Rachel Donald, partner in Penningtons Manches Cooper's family law team, considers the issues that may arise for separating couples in a volatile market.
Last week sterling fell to a record low. In 2022, the pound has fallen over 16% against the US dollar and 7% on a trade weighted index. It is anticipated that this fall will mean greater increases to the cost of living, as the cost of exports rise. The government’s U-turn on the 45p tax rate announced today has resulted in the markets recovering temporarily, but there are economists who fear that the worst is yet to come. The Bank of England has responded to the crisis and raised interest rates by 50 basis points last week in an attempt to balance inflation. Since January this year, the UK has experienced interest rates rise from 0.1% to 2.25% and it is expected that they are to continue to rise well into 2023. These changes will have a significant impact on most households and families across the UK, but what does this mean for couples getting divorced and their financial settlements?
A financial agreement following a divorce is centred around financial disclosure - this means agreeing the value of domestic and offshore assets including investments, shares, digital assets such as crypto currencies, and pensions. If you are in the process of negotiating the terms of a financial settlement it is vital that updated values are produced regularly to ensure any assets schedules which form the basis of negotiations provide an accurate reflection of what your assets are worth in the current market. Given the volatile markets, it may be more appropriate to divide assets rather than agree offsetting lump sums to share the risk across a portfolio and avoid a gamble on the market.
For international families with investment and property portfolios across several different jurisdictions, the fall in the pound creates difficulties when considering the relative values of domestic and international assets. This may lead to couples revisiting financial settlements to recalculate how assets have been allocated and divided. This is particularly the case with individuals who may have assets held in the US, or funds held in US dollars, given the weakness of the pound.
If expert valuations have been prepared during negations or financial proceedings, you should consider asking the expert to update their findings based on current market conditions. Many companies will find that their export costs have rocketed which may have a significant impact on its profitability, the value of shareholdings and the income that will be drawn from shareholders as dividends. Therefore, reliance on previous performance and last year’s accounts / returns may not be a reliable indication of how a company will perform.
The courts made it clear in case law following the 2008 financial crash that financial agreements that had already been approved by the court could not be revisited due to unpredicted economic change and that market fluctuations do not justify reopening and re-drawing capital orders. However, there may be scope for agreements made by consent and order that have been approved but not yet implements to adjust orders where market volatility has resulted in an unfair outcome that is not in line with what the parties (or the court) had intended.
Another factor that may have a huge impact on the terms of a financial settlement in a divorce is the impact of increasing mortgage rates, and in turn the effects on the housing market. The ability to purchase a home and the reasonable housing needs of the family can be a turning point and crucial factor in negotiations for the court. Our real estate partner, Lee Greaves, who frequently acts for clients purchasing and selling high value property and estates, comments:
“The increase in mortgage interest rates affects affordability and will start to put the housing market under stress. When the costs of borrowing increase dramatically, the ability to purchase a property which meets the needs of the family becomes more difficult. The recent changes to Stamp Duty Land Tax in the mini-budget, which are small in comparison, will do little to change that picture. The availability of affordable finance on a re-mortgage can also affect the ability of parties to raise funds on property that forms part of the settlement.”
Mortgage borrowing capacity can be influential in agreeing the terms of a settlement, therefore it is important that any deal is based on current market possibilities and is also realistic when considering affordability and monthly mortgage payments when budgeting.
The changes implemented to taxation under the new government will also need to be considered and reviewed when agree the terms of a financial settlement. Any projections based on historic rates of income tax and corporation tax will need to be updated to reflect the updates following the mini-budget this week. Tax expert, Adrian Moss, comments that:
“Whether you agree with the government’s path or not, changes announced on 23rd by Kwasi Kwarteng will need to be factored into income projections. For companies, the proposed increase of Corporation Tax to 25% has been shelved, with the rate to remain at 19%. In respect of personal income taxation, there were three major announcements – the impending increase to national insurance (of 1.25%) has been scrapped and from April 2023, for taxpayers in England, Wales and Northern Ireland, the basic rate of income tax will be reduced to 19% (from 20%) and, finally, it was announced that there will no longer be an additional rate of income tax at 45% for income over £150,000. However, following severe political and economic pressure, on 3 October 2022, the Chancellor announced that the plan to remove the 45% additional rate of income tax would be cancelled. I do not doubt that the political pressure will remain in respect of the governments ‘growth plan’ and as such, I think it will be wise to keep an eye on any adjustments to the tax system in the Chancellor’s statement on 23 November 2022 and the Budget in Spring 2023”.
Pensions are also a key consideration within a financial divorce settlement. The court has powers to make pension sharing orders and these are often calculated by actuaries, based on economic assumptions and market trends. The recent rise in Bank of England rates may have a major impact on the Cash Equivalent Value of pensions which is the figure that most divorce settlements rely on. A change in the CEV may have a dramatic impact on a pension sharing order that is being calculated but has not yet implemented. This is because a pension sharing order takes a percentage of the transferor’s schemes based on the valuation at the time the calculation was made. If there is a change in the value of the pension before it is implemented, this means the transferee will receive a much lower pension credit than expected.
For couples who are agreeing to offset the value of their pensions against other assets such as cash or property, they must consider that there is now more risk than ever that the CEV will not be a reliable or realistic indication of the asset’s market value.
This risk should be considered when agreeing the terms of a financial settlement, and you may wish to consider instructing a pension actuary to advise on mitigating it when preparing pension sharing calculations. Alison Hills, Penningtons Manches Cooper’s head of pensions, advises:
“The manner in which pension sharing orders are implemented can give rise – particularly in uncertain times like these – to unexpected results, with the % share awarded to the spouse representing a wildly different % of the total fund by the time it is implemented (which can be up to four months after the pension sharing order takes effect once the scheme administrator has all the information needed to give effect to the order).”
If you are in the process of negotiating the rate of spousal maintenance within your financial settlement, it is essential that monthly budgets are reviewed and updated. The family court in England and Wales quantifies the appropriate rate of spousal maintenance by assessing needs of both the recipient and the payer. It is therefore imperative that income needs schedules accurately account for any increase in the cost of living to ensure that the terms of any agreement reach is affordable now, and in the future. If your budgets are not up to date, it is likely that the agreed rate of maintenance will not meet your needs, and this may lead to a flurry of applications to vary maintenance rates. Variation applications may be inevitable for those who have already reached an agreement but could be avoided if you have not yet finalised a deal.
You may have already negotiated the terms of a financial settlement and be concerned that the values used to agree the terms have now changed significantly due to the current economic climate and the fall in the pound. Generally, the courts are clear that fluctuation in economic markets does not automatically allow couples to reopen financial settlements. However, in limited circumstances it is possible to delay the payment of lump sums or restructure a deal if the impact is significant, or if the change was significant and unforeseen.
It is important to remember that ongoing spousal and child maintenance orders are variable where there is a change of circumstance. Therefore, there may be scope to revisit income orders if there has been a significant change to the payer’s income, or if a recipient can no longer meeting their own, or any child’s needs, from the sum being paid.
If you are in receipt of maintenance and it is index linked to inflation, check the terms of the order and ensure that the rate of maintenance is increased if appropriate. Often, this is provided for automatically in a spousal maintenance order.
It is important to seek advice from a specialist family lawyer if you are concern that your financial agreement may have been impacted by the fall in the pound.