Protecting Your Client's Business In Divorce

by John Joseph Schrot on Jan. 02, 2014

Divorce & Family Law Divorce Business  Corporate Divorce & Family Law  Family Law 

Summary: Business assets are a part of divorce assets. There are methods available to protect those assets.

If your married client owns a business, or has an interest in a business, breaking up is even harder to do.  A divorce can be a messy affair.  Roll a business into the equation, and divorce can become emotionally and financially devastating, not just for the divorcing couple and for their family, but also for the business employees and co-owners.  Divorce can be bad business.  Avoiding a court battle will minimize the pitfalls.  Ending a divorce is never an easy process.  When you are going through a divorce and business assets are part of the picture, dividing the marital property becomes more complicated.  But when your client owns his or her own business and decides to end his or her marriage, he or she is not just putting personal assets at risk, the entire business is at stake.  The divorce of a business owner can disseminate the fruits of years of hard work.  A spouse may never have set foot in their partner's business, but if a marriage breaks down they could still claim against the business assets, directors' loan accounts, cash and income streams, or even force a sale.  The unfortunate reality as a business owner is that planning is not just something your client should do, it is something he or she must do before he or she even considers ending his or her marriage. 

Michigan Law requires that assets acquired during a divorce be valued so that the marital estate can be fairly divided to the divorcing spouses.  Frequently, only one of the spouses operates the business, though the other may own shares.  After your client has spent years of his or her life putting effort into growing his or her business, a divorce can have a dramatic impact on his or her company's future.  In the worst case, it may be necessary to have your client close his or her business to come to a satisfactory settlement.  In the best case, the divorce will be able to take place without the performance of the company being affected, with the divorce settlement being paid over time through the continuing revenue streams of the company.  Divorce presents many issues, including whether a court will order the spouse who operates the business to transfer shares to the one who doesn't; whether a business can redeem shares held by the non-participating spouse and at what price; how much information a business must disclose; and whether the owner who operates the business must pay the other spouse for his or her marital interest in the business and how that interest is valued.  Business owners must find out how they can protect their business and separate property interest, especially so as to make sure they transfer their hard-earned income and assets to the person they want.  When your client makes the right decisions in his or her marital planning and divorce process, everyone benefits, especially your client's children and employees. 

The business is often the most valuable asset in the marriage.  This can make it the biggest bone of contention in the divorce settlement.  The division of property is usually the chief issue in divorce.  Most things acquired during the marriage are subject to equitable division, including businesses.  The actual business is retained by the owner, while the non-owning spouse is awarded her share of the value of the business.  In the majority of divorces, the business suffers because of additional costs for legal and accounting services, inattention from stressed-out, depressed, or preoccupied owners, loss of employees, loss of customers, or the failure of the owner to take advantage of business opportunities.  There may be a number of people who all have an interest in the company who will not agree to a change in structure of the company.  The court has no power to influence or to make orders in respect of third parties, and the court's options may be, therefore, limited.  There are two types of business: those that are personal to the business owner and those that are not.  For example, if your client is a licensed health care provider and has a health care business, the spouse could not be awarded this business as the license is not the spouse's license.  Your client could be required to make payments to the spouse for a period of time if the court concludes that the business was developed and made into a success during the marriage.  A non-personal business is one that could be sold to a stranger for cash.  A personal business usually does not carry any "good will value" because the good will is personal to the operator and cannot be transferred to another. 

Regardless of whether the business is an S corporation, a limited liability company, a limited partnership or even a sole proprietorship, your client's spouse has the right to have this entity valued and fairly distributed, typically in the form of a lump sum payout to the uninvolved spouse, upon divorce. 

Valuing the business is a major flashpoint of conflict.  That is because the spouse who wants to retain the business i tempted to low-ball the value while the other wants it valued as high as possible.  If divorce is imminent, remember that the business is the goose that lays the golden eggs, and no one benefits if it is killed.  The parties need to control the process and maintain avenues of communication.  Otherwise, laywers' fees can consume assets, and there may be nothing left of the business by the time the dust of divorce settles. 

Historically, the courts have been reluctant to force the sale of a business against the wish of the party who wanted to continue the venture.  What a court will not usually do is leave the shareholder with all the risk and the other spouse with all the sold risk free assets.  The approach of the courts in recent leading cases has been to treat the family business in the same way as any other family assets and as such, it can be difficult to prevent business assets being taken into account.  Divorce courts typically support the idea of a 50-50 division of all assets.  This includes any businesses.  While this may seem execessive to the breadwinner (usually the husband), if he has been the one responsible for building the company over the years, the divorce court will usually consider the contribution of the homemaker partner as being as nearly as valuable in that the homemaker has shared in the personal financial risks inherent in starting a business, and has provided emotional, moral and/or other forms of support which have aided in the development of the company even if indirectly.  Even in the most extreme and well argued cases, one is likely to get no more than a 60% share of the total assets of the family.  Unlike the strictly delineated constraints of commercial law, the legislation governing the distribution of assets upon divorce gives the family courts a wide and far-reaching discretion to divide and reallocate assets according to the particular circumstances of the case.  The principles governing the exercise of that discretion continue to be shaped through case law. 

Business owners can take a number of steps to protect their interests in the event of divorce, but at least some of the grief and expense can be avoided by taking preventive steps.  With more and more people getting divorced instead of staying married for their entire lives, it seems as though the solution might just be not to get married at all if you are concerned about defending your assets.  Even before the word divorce is uttered, business-owner clients should put policies in place to address the rights of owners, including rules that apply if an owner transfers his or her interest due to a property settlement or court order.  If a divorce is imminent, getting the right advisors for legal and business valuation advice is critical.  Your client must have an attorney who knows the client's business and also understands how to be tactful in helping both parties understand the value and importance of making mutually-beneficial decisions.  Counsel must be a knowledgeable lawyer, with common sense and an interest in helping the client solve problems rather than creating conflict.  Counsel can help the client understand the importance of a prenuptial agreement or other legal documentation in order to protect everyone involved.  Clients must concentrate on their businesses, not what their attorney is up to.  Your client's decision on the right family law attorney and/or forensic accountant is just as important as his or her decisions in the board room.  Counsel has to plan and execute business planning and/or divorce procedures with the same attention to detail as a multi-faceted business plan.  This is just as important as a company's budget.  Your client's legal counsel and financial advisors need to explore creative alternatives to help minimize disruption and protect the long-term stability of your client's venture.  If there is litigation, the strategies should contain the conflict and allow your client's business to function. 

Shareholder, operating and/or partnership agreements may contain provisions that protect owners' interests in the event that one of the owners gets divorced.  The provisions vary depending on the size and makeup of the business.  Some examples of protective provisions include: (1) a prohibition against the transfer of shares without the approval of other partners or shareholders and the right, but not the obligation, of the business or individual owners to redeem the shares or interests of one or more of the divorcing parties so that other owners maintain control of the business; (2) a requirement that unmarried shareholders provide the company with a pre-marital agreement prior to marriage that includes a waiver by the owner's spouse to be of his or her future interest in the business; and (3) a requirement that a non-participating spouse sign an agreement consenting to be bound by provisions in the shareholder or operating agreement regarding restrictions on the transfer of shares or interest.  It may contain a provision that the transfer of shares in a divorce is prohibited or that if any shares are transferred, the spouse may hold them but will not have voting rights or other power to control the business. 

If your client owns a business and is about to get married, draft a prenuptial agreement for the client prior to the marriage.  Specify that the business is your client's individual property.  While pre-nuptial agreements are not always iron-clad, a strongly constructed prenuptial agreement drafted by a competent lawyer can provide an excellent advantage in the event that  divorce occurs.  Many people are put off from the idea of getting a prenuptial agreement because they believe that it will offend the person they are in love with.  The idea of a prenuptial agreement can be a hard sell to your partner, since it seems to anticipate that the marriage will fail, however, if the person that you want to marry is truly interested in having you feel secure, you should be able to convince them to sign an agreement that protects your company specifically from being split or factored into total assets in the event of divorce, or that makes it impossible in a more general way for either party to profit from the dissolution of the marriage.  One way that it may be possible to sell the idea of having a prenuptial agreement is that, if the company has been an ongoing business concern or if you are building it in order to support members of yoru family, your resposnibility towards them requires you to have the company protected.  In this case, even though you are the one who legally owns the company, the company is considered to be something that belongs to the family.  Keep in mind that a prenuptial agreement is not all negative.  Ideally, it protects both parties, as well as their children, especially in second marriages, or in the event of the death of either the wife or the husband.  The idea is to de-emphasize protecting your property from divorce and to emphasize the important of protecting everyone's interests in the event of death.

If the parties are already married, then consideration should be given to entering into a postnuptial agreement.  A postnuptial agreement is an agreement entered into during marriage that regulates what should happen if the relationship breaks down. 

This document should provide a formula for valuing the buisness in the event of a divorce or debt, and specifically who gets what.  For people who find themselves in a marriage already and are concerned about the possibility that a divorce could split up or end the company, the outlook is not as good.  There is probably already trouble in the marriage.  Getting both parties to come to terms can be tough.  Still, there are ways that the company can be preserved.  A post-nuptial agreement is much less common than a pre-nuptrial agreement, and if the marriage is currently under stress, just asking for your partner to sign a postnuptial agreement could put on additional strain that could hasten the end of the marriage.  Another possibility that, if a divorce is anticipated, the company can be sold prior to the divoirce.  This will protect the company itself in that the company will no longer be an asset of the person directly involved in the buisness.  All that will be vulnerable during the legal process will be the proceeds from the sale, and the breadwinner can even continue to play a role in the management of the company (although it may be necessary to help pay for the divorce settlement with part of the management salary). 

A family-owned corporation may require premarital agreements and restrictions aimed at preventing shareholders from selling or giving their shares to anyone outside the family.  If the business is started up after the marriage, then it is important to build into its structure ways of dealing with the possibility of a marriage breakdown by determining how shares or interests are going to be held or through careful drafting to include the mechanism for valuing the shares and/or interests.  Try to compromise on how the business should be valued and on reasonable income for support.  That way, both your client and his spouse come out in better shape.  Make sure everyone's financial needs are addressed.  Since most conflicts ultimately center around money, take steps to cool tempers.  This can be done with trusts, as well as with life insurance.  For instance, much of the sting of a prenuptial agreement that keeps a valuable business in your client's name can be reduced with a comparable life insurance policy on your client's life, with his spouse named as owner and beneficiary. 

Furthermore, there may be ways in which you can legitimately limit your client's personal financial risk, if not that of the business, for instance by altering the structure of the business entity (such as reorganizing it as an LLC or a corporation), or even just by changing your client's work schedule.

Also, to assure that a business stays within the family if a member divorces,  consider a Family Limited Partnership arrangement.  These versatile estate transfer tools can specify that business interests are not subject to division in divorce. 

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