Mackenzie Elvin

The value of a S.21 Agreement and its relevance to trusts.

Introduction

In my last article (Protecting your Wealth), the enhanced ability of one partner upon a relationship breakdown to be able to force an unintended access to family trust assets was examined, arising out of the recent Supreme Court decision of Regal Castings v Lightbody [2009] 2 NZLR 433. This decision has highlighted the significance of intention. It was standard practice in the 1990s to dispose of assets into family trusts for the purposes of succession planning, to protect those assets from relationship property claims (including generationally), to provide protection from creditors, and to be divested of personal assets to qualify for a rest home subsidy, or any mixture of such motivations. Therefore it is likely that it was commonly the case that assets were transferred into a family trust with the intention of defeating a future relationship property claim. The 1990s was also a time when the statutory relationship property regime did not apply to de facto relationships, these forms of relationship being included only from 1 February 2002, by amendment and renaming of the existing legislation to the Property (Relationships) Act 1976 (the "PRA"). The PRA also introduced the unusual ability to have a retrospective effect, meaning that it applied not only to de facto relationships that were in existence on 1 February 2002, but also applied to de facto relationships that had been in existence before that date, and then continued beyond it.

Many people who were in de facto relationships and aware of the debate and controversy surrounding the impending law change, had endeavoured to get their affairs in order to protect their assets. The law did not at that time apply to them or their situation and they sought to keep it that way. And this usually meant establishing and moving assets into a trust. However, as the law has continued to develop, particularly with respect to the application of s44 and s44B of the PRA to family trusts upon relationship breakdown, it is becoming evident that a formal s21 agreement was often not part of the restructuring arrangements entered into. That may have been for good reason. At that time, the PRA did not apply to de facto relationships. However, for those who restructured their affairs in the 1990s and whose de facto relationships continue to endure, wisdom would suggest that as part of their next trust review, the trustees of such trusts should examine the usefulness of inviting the relevant parties to conclude a s21 agreement, as being reflective of their personal intentions with respect to relationship property in life and in death and to contract out of the application of the Act to better protect the assets of the trust. The trustees have also then better discharged their fiduciary duty towards the assets and beneficiaries of the trust, having sought to minimise the risk of court intervention through the gateway of relationship breakdown and the application of the PRA.

What is an s21 Agreement?

The PRA provides a mechanism to contract out of the Act by relationship partners entering into their own agreement to determine the status, ownership and division of property between them. This should include the status of any beneficial interest in a trust, the power of appointment with respect to a trust and the asset in a debt back to one of the partners from a trust arising on the transfer of an asset into it. If relationship partners do this and meet the compliance requirements, the Act will not apply to them. However, there still remains the ability for either partner to challenge the agreement at later time based on the "serious injustice" test. These sorts of property agreements, typically entered into before a marriage, have been referred to as "pre-nuptial" agreements and often occur where one partner brings to the relationship substantially more property than the other. However, they have a much broader application. As a result of the proliferation of family trusts, they should be considered as part of initial estate and wealth protection planning, as well as being considered in subsequent trust review processes.

An "opt-out" system

The PRA works on an "opt out" basis. If relationship partners take no steps, that is, if they make no agreement, the statutory regime will apply. This may include the ability of one partner to access the assets of a trust which might otherwise be relationship property, if they were transferred into with the intention of defeating a relationship property claim. This may even be where these steps were properly taken within a de facto relationship situation at a time when the PRA did not apply to that relationship because of the application of retrospectivity. Irrespective of the merits or fairness of this, and the uncertainty of the legal debate around the issue at the present time, the fact remains that the PRA applies unless partners in a relationship have contracted out of it. If they wish to avoid this, must actively "opt out" by entering a s21 agreement.

What should be included in the agreement?

A s21 agreement can include such considerations as:

• What property is intended to be owned together as relationship property, and in what shares (equal or some other proportion, and jointly or as tenants in common).
• What property is to remain the separate property of each party, which may include beneficial interests in a trust (including discretionary interests), any debts back from a trust and the property in the power of appointment of trustees to a trust.
• Whether or not any property should no longer be classed as separate property because it has been or will be used for the benefit of the relationship.
• Who owns any gifts made by one party to the other, or any gifts from third parties
• How inheritances are to be treated.
• How debts are to be treated.
• What provisions are to be on the death of one partner for the benefit of the surviving partner.

It can also preserve the application of the statutory regime by a continuing application of the PRA to certain parts of the assets of the relationship, seeking only to contract out of certain other parts.

What are the statutory compliance requirements?

The special requirements that must be met for a "contracting out" agreement to be valid include the following:

• The agreement must be in writing.
• It must be signed by both parties.
• Each must have received independent legal advice.
• Each partyís signature must be witnessed by a New Zealand solicitor, who must certify on the agreement that its effect and implications were explained to the signing party (which can cause problems where one party is out of New Zealand).

What if the agreement does not comply?

While on the face of it the agreement would be unenforceable, the court can validate an agreement that does not comply if the failure has not materially prejudiced either partyís interests. This can include oral agreements, and may be important in providing protection in some situations where a s21 agreement was not formalised but the parties were clear between themselves as to their agreement to respect the existing and continuing separate ownership of the various assets of either of them, notwithstanding the commencement and continuation of their de facto relationship. In these situations, it was also typically the case that the PRA did not then apply. On a subsequent break down of such a relationship one party may then seek a share of the assets that may have been part of such an informal agreement, (including those previously transferred to a trust), because the law allows them to do so through the application of the PRA. However, it is difficult to rely solely on the discretion of the court to give effect to an agreement that does not comply with the requirements of the Act and which may be difficult to prove if it was never committed to writing. The safest remedy is to formally enter into a s21 agreement, clear in its intention to contract out of the provisions of the PRA, and which meets the compliance requirements of the Act.

The power of the Court to set aside an agreement if "serious injustice" exists

A contracting out agreement remains subject to the risk of future challenge by the preservation in s 21J of the PRA of a mechanism to set the agreement aside if serious injustice exists. "Serious injustice" as a higher threshold than before 1 February 2002 was a deliberate policy decision by Parliament because de facto relationships were now being included. It means that the courts are now less likely to overturn agreements than was previously the case. It also means that something more than just an inequality of outcome would be required to establish serious injustice, as this was often the intended and expected purpose of a s21 agreement. As the Court of Appeal said in Harrison v Harrison [2005] 2 NZLR 349 "At least for contracting out agreements, "serious injustice" is likely to be demonstrated more often by an unsatisfactory process resulting in equality of outcome rather than mere inequality of outcome itself."

In deciding whether the agreement would cause serious injustice, the court considers:

• The provisions of the agreement.
• How much time has passed since the agreement was entered into.
• Whether the agreement was unfair or unreasonable when it was entered into.
• Whether the agreement has become unfair or unreasonable in the light of changed circumstances since it was entered into.
• Whether the agreement complies with the statutory requirements as to independent legal advice.
• Any other relevant issues.

Marriages, civil unions and relationships of less than three years ("short duration")

The equal-sharing rules in the PRA usually apply to marriages, civil union or de facto relationships of at least three years. A marriage or civil union of less than three years is called a "relationship of short duration".

• In the case of marriages or civil unions of short duration, special rules apply to decide how the property is divided. Instead of automatic equal sharing, the property is divided according to the contributions the parties made to the relationship (which can lead to the same result).
• In the case of de facto relationships of short duration, the Act does not apply at all (unless there are special circumstances, such as there being a child).

Sunset clauses

Property agreements sometimes contain a "sunset clause". This provides that the agreement will automatically end after a specified length of time, the relationship becoming again subject to a general application of the PRA (including the protections it already contains). This can be of value in trying to hold in appropriate tension the fairness of maintaining separate property ownership at the commencement of a relationship beyond the protections the PRA provide, with changing circumstances as the relationship endures when children may be born and raised, there is a developing reality to the division of role and function within the relationship, resources are pooled and lives become interwoven and shared.

A Final Note

Contracting out of the PRA by agreement can be undertaken at any time before a relationship ends and should be an integral and essential part of an estate and wealth protection plan. If you have a family trust, you are in a relationship and you do not have a s21 contracting out agreement, we recommend you contact us.

Fiona Mackenzie
Mackenzie Elvin
Solicitors
Tauranga
November 2009