The Covid-19 pandemic has had financial consequences for business and individuals alike. While it is unclear what the long-term effects of the market fluctuations will be, it is clear that separated couples going through a divorce are not immune to devaluation of their assets as a result of the pandemic.
When a marriage breaks down, each spouse is required to equally share the property accumulated throughout the marriage (with some exceptions). In many cases, the spouse with the greater assets is required to provide an equalization payment to their former partner, which is a sum equal to one-half of the difference between the spouses’ assets held at the time of separation, minus the assets held at the time of marriage (subject to defined exclusions). Typically, the spouse that holds the asset bears the impact of a post-separation increase or decrease in value. However, an equalization payment may be altered after the separation date if equalizing the net assets would be unconscionable. To be unconscionable, it must be “shocking to the conscience” or repugnant to one’s sense of justice.
Formerly-married couples who separated before the COVID-19 pandemic may find themselves in a situation where their assets were worth more at the time of separation and have since experienced a decline due to the economic impact of COVID-19. This may result in one spouse owing an equalization payment that is greater than, or not representative of his/her current net worth. Such was the case in Serra v Serra ONCA 2009.
Serra v Serra ONCA 2009
Mr. Serra owned a profitable textile company worth upwards of $10 million at the time of separation. Ms. Serra held significantly less assets than Mr. Serra. Accordingly, Mr. Serra owed Ms. Serra a large equalization payment worth over $4 million dollars. Over time, however, the value of the textile company dropped significantly to a value between $1-2 million. By the time of trial, Mr. Serra owed an equalization payment that was greater than his net worth. The trial judge concluded that a market-driven post-separation date decline in the value of an asset cannot be taken into account in determining if an equalization payment is unconscionable. The trial judge’s decision was overturned on appeal.
A post-separation market-driven decline in the value of marital assets can be considered in determining if an equalization payment is unconscionable
The Ontario Court of Appeal in Serra made it clear that a market-driven decline in the value of an asset can be taken into account when deciding whether an equalization payment is unconscionable and therefore alterable after the date of separation.
An order for an unequal division of assets can be made on such a basis:
(i) where the circumstances giving rise to the change in value relate (directly or indirectly) to the acquisition, disposition, preservation, maintenance or improvement of property (s. 5(6)(h) of the Family Law Act), and
(ii) where equalizing the net family property would be unconscionable, having regard to those circumstances (taken alone or in conjunction with other factors mentioned in s. 5(6)) of the Family Law Act.
In the case of Mr. Serra, the downturn in the textile industry was a circumstance relating to “disposition, preservation and maintenance” of Mr. Serra’s business. The finding of unconscionability was based solely on a market driven change in value. While the market decline was sufficient on its own to establish unconscionability in Serra, in other situations, other factors may weigh against the market driven decrease in the analysis of unconscionability. What is sufficient to establish a finding of unconscionability is dependent on the facts of each case.
Mr. Serra was not at fault for the devaluation of the business. Mr. Serra was ‘handcuffed’ by an order to preserve the business and could not sell his business even though its value was dropping rapidly. Even if he wasn’t constrained by the preservation order, there was no market to sell the business in, in an attempt to mitigate his losses. He continued to do everything in his power to keep the company viable but the suffering of the textile business was not merely due to a temporary recession. Instead, it was due to international outsourcing and other factors that would continue to threaten the financial viability of the textile industry for the foreseeable future. For these reasons, Mr. Serra’s equalization payment was reduced to nearly ¼ of its original value.
Devaluation based solely on market-driven forces must be extreme to be unconscionable
Only in the most extreme circumstances will the situation reach a level of unconscionability such that the prescribed equalization payment will be adjusted. Circumstances that are unfair, harsh or unjust do not meet the threshold of unconscionability. Only occurrences that are “repugnant to anyone’s sense of justice” will be considered unconscionable.
The equalization payment need not result in a figure greater than a party’s net worth to be unconscionable (Kean v Clausi 2010 ONSC). However, absent other factors that would make the equalization payment unconscionable, the amount of the equalization payment must be extreme in order to shock the conscience of the court (Lo v Lo 2011 ONSC).
Will the COVID-19 pandemic alter equalization payments based on unconscionability?
Businesses are being forced to close their doors – both temporarily and permanently, affecting owners and employees alike. The economic impact is widespread, and in some cases, may be permanent. Spouses are being forced to provide equalization payments based upon wealth they held prior to this unprecedented pandemic and its associated financial crisis. While the spouses may have had the means to make the payment a few months ago, their ability to provide the payment may be significantly hindered now. It may be unfair that an equalization payment is not reflective of a spouse’s current wealth, but it is not necessarily unconscionable.
Is it repugnant to one’s sense of justice to require someone who lost their business as a result of the economic impact of the pandemic to pay a large equalization payment based on the previously high value of the once successful business? Is it shocking to the conscience of the court to require a once wealthy person to pay a high equalization payment that they can no longer afford, having lost their job during the pandemic? Perhaps, but it is important to keep in mind that a finding of unconscionability often requires a plethora of contributing factors. The courts have rarely altered equalization payments based on economic factors alone, making it difficult to predict how this financial crisis might be treated. The Serra decision establishing that market factors may be considered in determining if an equalization payment is unconscionable occurred in the shadow of the last prominent financial crisis, and we have not faced a severe financial setback since, let alone a crisis caused by a worldwide and long-lasting pandemic.
If a spouse’s assets, however, have declined in the wake of the pandemic, and it is impacting that spouse’s ability to make an equalization payment, the following factors may be taken into account, in addition to the declining market forces, in considering if the equalization payment has reached the high threshold of unconscionability:
- Is there a market to sell the asset in to mitigate the losses?
- Even if the market for that particular asset is failing, did the owing spouse attempt to sell the asset in order to preserve at least some of its value?
- Is there anything preventing the owing spouse from selling the asset (for example, a preservation order)?
- If there is a market to sell the business, is there potential for a buyer?
- There will always be a market for certain types of businesses: for example, medical professionals and restaurants. However, there may not be buyers with sufficient funds to purchase the assets in the midst of an economic downturn.
- If the value of the asset has decreased significantly, is there a chance that the value of the asset will recover in the future? Will it recover to its value prior to the pandemic and resulting financial crisis?
- If there is a chance that the asset will recover its value after the financial crisis, how long will it take to recover and how will that impact the ability to make the equalization payment in the meantime?
- Can the owing spouse fund the equalization payment through other means
- What is the quantum of the loss? How much will the equalization payment decrease if the decrease in value is accounted for?
- In Lo v. Lo 2011 ONSC, an equalization payment of over $173,000 that would decrease by over $47,000 if post-separation devaluation was taken into account did not reach the threshold of unconscionability. The payment need not exceed one’s net worth to be unconscionable, but, based on Lo, a decrease in the value of an asset that would decrease the equalization payment by approximately 27% was insufficient on its own.
- In Kean v Clausi 2010 ONSC, one significant asset accounted for in the equalization payment dropped in value by over $70,000 after separation. The court allowed for the equalization payment to be altered to reflect its post-separation decrease in value, but this was partly in response to the fact that the asset in question was held in name by one spouse but was controlled entirely by the other spouse. The court did not wish to make the spouse with no control over the asset bear the loss of its market value.
- Is the spouse at fault for at least some degree of the decrease in value of the asset? For example, did the spouse recklessly deplete the value of the asset? Generally speaking, the majority of findings of unconscionability in Ontario have been based on fault-based, unconscionable conduct of one of the spouses. Improper conduct on the part of the spouse owing an equalization payment may be weighed against a market-driven decrease in value in establishing if a payment is unconscionable.
What if a former spouse declares bankruptcy while still owing an equalization payment?
Upon bankruptcy, an outstanding equalization payment is “swept into the bankruptcy”. In simple terms, the equalization payment is treated like every other debt owed by the bankrupt spouse, and the spouse that is owed money does not get priority over other secured creditors.
Declaring bankruptcy does not necessarily eliminate the obligation to pay an equalization payment. Rather, it simply puts the payment of secured creditors at a higher priority than the former spouse that is owed an equalization payment.
To complicate matters, a bankrupt person may be “discharged of their debts”. If this occurs, a person is discharged of their responsibility to make an equalization payment. The courts have often responded to this in certain situations by increasing the amount and duration of support payments.
Section 9(1) of the Family Law Act allows for enhanced remedies whereby property rights may be granted to a spouse upon separation rather than an equalization payment. This would give the spouse who is owed money greater priority should his/her former spouse declare bankruptcy after separation. However, the courts are not quick to impose property rights rather than an equalization payment, and this may only be ordered “where it is established — based on the targeted spouse's previous actions and reasonably anticipated future behaviour — that the equalization payment order granted will not likely be complied with in the absence of additional, more intrusive provisions” (Thibodeau v Thibodeau 2011 ONCA).
The unconscionability of an equalization payment must be determined on the facts of each case. The courts have rarely changed equalization payments based solely on market fluctuations, and since we have never experienced a pandemic to the magnitude of Covid-19, it is difficult to predict whether the dire financial circumstances separating couples are facing right now and moving forward will reach the threshold of unconscionability so as to alter an equalization payment. That said, it is entirely possible, as the pandemic continues to change our daily lives in ways we could have never imagined, that these unprecedented times and the financial impacts will be sufficient to establish a finding of unconscionability and alter equalization payments.