Ontario court ruling factors into divorce planning

A new wrinkle has been added to divorce proceedings, with the decision by the Ontario Court of Appeal on Wednesday, that external economic conditions can be factored into how a judge awards equalization payments. For planners, this means market conditions can impact what your client can expect to pay or receive in a divorce settlement.

Generally speaking, Ontario courts will impose equalization payments in a divorce case to split the net worth of two spouses acquired while they were married, so that each spouse leaves the marriage with a relatively equal share of that net worth. Traditionally, an individual’s net worth is determined at a specified valuation date, usually at or near the date of separation.

A problem occurs if the value of assets declines dramatically between the valuation date and the final court proceeding. This is what happened to Harold and Barbara Serra.

At the time of the couple’s separation in 2000, after 24 years of marriage, Harold Serra owned a profitable textile business in Ajax, Ontario. The majority of his net worth was tied up in the business, with his shareholdings valued at between $9.5 million and $11.25 million.

The court documents note, however, that by the time of the divorce hearing, the value of the business had decreased to somewhere between $1.875 million and $2.6 million — a drop of approximately $8 to $9 million. Mr. Serra argued in the initial court case that the Canadian textile business had been obliterated by China joining the World Trade Organization, and its subsequent ability to undercut productions costs.

Nevertheless, the original judge still ordered Mr. Serra to pay Ms. Serra an equalization payment of $4,129,832.50, which exceeded his total net worth. Not surprisingly Mr. Serra appealed to the Ontario Court of Appeal, where the judges unanimously voted 3-0 in favour of reducing the equalization payments owed, citing uncontrollable economic factors.

“This dramatic change was not due to any fault on the part of Mr. Serra, who has done everything in his power to keep his failing business afloat. The change is attributed entirely to shifting market forces that have adversely affected the Canadian textile industry generally,” Justice Robert Blair wrote in the decision. “In these circumstances, an equalization of net family property that requires Mr. Serra to pay more than his total net worth (and arguably as much as twice his net worth) because of a marked decline in the value of his major assets post-separation — over which he had absolutely no control and in spite of his best efforts to save the business in the face of Ms. Serra’s trust claims, the preservation order and the need to comply with his support obligations — is, in my view, unconscionable.”

The Ontario Court of Appeal concluded that the difference between the two net family properties is $3 million, one-half of which is $1.5 million. From that amount, Justice Blair said, the court deducted credit for capital payments already made by Mr. Serra. He determined that technically the balance left owing should be $656,000. Justice Blair suggested the court tack on an additional $250,000 to that amount.

“I would make an upward adjustment of approximately $250,000 in that amount. I do so to give better effect in particular to these considerations: (i) the possibility, however remote, of a modest turnaround in the fortunes of the Ajax Textiles business; (ii) the length of the Serras’ marriage; (iii) the principle of dividing matrimonial property in a way that recognizes the equal contribution of spouses to the accumulation of wealth during a marriage; and, (iv) a desire not simply to substitute a trial-date valuation for the separation-date valuation in the circumstances of this case,” he wrote.

The decision appears to have opened the door for adjustments to be made to divorce settlements based on market conditions. Given current market conditions, there could be a lot of divorces that see a big disparity between values at separation and trial date.

Ultimately, lawyers will have to determine what conditions would require an adjustment. It would appear the pendulum could swing both ways, with some spouses now able to claim they are paying too much in equalization payments if a downturn occurs after a valuation date, and other spouses demanding a bigger piece of the pie after an upswing.

Blair was not willing to rule on whether a temporary market downturn could dictate an adjustment.

“Nor, I emphasize, is it a case of a temporary decrease in the value of an asset resulting from a temporary economic recession; the difficulties in the domestic textile industry were well embedded before the onset of the current economic downturn,” Justice Blair writes. “Each case must be determined on its own facts. In the circumstances here, however, I am satisfied that an equalization of net family property would be unconscionable, given the dramatic downward turn in Mr. Serra’s fortunes and the factors giving rise to, and surrounding, it.”

Linda Cartier, president of the Academy of Financial Divorce Specialists, expects the decision will materially impact how she helps clients arrange their finances during a divorce.

“I think this is going to change how things are dealt with,” she says. “It does add another dynamic to divorce planning and I think it it’s a good reason to have financial professionals involved even more with divorce.”

Cartier says basing valuations on the date of separation was already a contentious issue, with some clients trying to work with lawyers to get the right valuation date in order to maximize or minimize valuations depending on their circumstances.

She also points out that good divorce planners work with their client to assess the future value of assets and to try to factor in their long-term growth. That means looking at investments that may belong to one spouse and trying to determine what a reasonable long-term rate of return would be for investments that don’t have a guaranteed rate of return, and then factoring that into a financial plan.

“Definitely that is one of the things we’re factoring in with our planning,” she says. “You would use a reasonable rate of return for any investments that are in a potential growth position. A lot of times, we try to take into account that [most investments] yield 5% or 6% rate of return over a long period of time.”

(02/05/09)