Partner Desmond O'Donnell recently shared his thoughts in an article for ePrivate Client
Despite the best intentions of the spouses and their legal representatives, divorce is often a traumatic and difficult process. Divorce proceedings are frequently complicated and protracted and the animosity between the parties will often increase where there is a family business.
A business may be treated by the courts in England and Wales as a matrimonial (or civil partnership) asset and indeed in some cases, it may be the most valuable asset. Although a business is not a liquid asset in the way property and cash are, a spouse may ask the court to make money available to them by, for example, the other spouse drawing down company funds to pay them a cash lump sum.
Often, business assets which exist because of the efforts of one party (e.g. if the business was inherited by one spouse or where the value is due entirely to one spouse’s efforts) may be categorised as being non-matrimonial assets. However, this does not mean that they will be ring-fenced or excluded from consideration by the court. Instead, they will be treated as that spouse’s “unmatched contribution” and as a result, a judge may award that spouse more than a 50% share of the assets.
While many businesspeople wish to retain control over their business and avoid their spouses having an interest in it, other businesspeople consider retaining a business as being riskier than sharing other assets, such as cash and real property. A business is often referred to by the courts as being a “risk laden” asset, whereas, cash and property are treated as “copper-bottomed” assets and therefore, less risky.
Sharing the risk, as part of a financial settlement, is often sensible and a failure to do so can have potentially catastrophic consequences for a spouse. In 2009, there was a well-publicised case of Mr Myerson, who agreed to divide the total assets of about £25.5 million between him and his wife, so he received a 57% share (made up almost entirely of his shareholding in his company, which traded on the AIM). He was keen to keep control of the company. His wife received a 43% share, which was made up of cash and properties. At the time of the agreed settlement, the company shares were worth £15m (each share being valued at £2.99), but by the time of his appeal against the order (which had been made by consent), the shares were trading at only 27.5p.
The husband applied to vary the order because he considered the order to be no longer fair. However, his appeal was rejected, despite the huge difference between the values of the respective spouses’ assets. According to the court, the husband, with all his knowledge and experience, had agreed the terms of settlement. It was held that in attempting to vary it by offering the wife shares instead, he was trying to unburden himself of the unsuccessful risk he had decided to take.
In cases where the parties do not agree to share the risk, if the judges fail to consider the risks and unfairness involved in not dividing matrimonial assets between copper-bottomed assets and risk laden assets, the party who receives the riskier assets, is likely to successfully appeal that judge’s order.
On some occasions family judges have treated a business as the 'alter ego' of a spouse and made an order to “pierce the corporate veil”, by treating company assets as matrimonial assets. The company is treated as a separate legal entity from its shareholders, even where one or more of the spouses are the only shareholders. However, in the well-known case of Prest v Petrodel Resources in 2013, the wife appealed successfully to the Supreme Court, who decided that the husband was the true beneficial owner of the properties and that the companies held the properties on trust for the husband ‘by virtue of the particular circumstances in which the properties came to be vested’ in them. However, this was an unusual outcome, as the courts will only pierce the corporate veil in this way in exceptional cases.
The court needs to establish is the value of the business and experts are usually instructed to do this, in order to assess its liquidity, provide an accurate valuation, including any discounts which may apply upon a sale or transfer, detail any impact which an order would have on the business and its profits and consider any resulting tax implications. A valuation would be particularly important in cases relating to post-separation accrual and non-matrimonial assets.
Having established the value of the business, the court then needs to decide how it should be treated in the financial settlement. There are a number of powers which a court has within divorce proceedings to deal with family businesses. What the right outcome is for the individual concerned and indeed the business itself will be different in every situation.
Generally, a judge will try to avoid the sale of a company but there will be occasions when its sale cannot be avoided, in order to ensure fairness. Other options are often looked at, such as the party not involved with the business receiving ongoing maintenance or, even both parties retaining shares in the business. This latter option is often unattractive for the person who will have day to day involvement in the business, because they feel the other party will unfairly benefit from their efforts post-separation. The court also has the power to order a spouse to sell shares in a private limited company.
However, efforts will usually be made to give the business owning spouse an opportunity to “buy out” their spouse’s interest in the business. It is also not unusual for a judge to allow the business owning spouse sufficient time to find a buyer to avoid the business being sold at an under value.
It is important to consider the implications of any breakdown of that marriage on the business. With the correct planning in place at any early stage, one can take steps to protect one’s business, such as:
- Have a prenuptial or postnuptial agreement to try to protect one’s business and limit future claims against it.
- Make sure one’s Will mirrors the terms of any prenuptial or postnuptial agreement regarding how one’s shares or any cash value will be distributed.
- As far as possible, keep one’s business assets separate from one’s private wealth.
- Ensure any loans made to the company are properly and formally documented.
- It is important to strike a balance between involving one’s spouse in the business (to make use of tax reliefs, for example) and involving them to the extent that they can be said to have contributed to its success. If both spouses are to be shareholders in a business after their divorce, it will be essential to have a comprehensive shareholders' agreement to avoid one spouse acting improperly.
- Be smart with the ownership structure of the business. If it is jointly owned with other shareholders, it may be less likely that the Court will take steps that could negatively impact the other shareholders. Consider also having a Shareholders Agreement in place which could give the other shareholders pre-emptive rights to purchase one’s shares in the event that one were have to part with one’s shares in the business for any reason.
- Think about one’s business early on, before any difficulties arise in one’s relationship. Avoid making any changes to the company or transferring assets out of it late in the day, which could be seen as an obvious attempt to obstruct financial negotiations and may be detrimental to your position.
For all of the above reasons, it is recommended that when dealing with businesses one takes advice early to explore all of the available options.
Lawyers should also encourage their clients to consider alternative dispute resolution as a procedure for settling disputes without litigation, such as arbitration and mediation. Certainly mediation is often a cheaper, quicker and all together more satisfactory way of achieving an outcome which is in everyone’s interests. However, for mediation to be successful, it requires both parties to enter the (voluntary) process in good faith, something which sadly is not always possible when parties separate.
This article first appeared in ePrivate Client.