another claim against them in the future.
A Statutory Declaration or written agreement signed by the parties setting out the divorce settlement terms is insufficient, and if either of those documents were entered into by Peter and Amanda it would not protect them from a subsequent claim.
Unwanted taxation issues & loss of stamp duty exemptions
If Peter and Amanda had formalised their settlement, they would not have paid stamp duty on the transfer of the real properties.
Where a property is transferred pursuant to the terms of a Court Order or a Financial Agreement, no duty is payable on the transaction.
By Peter transferring his interest in the principal place of residence to Amanda and Amanda transferring her interest to Peter in the investment property two CGT events have taken place.
Whilst this should not be an issue for Peter as he would be able to claim the main residence exemption in terms of the transfer of his interest in the principal place of residence to Amanda, as Amanda has disposed of her interest in an investment property, this may result in a Capital Gains Tax liability arising for her.
Amanda will have to pay the tax on any capital gain at her marginal rate upon lodging her tax return. A nasty surprise for Amanda.
If Amanda’s interest in the investment property had been transferred to Peter pursuant to a Court Order or Financial Agreement under the Family Law Act, she would have received CGT rollover relief and any capital gains tax would have been disregarded.
Who is in control of Peter’s Family Discretionary Trust?
Although Peter has taken steps to remove Amanda as a director and shareholder of the corporate trustee of the Trust, he has overlooked Amanda resigning as an Appointor of the Trust.
The Appointors of a Trust are in essence in control of the Trust as they have the power to replace the trustee. Standard trust deeds normally require Appointors to exercise their powers unanimously (or sometimes if there is 3 or more by majority) and generally only permit the trustee to vary the terms of the Trust Deed with the written consent of the Appointors.
Amanda as a co-Appointor still has a certain amount of control over the Family Discretionary Trust. If Peter’s relationship with Amanda sours in the future:
- Peter could be prevented from varying the terms of the Trust Deed except with Amanda’s written consent;
- Peter may not be able to appoint another person to act as Appointor with Amanda and himself (to create a majority), except with Amanda’s written consent; and
- If Peter dies or loses capacity he risks Amanda being left in complete control of the Family Discretionary Trust although she has already received her property settlement.
Calling in the dormant loan account
As Amanda’s debit loan account owed to the Family Discretionary Trust was not dealt with in the settlement agreement, the liability still exists and Peter could demand payment of the loan account. Amanda would be required to repay the loan amount to the Trust from the assets she received by way of property settlement as the loan account it is a legitimate debt owing by her to the Trust.
The forgotten personal guarantee
By not consulting a lawyer to discuss her divorce settlement agreement with Peter, the personal guarantee that Amanda gave to a bank as security for a loan facility for the Trust has been forgotten and Amanda has not been released from the personal guarantee as part of the settlement agreement.
If the Trust is unable to meet its obligations to the bank in the future, Amanda could find herself being unexpectedly pursued by the bank to meet the debt owed by the Trust under the personal guarantee. By not being released from her personal guarantee, Amanda’s personal assets (including the principal residence) that she received in the settlement are at risk while the loan facility remains in existence.
Risk of repossession of the family vehicle
Peter has transferred the family vehicle to Amanda but has not paid out the finance owing on the vehicle. This means that the family vehicle is registered in Amanda’s name but is still subject to the chattel mortgage in favour of the financier. If Peter does not honour his obligation to meet the finance payments on the vehicle the financer could repossess the vehicle without notice to Amanda. All Amanda can do is watch as the vehicle is being taken away.
This could have been avoided if the family vehicle was transferred to Amanda unencumbered as part of the divorce settlement agreement.
Unilateral change in care arrangements
As the care arrangements for the children have not been formalised by way of Court Orders, and thus are not legally binding, if Amanda and Peter have a falling out in the future Peter could be faced with the problem of Amanda (as the primary carer of the children) changing the time that he spends with them.
If Peter is unhappy with the change he will be required to participate in Family Dispute Resolution mediation with Amanda in an attempt to negotiate revised care arrangements for the children and if this is not successful involving lawyers to litigate the parenting dispute before the Court, which would involve the parties incurring significant legal costs.
This potential outcome was not contemplated by Peter at the time of separation as he remained amicable with Amanda until recently. If the parenting arrangements had been formalised by way of Court Orders (made by consent) when the parties first separated and negotiated the care arrangements, binding Orders would have been in place to avoid this outcome.