The following article is by Nicola Harries, a partner in the family law practice at Stevens & Bolton. She writes about recent developments in the evolving pre-nuptial area of matrimonial law.

The following article is by Nicola Harries, a partner in the family law practice at Stevens & Bolton. She writes about recent developments in the evolving pre-nuptial area of matrimonial law. As always, while this publication is delighted to carry such expert analysis, the editors do not necessarily endorse all of the opinions in the article.

Pre-nuptial agreements have grown in popularity following several well publicised court cases where they have been upheld. Many wealth advisors consider them an important part of a family wealth management strategy. Wealthy parents are often the drivers behind such agreements, looking to protect the wealth that they have, or will, pass on to their children and grandchildren. 

The aim of a pre-nup is to provide some certainty and protection to couples and their assets in the event of marital breakdown. Simple pre-nups may seek only to ring-fence specific assets brought to the marriage by one or both spouses. However, the more complex (and riskier) agreements try to anticipate what payments should be made if a marriage fails at a point in the future. Typically, the longer the marriage lasts, the greater the provision that is envisaged for the financially weaker spouse. Advisors must “crystal ball gaze”, looking at the parties’ lifestyles and family expectations, balancing them against case law and how that is expected to develop. In undertaking that process, it is essential to consider the make-up of the assets and to be creative and cautious in equal measure.

An agreement to transfer a specific piece of property or to pay a predetermined sum of money on the break-up of a marriage can be very risky. Financial history is littered with examples that should serve as a warning against this approach. Consider the example of an entrepreneur who generated huge wealth in the 90’s with a large shareholding in a “dot-com” company. He then entered into a pre-nup to protect that wealth and agreed to pay a specific amount to his future spouse if they separated. When the marriage imploded just as the “dot.com” bubble burst, that sum, referable to out-of-date share values, represented a huge proportion of his wealth. But for the pre-nup, a much smaller sum may well have been payable to take into account the value of the “dot.com” shares at the time of the break-up.

Rather than agree to pay a specific amount, it would have been prudent to offer a sum linked to the value of the shares at the time of the marriage breakdown. For example, a lump sum equivalent to 15 per cent of the value of the shareholding would have spread the risk between both parties. Agreeing to pay a set amount is risky in almost any situation. Not every entrepreneur is serially successful; I recall a successful husband who made around £20 million from his first venture. Believing he could replicate the success, he went on to invest in numerous, risky and speculative ventures, none of which succeeded. Had a pre-nup been concluded to pay a set sum based on his initial wealth, the consequences for him (and his advisors) could have been dire.

Hazards

Similarly, agreeing to allocate a particular property to one spouse can be hazardous. For example, allocating the London piedà terre to one spouse, and the country home to the other could lead to a significant financial imbalance. The recent London property bubble highlights this risk.  With London property prices soaring by 10 per cent or more in September alone, the value of the London home is likely to have outstripped the country house by some margin. A pre-nup agreeing that the couple apportion the values of both properties would spread the risk, either by agreeing a sale of both properties, with the sale proceeds being shared, or by agreeing a balancing payment for the spouse keeping the less valuable house.

Knight Frank’s Luxury Investment Index shows the variation in performance across different luxury asset classes. Classic car values seem to stand up well over time, but art and antique furniture are much more volatile, being closely linked to tastes which change over time. Last year alone Damien Hirst’s art fell in value by about 30 per cent.

Investment-grade wine has returned to growth this year but both wine and art are more volatile as investments than FTSE 100 shares. If couples are invested in such assets this must be kept in mind when considering the terms of a pre-nup.

The obvious way to share the risks between the parties is to look at provision by payment of a percentage of the assets in the event of a split. Family lawyers know that many divorces involve lengthy and detailed arguments about the extent and value of the family assets to be divided, before the couple can proceed to arguments about how the proportions in which those assets are actually shared. The recent case between Michelle and Scot Young is a case in point.

However a pre-nup can tackle this by providing a clear mechanism by which the specified assets are to be valued, when they are to be valued and even by whom. There is no way to eliminate all possibility of litigation in such situations, but if two adults have been independently advised, and have agreed that a certain firm of accountants will undertake a valuation of the wealth to be shared, it will be much harder for one spouse to renege on that agreement. In taking this route, advisors must anticipate as many issues as possible. If couples have interests in numerous different assets classes, thought should be given to the various individual experts who should value them. Choosing your experts at the pre-nup stage could save thousands of pounds of legal fees by pre-determining such issues.

Advisors should also consider the net value of assets. If shares need to be sold to pay off a spouse, what tax liabilities will that trigger? What are the costs of sale going to be? The costs of selling antiques, cars and art may be considerably higher than selling shares. These are legitimate expenses of which account should be taken. Set them out clearly in a pre-nup as expenses that are deductible in reaching the net value of the assets, and you close down as many arguments as you can at an early stage.

Lastly, do not overlook the possible impact of currency fluctuations. Agreements to pay sums in one currency could lead to unexpected consequences. Both parties might do well to hedge their bets if assets are spread internationally. Pre-nups could provide for sums to be paid in two or more different currencies to smooth the impact of such fluctuations.

No pre-nup can anticipate every eventuality.  However, creative thinking and drafting can go a long way to setting out mechanisms to minimise the impact of some of the risks. The more imbalanced the effect of a pre-nup is, the greater the risk that a court may choose to vary its terms. It is therefore important for both parties, to think ahead to ensure (as far as possible) that property bubbles and ‘dot-com’ booms don’t derail their agreement. 

For the time being at least, pre-nups in England and Wales are not automatically legally binding.  Courts have been increasingly willing to hold parties to the terms of their agreements. Legal advice must be taken by both parties to ensure that their agreement is drafted to give it the best chance of being upheld.  The Law Commission has reviewed the law in this area and it is widely anticipated that it will propose a change to the law to make pre-nups binding. It is hoped that the report, now several weeks overdue, will herald the advent of that change.