This article examines how even for the wealthiest couples, divorce can lead to debt problems, as well as an issue of access to liquid assets.

There have been some expensive divorce settlements in recent months – most recently the Hohn case in the UK – and this may leave the impression that where high net worth cases are concerned, the parties will not suffer hardship going forward. But divorce can leave former spouses in debt in certain circumstances. In this article, Emma Collins, a partner, and Lottie Tyler, an associate, at national law firm Weightmans, consider the issues. The views expressed are not necessarily endorsed by the editors of this publication but we are grateful for the authors’ insights and invite readers to respond.

A recent survey has shown that an increasing number of people are finding themselves in debt following the breakdown of their marriage or relationship. The survey suggests almost a third of people have taken out a loan or incurred an overdraft as a direct result of deciding to go their separate ways.

It would seem reasonable to assume that relationship breakdown only results in debt for lower income families; however, there are also pitfalls for those ending a relationship in which there is significant wealth to divide.

Liquidity is often the key issue facing divorcing couples. High net worth individuals can find themselves obliged to incur debt on relationship breakdown for a number of reasons. For one, there is the misconception that being rich on paper means ready access to significant capital. If money is invested for the long-term, tied up in investment property or reflected in shareholdings in private companies, access to funds is not necessarily immediate.

Tax liabilities may well crystallise on the realisation of assets to fund a settlement. In conjunction with the loss of use of reliefs and nil gain inter-spouse transfers, which were available for tax planning during the relationship, unanticipated asset reduction can occur particularly if a settlement structure is not carefully considered with appropriate tax advice.

Conduct during a relationship breakdown can cause debt to be incurred. In an acrimonious divorce where one party has control over the joint finances, the other party may find that income has ceased to be paid into a joint account or credit and store cards have been cancelled. They may be driving an expensive car and dropping their children at the gates of an illustrious public school but could still be forced into borrowing from friends until an urgent court order is obtained to secure an appropriate level of maintenance.

Lifestyles supported by long-established family wealth can become precarious as, in particular, trustees will want to take their own legal advice as to the support they have provided one or both parties as beneficiaries under trusts, how to best protect the trusts and whether there would be merit in the trusts becoming involved in any impending court proceedings.

As well as the cost of supporting two households there will be two sets of legal fees. It will always take both parties in a relationship to be level-headed if legal fees are going to be kept to a minimum. An aggressive approach by one party could cause legal fees to become a spiralling expense for both. Despite significant assets to use as collateral, both parties may find themselves in positions where they need to resort to short-term debt in the form of bank loans or litigation loans, with the associated interest costs in order to finance the proceedings and maintain their existing lifestyles.

Costs on divorce can quickly escalate in any event, particularly where there are complex asset structures to unravel and expert valuation, pension, tax or other advice is required. There are however ways to mitigate this which fundamentally go to the choice of process on divorce or, if the court process has already been engaged, the manner in which that process is managed.

A variety of options are now available to separating couples from mediation and/or seeking an early neutral evaluation to collaborative law, where matters are agreed in a series of roundtable meetings. If agreement cannot be reached without some third-party input there are other options available outside of court such as arbitration, which would give the couple control over timeframes, venue and a choice of arbitrator to suit them, thus reducing the costs caused by delay and inconsistency of judicial input. Even within the court process it is still possible to have a private financial dispute resolution, which allows for a choice of “judge” and timescale to maximise the prospect of settlement in a way not afforded by the system itself.

Any mechanism which allows for an agreed settlement gives the opportunity to reduce cost and asset erosion as it allows for discussion, agreement of tax effective structures and imaginative settlement solutions which courts would not necessarily have the power, or inclination, to impose.  

Of course debt incurred at the end of a relationship is not always entirely negative. Where there are significant but unrealisable capital assets which one party would prefer to retain, rather than suffer the loss inherent in realising them to fund a settlement, a choice may be made to secure borrowing against assets to meet an ex-partner’s claims. To be left with a debt at the end of a relationship, if it has enabled significant assets to be preserved at a low notional value with the potential for future growth, would be a positive outcome.

For those with wealth and/or business interests who have not yet married, a large degree of protection from both the vagaries of the court system and the discretionary nature of divorce legislation can be obtained by entering into a pre-nuptial agreement. Subject to the agreement meeting appropriate criteria, not least that it is fair, significant costs and uncertainty can be avoided if the relationship subsequently breaks down. There is far more scope for careful tax planning to be agreed in a pre-nuptial agreement, whilst things remain amicable, than once a breakdown has occurred.

Agreements are not limited to those entered into prior to a marriage. There is also scope to agree potential settlement terms, the process to reach a settlement and appropriate tax planning in the event of a divorce. Post nuptial agreements represent planning for the future in much the same way as tax planning for death and making an appropriate will would do.

In short, financial strain during relationship breakdown is a universal concern but there are many ways to limit the more extreme effects so long as there is a consensus as to the approach to be adopted.