Who Gets The Keys To The Kingdom – When Divorce Gets In The Way Of The Kids’ Inheritance

Separation affects families in a way which is much broader than it seems at first blush.  Not only does it affect those who are separating, but it affects their children, and wider family, too.

When we think of ‘children’ being impacted by divorce, we instantly think of young children, who are destabilised by the loss of their unified family.  But adult children can also be impacted, financially and otherwise.

Not only do adult children mourn the demise of their parents’ relationship, worrying about them (or one of them) suddenly being ‘on their own’, emotionally and otherwise.  There are financial concerns for adult children to process as well.  That’s because family lawyers regularly encounter two situations which involve adult children, and their future.

Situation 1: Family Business

Firstly, where a significant ‘family’ business is involved – one which has been held for a number of generations, or which has been created in the present generation by ‘mum and dad’.  Very commonly, the adult children of that relationship are involved in the running of that business, with a view to the reins one day being handed over (on the basis that the parents will then receive a passive income from it).  Those children have often worked in that business for many years, on the understanding that they would forego other more lucrative jobs external to the family business, and sometimes for less immediate income, in exchange for the long-term benefit of having its ownership and management eventually passed along to them.

Situation 2: Subsequent Re-marriage

Secondly, when mum and dad have separated, and where one of them has re-married, or re-partnered with, a third party (step-parent).  The biological parent will have usually brought wealth to that new relationship (comprised of the property settlement received from the prior relationship), and will have plans to leave a particular asset – the family home, and investment portfolio, a commercial property – to their children.  That provision is intended as the children’s ‘inheritance’, to see them ‘set up’ for their financial future.  However, separation intervenes, and the step-parent makes a financial claim in respect of those assets, suddenly jeopardising the biological parents’ plans to preserve their pre-relationship wealth for the benefit their children.

So, what happens in each of these situations, and what can be done to manage them?

Where your children have earned a stake in the family business

If both parents acknowledge the investment the children have made in the family business, and the agreement that this effort will be rewarded with ownership, then all is well – that interest can be formally recorded, such that the property being divided in the separation between mum and dad excludes the children’s share.  In some cases, the settlement outcome between the parents can even be structured such that the transfer of an ‘official’ interest in the business to the children occurs as part of the property settlement.

If that agreement or entitlement is disputed by one parent, however, things get sticky – legally, and otherwise.  This can see the family divided into two discrete ‘sides’ – one parent and the children in the red corner, and the other parent in the blue corner.  Often the children must become involved as third parties in the proceedings between their parents, to protect their interests (or they are joined in those proceedings by one of the parties).  It then falls to a Judge to determine whether the children have an interest in the business based on the ‘history’ of contributions, and the discussions which have underpinned that input.  Each ‘camp’ is left scrambling to assemble whatever documentary evidence exists to support their version of events.  The result is high-risk and expensive litigation, the result of which is usually hard to predict.

Whatever the outcome, it is difficult for families to overcome such a feud, and the damage done is often irreparable.  That brings the following reality into sharp focus – the situation should have been formalised long ago, so that the children, and the family business, were not pulled into the vortex of a family law dispute between separated parents.

The ancient English expression, ‘Providing is preventing’, is left ringing in everyone’s ears.  Had there been frank discussions much earlier on, and a clear plan documented for the transition of the business, what is now a deep family ‘rift’ could have been avoided.   That discussion might have involved the business’ commercial lawyers, and a creative outcome, acceptable to all, brokered with input from family lawyers and estate planning lawyers.  Importantly, the outcome would have been certain, rather than being ‘open to interpretation’ (with each parent having a different view as to that interpretation).

Where you have earmarked property for your children’s ‘inheritance’

Family lawyers regularly receive from their clients a recount of discussions which were had when they embarked on a new marriage or de facto relationship – that they had made clear that their pre-relationship wealth was intended for their children, and that their spouse acknowledged this, promising never to lay claim to that wealth if the marriage or relationship ever broke down.

The trouble is, that discussion is often disavowed by the other party after separation, and in any event, it cannot be enforced.  It is often worthless in blocking the claim of a former spouse, whose financial claim against that wealth will, after separation, be assessed on their contributions to the relationship, and on the factors impacting on their future circumstances.  If the relationship was short, the damage may be able to be controlled.  But if the relationship has endured for several years, the claim may be significant.

Commonly, those clients will observe that their children’s ‘inheritance’ will be eroded by the claim, and enquire what they, or their children, can do, to stop that from happening.  Usually, the answer is ‘nothing’ – it is simply too late.  There is nothing that will legally preclude the Court from making financial orders in respect of the relationship now at end.  And their children, if they have not contributed to the assets in the question (such as in the example above, working in the family business over a number of years in expectation that they would receive all or part of it), have no standing to prevent the making of financial orders.

We occasionally even hear from the adult children of our clients, who observe that they feel as if they are standing helplessly by, watching their inheritance being watered down.  Where that inheritance is only an expectation, their observation is usually correct.

The situation would be very different had there been a pause while a Financial Agreement was prepared, either before or early in the marriage (or de facto relationship).  If there had been discussion, and an agreement in principle reached, that certain assets are to be ‘quarantined’ (to pass to children of the spouse who brought those assets to the relationship, irrespective of any separation), that could have been the segue into the subject of a Financial Agreement.  That Financial Agreement could have provided that, if and when separation ever occurred, those assets will be treated in a specified way – for example, retained by the spouse who ‘brought them in’ to the relationship, free from any financial claim by the other (see my Blog on Financial Agreements – ‘Taking the Grey out of Divorce – Using a Financial Agreement to Make Your Business’ Future Black and White’).

Lessons Learned

The lesson from these very common situations is clear – prevention is better than cure.  This means that:-

1. If you have an agreement with your children that, in exchange for their past and/or future input, they will receive total or partial ownership of the family business, get that in writing, now, so that everyone understands the ‘deal’, and its terms. Just because the participants in that outcome are ‘family’ does not mean that it can be safely left undocumented.  Handshake deals can unravel when other events, such as separation and divorce, intervene.  Treat such important matters in the same was as any other commercial issue, and put them beyond doubt;
2. Informal or undocumented agreements with a new spouse about the treatment of pre-relationship wealth usually count for nothing. Unless you are prepared to see your plans become subservient to financial claims arising from later divorce and separation, those discussions must be formally recorded, in the form of a Financial Agreement.  Only then is there clarity around the fate of items of property which you had earmarked for your children’s financial future, in a form which is capable of being enforced.

If you are exposed to either of these situations, speak to your family lawyer about bringing some certainty to the uncertain.  Even if it has been some years since agreements about these things were first conceived, it may not be too late.  Yes, these steps take some careful thought, as well as your time and energy in their execution.  But some short-term pain is worth it if the consequences above can be avoided, and your intentions for your children can be carried into effect.  Your kids will thank you for it.