The Effects of Divorce on Business

December 7, 2017

A divorce proceeding is never a pleasant situation, and is something that is rarely planned for, or anticipated.

 

It can be made particularly difficult when there are assets involved, and when a business is involved can become increasingly complex. In many cases, emotions overcome logic and can worsen the situation still.

As a lawyer, I know how rare it is for a couple to have commercial agreements in place when it comes to their business. I often hear that they don’t need the documents because they are “married and in love,” and while Pre/Post Nuptial Agreements aren’t the most romantic propositions for couples they can be necessary. When couples have been commercial in their approaches they often have a Pre or Post Nuptial Agreement, their home ownership is clearly documented and their business has a partnership/shareholders agreement.

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 are combined and (unless it can be proven that they belong solely to one person) are equally split. On the other hand, if there is a shareholding agreement in place for the business, when it was set up, it dominates the division.

Should a business decision be required, but not agreed upon, and the owners have an equal share the company could potentially be wound up. It is common for one partner to play no role in the business, but use their joint ownership entitlements to gain more from the 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, because the money had not been labelled, all assets were pooled and split equally – meaning all his extra investments were lost.

 

Three Things to Consider

While divorce isn’t something that we often want to think about, 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.

 

Protecting Assets

Assets such as property or investments may not be sold for some time, and this can prevent a court easily offering 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.

 

 

Hiding Assets

There have been several cases whereby couples have deployed different tactics to hide assets when a relationship has gone sour.

– 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 founder’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.

 

Amicable resolution

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.

 

About the author

Karen Holden is an award-winning lawyer and founder of A City Law Firm.

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