We are now seeing a marked increase in estate litigation – particularly family provision applications (FPAs), as well as proprietary estoppel and testator capacity claims.
With the impending mass intergenerational wealth transfer, which will see an estimated $5.4 trillion in assets passed down from the baby boomer generation to their heirs in the next two decades, this trend is likely to continue.
We can also expect to see an increase in the scope and creativity of asset protection measures designed to minimise the risk of an estate claim after a testator’s death.
In addition to more familiar measures such as the establishment of family discretionary trusts and gift and loan back arrangements, there is a question as to whether a binding financial agreement (BFA) that complies with the statutory formalities under the Family Law Act 1975 (Cth) (Act) may be used as a means to reduce the size of the estate which may be subject to a third party FPA.
The simple answer is: do not assume a BFA is effective to “contract out” of the family provision legislation. There is a risk that a BFA will not have that result, however “watertight” it purports to be. Both clients and practitioners need to be aware of this risk in properly evaluating their estate plans and obligations.
What can a BFA cover?
Under the Act, spouses can enter into a BFA prior to the marriage, after the marriage (including after they have separated but remain married) or after they are divorced.[1] De facto couples can enter into a BFA before their relationship commences, or after it has commenced (whether prior to or after a relationship break down).[2]
A BFA can cover:
- how, in the event of the “breakdown of the marriage”, all or any of the property or financial resources of the parties are to be dealt with;
- maintenance;
- matters incidental or ancillary to the above; and
- “other matters”.[3]
The term “breakdown” is specifically defined in section 4(1) of the Act – and this is important for reasons that will become apparent. The definition is stated to exclude a breakdown of the marriage or de facto relationship by reason of death.
Nevertheless, given their potential use as succession planning tools, BFAs are commonly drafted to also provide for the distribution of property (and maintenance payments, if any) in the event of not only separation by a traditional breakdown in the relationship (i.e. a “breakdown” under the Act), but also in the event of “separation by death” (i.e. when one of the parties dies while they remain married or in a de facto relationship).
Property and maintenance matters in the event of death (without a prior breakdown) could be seen to fall within the concept of “other matters” that can validly be included in a BFA under the Act.
But what happens when one of the parties to a BFA actually dies?
The Act expressly provides that a BFA that is binding on the parties to the agreement (in the sense that it has become operative) will continue to operate “despite the death of a party to the agreement” and that, in such a case, the BFA “operates in favour of, and is binding on, the legal personal representative” of the deceased party.[4]
But the question is when a BFA becomes operative and binding on the spouses or de facto couple in the first place.
The Act states that terms of a BFA dealing with how the property or financial resources of the parties are to be dealt with upon the “breakdown” of the marriage or de facto relationship (i.e. again, meaning a separation that occurs other than by death) are of no force or effect until a “separation declaration” has been made (unless the parties have already separated and one of them then dies before a declaration is made).[5]
However, a possible spanner in the works to a BFA being used as a succession planning tool – via the use of terms specifying what happens to the property of the parties in the event of a “separation by death” – is that sections 90DB(2) (spouses) and 90UG (de factos) of the Act also state that any terms of a BFA dealing with incidental, ancillary or “other” matters is “of no force or effect unless and until” the marriage or de facto relationship “breaks down”.
Taken at face value, this could mean that, while technically a BFA can include terms providing for a property allocation in the event of “separation by death” (i.e. at a time when the relationship remained on foot), those terms would never actually come into effect, bearing in mind the definition of “breakdown” in the Act we drew attention to earlier – which excludes a breakdown that occurs by death.
A counter-argument is that sections 90DB(2) and 90UG of the Act refer to a relationship that “breaks down”. This is not the same as the defined term “breakdown” in section 4(1) of the Act.
On a strict interpretation, therefore, it could be argued that a marriage or de facto relationship that remains on foot, and ends only when a party dies, results in a relationship that “breaks down”, thereby satisfying the terms of sections 90DB(2) or 90UG (as applicable) of the Act.
On that basis, provisions dealing with the allocation of property upon separation by death would be valid and binding on the parties – and any legal personal representative – from the time of death.
Even if that hurdle can be overcome, however, another much trickier obstacle remains.
The interaction between BFAs and FPAs – competing public policy issues
The nature of a BFA is that of a private contract. It could fairly be assumed that, as a result – and aided by provisions in the Act which make a BFA binding on a person’s legal personal representative after their death (see above) – an executor’s contractual obligation to distribute property to the deceased’s spouse or de facto pursuant to “separation by death” clauses in the BFA would reduce the size of the estate, and property which could be the subject of a FPA.
However, that is not what the Act says. The fact a BFA is binding on an executor does not mean it is binding on a court – and the very nature of the family provision legislation in each state and territory is that a court has jurisdiction to order an alternative distribution of a testator’s property, irrespective of what the testator wishes to occur.
The courts have already accepted that a BFA is not able to oust the jurisdiction of a court to make family provision orders upon the application of the spouse or de facto that was the counter-party to the BFA, as this is contrary to public policy.[6] Nevertheless, it is common for BFAs to still include waiver clauses, according to which each party agrees not to make a FPA if the other party dies. The inclusion of such a waiver, while not binding (except in New South Wales, if the waiver is expressly approved by the court),[7] is still taken into account by the court in exercising its discretion to make a family provision order.
But what about a claim by a third party that has not signed the BFA? There is no privity of contract in this case, and the “contractual force” argument that the BFA ought to be regarded as removing assets from the estate so they are beyond the reach of a FPA has less force.
Further, in Barns v Barns,[8] the High Court held that a “mutual wills” contract entered into by the deceased prior to his death (in which the deceased and his wife agreed to dispose of their estates in a particular manner, with any alterations possible only with the consent of the parties and their son) did not reduce the size of the “estate” or prevent a later FPA by the deceased’s daughter.
The High Court pointed to the clear intention of family provision legislation to confer a discretion on the courts to “override testamentary intention”. To uphold the ability of a person to effectively nullify the operation of the legislation by “agreeing in advance to dispose of his or her estate in a certain fashion” was said to defeat the purpose of the legislation and to be against public policy.[9] Private contractual arrangements must, on that basis, be “understood and applied subject to the operation” of the family provision legislation.[10]
Again, a BFA, like a mutual will arrangement, is a private contract between parties. Should it therefore not result in the same outcome as the mutual will arrangement in Barns? The core public policy issue – that a private contract should not be permitted to oust the operation of “protective” legislation designed to safeguard the interests of those deemed by the legislature to be in a vulnerable position, and to have a specific need for provision capable of overriding the testator’s freedom of disposition, is identical.
The issue has not been determined by a court to date, despite its clear importance and the fact that BFAs are (in our experience) commonly drafted to include “separation by death” clauses which are assumed to remove assets from the scope of a FPA or other estate claim. This may be a reflection of the fact that FPAs rarely proceed to trial, and most commonly resolve out of court.
What should I do?
Until the matter is considered and resolved by a court, the safest option, to limit the prospect of an estate claim, may be to effect a transfer prior to death. However, that would lead to potentially adverse tax and stamp duty consequences. Further, in New South Wales, a transfer of property prior to death could still fall within the “notional estate” provisions that enable such property to still be the subject of a FPA.[11]
These issues raise significant uncertainty in the interplay between family law and estate legislation, and the competing public policy issues of testamentary freedom on the one hand, and fairness and equity considerations on the other hand.
At the very least, it should no longer simply be assumed that a BFA will trump a FPA by a third party. There is a very real possibility that a BFA will not lead to that outcome, and this risk should be both identified to clients, and factored into their estate planning, and borne in mind by professional advisers from a personal liability perspective.
Absent a court determination, legislative reform would be a desirable outcome.
Get in touch
At Hamilton Locke Private, we have a dedicated team of experts that are highly experienced in all trusts, estates and succession planning matters, including FPAs and the negotiation of BFAs as part of a comprehensive succession and asset protection strategy.
If you would like to discuss any of these issues in further detail, please get in touch with Brett Heading, Fran Becker, Jamie Blair, Jack Conway or Penelope Nicholls.
[1] Sections 90B, 90C and 90D of the Act, respectively.
[2] Sections 90UB, 90UC and 90UD of the Act, respectively.
[3] Sections 90B(2), 90B(3), 90C(2), 90C(3), 90D(2), 90D(3), 90UB(2), 90UB(3), 90UC(2), 90UC(3), 90UD(2) and 90UD(3) of the Act.
[4] Sections 90H (spouses) and 90UK (de factos) of the Act.
[5] Sections 90DA (spouses) and 90UF (de factos) of the Act.
[6] Kozak v Matthews [2007] QCA 296.
[7] Section 95 of the Succession Act 2006 (NSW).
[8] (2003) 214 CLR 169.
[9] At para 34 (Gleeson CJ).
[10] At para 127 (Kirby J).
[11] Section 80 of the Succession Act 2006 (NSW).
