Sarah Anticoni, partner and family mediator at law firm Charles Russell, discusses the impact of bonuses, deferred shares and other non-cash options on divorce settlements.

Sarah Anticoni, partner and family mediator at law firm Charles Russell, discusses the impact of bonuses, deferred shares and other non-cash options on divorce settlements.

Despite London being described as the “divorce capital of the world”, it would be wrong to assume that all divorcing couples have huge capital pots of marital wealth, from which they can carve a large chunk to obtain a clean break on divorce. A clean break requires a big enough sum to buy two homes and create sufficient income for two households, without even taking into account the maintenance fees from one spouse to another that will have to be sustained - whether for a period of years, for the rest of their joint lives or until the recipient remarries.

Most families simply are not in a position to do that. The reason they only ever had one marital home was because that was all they could afford, but now two are needed, which will probably mean one or two mortgages. Only the very wealthy can simply divide their capital assets and walk away.

The vast majority of families can still be described as “traditional” with one breadwinner, so many husbands and wives are reliant upon their ex-partner for monthly maintenance. On top of this, all children need financial support from parents, often for living as well as possible education costs. In the financial world of the 1980s and 1990s when financial packages in the business world were deliberately structured to be tax effective for employers and employees, basic salaries were dwarfed by the cash bonuses which were awarded on an individual or group’s performance. 

Complex calculations

Even as an intact family, it was quite difficult to calculate what the household net annual income was out of a blend of basic salary and a discretionary bonus. In reality, the higher earner with a large discretionary bonus tended to rack up large overdrafts or unsecured loans, carrying the weight of cash flow. The breadwinner would then pay annual school bills and other debts from the cash bonus as and when it was received. When the cash element of bonuses was eroded and disappeared, many families found that they had geared themselves in an unsustainable way.

The UK Chancellor reaped the rewards of the high cash bonus years, continuing to increase the level of income taxation to boost other falling revenues. Employers found increasingly inventive ways to circumvent the cost of paying such cash bonuses or mitigating the impact upon the sums received by their employees whom they wished to retain. This included a wide range of deferred shares and long-term investment schemes, many of which attracted capital gains tax at a lower rate than income tax. 

Upon divorce, the challenge of stretching the income of both parties to meet the needs of two households is a tough one. The alternatives that are considered are usually an order for a fixed monthly sum from the basic net salary and then an additional percentage participation in the cash bonus each year. This formula can have a minimum or maximum cap attached to it to ensure that the dependant spouse, usually still the wife, has a safety net amount to budget on per year whilst retaining some incentive for the paying spouse to continue to work.

Frequently courts expected the paying spouse to take the risk on cash flow, ordering a fixed amount per month to be paid to the financially weaker spouse, assuming that a cash bonus calculated on an average of the past three years would be awarded again the following year. The assumption of a payment of any cash bonus however, could not have been more ill-founded. Consequently, many financial divorce orders are having to be revisited in light of the new reality of illiquid bonus awards.

Revisiting the courtroom

To revisit, ex-spouses are able to renegotiate between themselves but often need to turn to mediation or to the court, comparing the financial context within which the original agreement was made (high cash bonuses and different tax regimes) and  the new financial reality for both spouses.

If the bonus is awarded in an illiquid form rather than cash and there is an existing divorce order for maintenance and the participation in the cash bonus, some readjustment is necessary. Until a court order is changed, the amount of maintenance has  to be paid, therefore swift professional advice should be sought immediately after any change in the bonus.

The option of taking a proportion of the net proceeds of deferred shares once they have vested or sold is unattractive for the economically weaker partner, who can neither control the timing or value of receipt of much needed income. Historically, child benefit and tax credits assisted a little, but that too is now a disappearing option.

It is decades since financial arrangements between divorcing couples were the Chancellor’s financial concern, with maintenance paid out of net income and received net of tax. Yet with the rising levels of divorcing couples and a trend towards a leaner financial award, both liquid and illiquid, what does the future hold? Legislative or fiscal change seems most unlikely, and with little appetite to turn to courts to resolve because of the costs, the more likely trend is to turn to family mediators to find more inventive solutions to stretch the income pot.