What happens to business interests in the face of divorce?
How do the family courts treat businesses in divorce proceedings? From a corporate point of view, how should shares be dealt with? BLM Family Solicitor Yasmin Khan-Gunns and London Head of Corporate & Commercial Matthew Poli join forces to explore this further.
The family law perspective
How will my business be dealt with on divorce?
A judge must consider all of the circumstances of the case, with first consideration being given to the welfare of any minor child or children of the family. Before making any decisions about the business, a judge will want full financial disclosure of it.
What financial disclosure do I need to provide the judge with for my business on divorce?
The parties will need to complete a document called Form E, where they will set out all of their financial disclosure with documentary evidence in support. Among other things, the party with the business will need to provide:
- the name and nature of the business and the extent of their business interest;
- confirmation of whether the party is a sole trader, partner in a partnership with others or shareholder in a limited company;
- total amount of any sums owed to the party by the business by way of a director’s loan account, partnership capital or current accounts;
- an estimate of the current value of the parties’ interest in the business with an explanation;
- an estimate of any Capital Gains Tax (CGT) that would be payable if the party were to dispose of the business now;
- the net value of the parties interest in the business after payment of CGT;
- a copy of the business accounts for the last two financial years;
- any documentation that is available to confirm the estimate of the current value of the business.
Will I need to obtain a valuation of my business or business interest on divorce?
It may be necessary to seek a valuation and legal advice should be sought here. If a valuation is necessary, consideration should be given to:
- how liquid the business or business interest is;
- methods available to extract funds from the business to fund a financial settlement;
- what discount needs to be applied to illiquid assets or minority shareholdings;
- whether shares need to be transferred from one party to the other;
- the income the business or business interest can provide;
- the tax implications of selling or disposing of shares in the business.
A judge will generally rely on an expert’s valuation unless the expert is discredited. This said, a judge will be aware that valuations do not always provide a true picture of a business’s value or business interest and where appropriate, a judge will treat the valuation as a guide rather than an absolute.
What if I started or built up my business before the marriage or after the marriage?
A judge will consider whether the business is matrimonial or non-matrimonial property.
Matrimonial property is property acquired during the marriage by the labours or endeavours of one or both parties. For example, a business established during the marriage or that provided income to the family during the marriage. In general terms, matrimonial property is likely to be shared equally. Non-matrimonial property is property that has been acquired by one of the parties outside of the marriage. For example, a business established before the marriage, inherited by one of the parties or that grows significantly after the parties have separated. In general terms, non-matrimonial property is likely to be retained by the contributor or shared unequally in favour of the contributor.
However, the distinction will carry little weight, if any weight, in a case where the parties’ financial needs cannot be met without resource to it, as needs have priority. The distinction may also carry less weight if the non-matrimonial property is or was of insignificant value, acquired many years ago or has been intermingled with other matrimonial property.
What orders can a court make about my business on divorce?
In most cases, one party retains the business or business interest and the other party is compensated with a lump sum, lump sum by instalments, periodical payments, or a combination of these. The court will need to consider whether a discount should be applied, as a result of illiquidity and or minority shareholdings.
If the business is a company, the court has the power to order one spouse to transfer their shares to the other spouse. The court also has the power to order the sale of shares owned by a party to the marriage.
A corporate viewpoint
From a corporate law point of view, shares held by an individual undergoing divorce proceedings can be troublesome and various factors need careful consideration to ensure that an agreement reached between the parties does no fall foul of obligations which exist elsewhere.
Negotiating a consent order
When two parties are divorcing and one of them owns shares, negotiations may well centre around how the non-shareholder party is protected from an intentional diminution in value of the shares - something over which they have a legitimate entitlement. This is particularly the case when the shares may be of modest value now, but are expected to gain in value in the future. In such a case, the non-shareholder party will primarily be interested in two things:
- whether they are entitled to any income derived from those shares in the form of dividends; and
- whether, on an exit event (such as the sale of the company), the non-shareholding party is entitled to a portion of the proceeds.
Any financial consent order between the parties should address these issues, and more besides. What would happen if the shareholding party continually waived his or her right to receive a dividend, or received a distribution in specie rather than in cash, for instance?
In addition to the above, the shareholding party must have careful mind to the company’s articles of association and any shareholders agreement to which they are a party. Agreeing to the safeguards inevitably required by the non-shareholding party will inevitably place limitations on the shareholding party’s ability to deal with his or her shares. Those limitations may place the shareholding party in breach of the company’s constitutional documents.
A case recently worked on turned on the requirement of a non-shareholding party to give consent to dealing with the shares by the shareholder. The concern was clear – that the shareholder would deal with the shares in such a way as to strip value from them, or put them beyond the reach of the non-shareholder, in each case depriving her of the value of the matrimonial asset. The company in which the shares were held took the view that if the shareholding party agreed to this concession (something, in this particular case, he was happy to do), he would find himself in breach of the company’s articles and, thus, be vulnerable to proceedings brought by the company itself against him.
Protecting your interests
It is clear that when corporate holdings are a factor in divorce and finance proceedings, a holistic approach must be taken to ensure that an agreed settlement protects any interest in the shares arising in the future, but in a way that does not compromise a shareholder now.