Karen Holden, founder of A City Law Firm, explains every consideration a company owner needs to take when divorcing a business partner, from assets to intellectual property.
Divorcing your spouse is never a pleasant situation and something that is rarely anticipated. What can make matters more complex is if your spouse is also your business partner. Often emotions dictate decisions which worsen the situation. It can be worrying, as you are not only facing the loss of your marriage but your business dream. In 2016, more than 46% of family-owned businesses faced challenges as a result of owners getting divorced.
As a commercial lawyer, I know how rare it is for a couple to have commercial agreements in place when it comes to their business. Often, couples claim they don’t need them because they are “married and in love.” While such agreements aren’t the most romantic propositions, when it comes to business, it can help guide unexpected situations.
When one business partner does not have much contribution in terms of running the business and is more of a silent partner, it becomes easier for one spouse to buy the other one out. But what happens when the couple individually are integral to the running of the business? Will one spouse still be able to persuade the other to buy them out? Can they continue to work together? Will the business shut down?
These are only a few of the different possibilities in such a situation. In this situation, a partnership or a shareholder’s agreement is best because it can help define the roles of the couple as business partners and dictate an outcome in the business world but be warned without a mirroring pre-nuptial agreement it might be overridden in the family courts.
While the conversation of what to do with your business should a divorce take place may seem uncomfortable and unnecessary, should a partnership end it can have devastating effects on a business. So, if you are a business owner in a relationship with your partner here is a rundown of what you should know:
The 50/50 split
Often, in family proceedings where there is no legal documentation, joint assets acquired during the marriage are combined and split between the parties upon divorce as they form part of the “matrimonial pot”. Intention for something else to happen or as required by fairness can be cumbersome and expensive.
The landmark case of White v White  established two key principles:
- No discrimination between parties based on their roles during the marriage
- Judges should measure their decision against the “yardstick of equality” and be able to justify any departures from an equal division of marital assets
As you can see, the starting point for divorce is that assets will be divided equally and any departure from a 50/50 split must be justified. At A City Law Firm we have acted for many clients that are joint business owners with equal shareholdings, and have been wound up because a vital business decision could not be agreed upon by the two parties. It is therefore very common for one partner to play no role in the business but use their joint ownership entitlements to gain more from the divorce.
If, however, there was a shareholding agreement and a pre-nuptial agreement in place, this would provide a persuasive basis upon which the division of the business would rely, which may be a fairer reflection of the contributions made by the parties and prevent the business being divided equally.
Three things to consider
While divorce isn’t something that we often want to think about, but when running a business there are three things that should be considered:
Who owns the Intellectual Property rights in your business?
Has this been transferred correctly to the business or is it personally owned by one or both of the individuals. IP can be a businesses most valuable asset and without an agreement could be held to ransom and lead to a costly dispute. In order for one person to use it, they must buy the other out and have the capital to afford to do so.
Document financial transfers
It is common for partners to inject money into a family business when needed without these loans being documented. However, this can make it difficult to recoup the loans during a divorce.
One client lost everything because he didn’t document loans to the company, his wife asked for money to support the company and he agreed. When they divorced, as the money had not been labelled, all the assets were pooled and spilt equally – meaning all his extra investments were lost.
Assets such as property or investments may not be sold for some time, and this can prevent a court easily ordering a clean break order. This is unless the value of the asset and the shares owned by each party can be easily offset against the total settlement – however the party/business will need to have the funds readily available.
There also have been cases where couples have deployed different tactics to hide assets when a relationship has gone sour. For example:
- Delaying account preparation before the proceedings is particularly common, particularly when one of the couple has a stronger relationship with the accountant and refuses consent. When pressured, the accountant can fear a conflict of interest and cease work altogether.
- One of the business partners could undersell business assets to score points or sell to a friend to rebuy later.
- Undervaluing assets of a company by gifting or liquefying ahead of a divorce is also commonly practiced as it ensures that neither party can have the assets.
Should any of the above events take place, the family courts now have far-reaching powers to reverse any transaction or to ‘count in’ the asset at the actual value so that there is no loss suffered.
How to protect your business
The best way to protect a business is to implement a partnership or shareholder’s agreement. This should cover, at the very least, the following points:
- Transfer of all IP to the company
- Plan what happens in the event of a dispute
- Specify the owner of each of the shares, and make it clear who has put in what amount of money.
- Keeping a clear log of accounting will prevent anyone hiding any information during the proceedings.
- Set restrictive agreements to prevent the departing spouse stealing clients, setting up a directly competitive business or sharing confidential information.
Having a Pre/Post-Nuptial Agreement to compliment any contracts can be helpful during divorce proceedings, particularly if each party has independent legal advice.
Ensuring personal Wills mirror this is important also, as they govern where shares, cash and assets go following the passing of any partner.
Practical steps to take to protect your business
- Keep heated discussions about the divorce and any possible effects on the business away from employees and colleagues. Do not involve them into your divorce.
- Maximise cash flow and preserve cash asses. You might need cash to buy out your partner.
- Give careful thought to communications with other owners or senior executives, lenders, significant suppliers and customers. You may want to delay disclosure of your divorce until you have a certain plan as you do not want to give insecurity to people who are integral to your business.
- Keep showing up to work and try to make the business environment comfortable for employees, no matter how emotional the situation may be. Encourage your partner to do the same, even if it is very difficult to do so.
While there are other alternatives, I encourage my clients to find an amicable resolution where possible – here are some steps to achieve this:
- Put well drafted, contractual agreements to deal with how the working relationship can come to an end into place.
- Keep a record of any financial transactions, in and out and record any loans to the company and the intention of repayment.
- Have lawyers and accountants resolve any issues rather than litigate.
- Have a mediator when discussing any plans, this will aid amicability, both sides may opt for a representative to prevent spite from the other.
It is the best practice to start any business with clear and comprehensive legal documents, this protects the business and its partners in the unexpected event of a divorce. It is easier to fairly separate the business in this case.
Karen Holden is founder of A City Law Firm
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