Co-Authored by Gena Lavallee
The end of marriage can spell the end of a married couple’s business relationship.
In family businesses, particularly those owned and operated by married couples, boundaries are often blurred between the affairs of the family and the management and ownership of the business. The finances of the family and those of the business are closely tied. Although familial bonds often lead to great success in businesses, there are challenges associated with the family business structure. Well drafted, protective, contractual provisions can help keep the family business operating and allow management and employees to remain focused on the day-to-day operations of the business, particularly in the midst of an emotionally charged divorce between the owner-operators of a company.
Don’t leave the fate of your business in the hands of a family court judge. Put plans in place to retain control of your business if your marriage falters.
When a married couple owns and operates a business together and the marriage ends, the fate of their business must be decided. Ideally, decisions regarding the future ownership and operation of the business will be determined by the terms of the contract put in place by the couple when the business was started, or at some point prior to the deterioration of the marriage. Such a contract, commonly known as a shareholder, partnership or member agreement depending on whether the company is a corporation, partnership or limited liability company, sets forth the relationship among the equity holders, including their respective rights and responsibilities.
The contract, referred to in this article as the shareholder agreement, will help protect what is, in many cases, the family’s most valuable assets, and ensure the continued success of the business in the event of divorce. A family court judge will likely enforce the terms of the shareholder agreement, including terms addressing ownership and operation of the business, thereby ensuring some predictability in an otherwise potentially volatile situation.
The shareholder agreement can include a variety of protective provisions. For example, the parties can stipulate that divorce will trigger mandatory buy-out of one of the spouses from the business (the “departing spouse”). It is key to include a clear mechanism for valuing the departing spouse’s interest in the company, and for the couple to consider possible financing options to fund the buyout, particularly if the couple may not have sufficient cash on hand to fund the buy-out.
There are several ways to determine the value of the departing spouse’s interest in the business, including setting a pre-agreed formula, fixing a set price, or requiring the determination to be made by an independent third party such as an appraisal firm. The parties should consider whether and on what terms the departing spouse’s interest may be offered for sale to a third party.
Consider entering into a pre-nuptial agreement to protect your family business.
While the shareholder agreement may be entered into post marriage, an individual with a recognized family business can protect those assets from his or her spouse in the event of a divorce by adding a provision addressing the business in a pre-nuptial agreement. If you do not want your future spouse to receive a percentage of your family business in the event of a divorce, then you should include a clear provision in the pre-nuptial agreement regarding the business.
SAMPLE LANGUAGE: In the event of divorce, [husband/wife] shall not be entitled to any interests in XYZ business, including any and all income, dividends, increase or decrease in value (including any increases as a result of the pay down of a liability associated with any asset), accumulations, additions, accretions, acquisitions, purchases, contribution or distributions. [Husband/wife] shall be awarded all of the above business interests.
You also may want to include a provision that “The parties agree that the court shall not consider XYZ’s business value or assets when dividing the remaining marital property.”
In New Hampshire, pursuant to RSA 460:2-a, parties are permitted to enter into a written contract “in contemplation of marriage.” At the time of drafting, both parties must provide a full disclosure of all assets, including the business assets and its value. A pre-nuptial agreement is presumed to valid unless “(1) the agreement was obtained through fraud, duress or mistake, or through misrepresentation or nondisclosure of a material fact; (2) the agreement is unconscionable; or (3) the facts and circumstances have so changed since the agreement was executed as to make the agreement unenforceable.” Matter of Nizhnikov, 168 N.H. 525, 528, (2016); In re Estate of Hollett, 150 N.H. 39, 42 (2003).
A pre-nuptial agreement allows you and your spouse to agree to the division of the business interest; thus removing it from a court determination. If both parties agree to how the business assets should be distributed in the event of a divorce, such that one of the parties will keep the business and the other party would be entitled to buyout, then the parties should consider setting forth a value of the business in the pre-nuptial agreement and agree to a formula for the buyout of the business. Establishing the business value as of the date of the marriage is helpful because while an increase in value gained during the marriage may be subject to division, the pre-marital value of the business as separate property could be protected. You may also treat any appreciation of the business as separate pre-marital property. There are several variations on how the business interest may be treated in a pre-nuptial agreement in the event of divorce. These are matters subject to negotiation.
It is important to note that pre-nuptial agreements are only one avenue for ensuring that your family business is carried out as you and your family sees fit. Families should also consider adding stock restrictions to their shareholder and other business agreements, as previously discussed.
Courts generally do not order divorcing to remain business partners.
If co-owner spouses have not put a shareholder agreement in place or they have not executed a pre-nuptial agreement, the public policy of New Hampshire is for a family court judge to award the business to one of the parties. Absent a pre-nuptial agreement, or possibly a trust, a family court judge will treat the business as a marital asset event if only one of the spouses owns the company. Taking into account public policy considerations, the court will make determinations regarding the division of the couple’s assets based on equitable principals. Courts generally do not order divorcing couples to remain business partners. That means that the spouse most capable of operating the business will retain ownership of the company and will have his or her employment terminated. He or she will either be paid cash for his or her share in the business or receive a note payable over years, generally not over more than a 10-year period. The note may be secured by the assets of the business or a lien may be placed against the equity interests in the business until the note has been paid in full.
It is important to note that, in certain circumstances, even though New Hampshire courts have allowed deferred installment payments, the payments must be made over a “reasonable” period of time. Buyout provisions over 10 years have been found to be unreasonable. By the end of the divorce proceedings, both the marriage and the day-to-day ongoing business relationship will terminate.
Protective provisions benefit owners of family businesses under a variety of circumstances, not just divorce.
The provisions discussed in this article can benefit the owners-operators of any closely held family business. The success of the family business depends on the ongoing, positive relationship of the owner-operators. Buy-out provisions can be triggered not only by divorce, but also be deadlock among the owners, untreated substance abused or mental health issues, a variety of bad behavior, including conviction of a felony, or the death of an owner.
A multitude of other protective provisions can be utilized. For example, restrictions can be placed on the sale of equity interests in the company and the ability of non-blood relations to own interests in the company. An independent advisor can be appointed to mediate family disputes. The agreement can mandate objective and professional decision-making to avoid the problems that arise when business decision-making by family members is driven by nepotism. Advanced succession planning provisions can help mitigate family discord that often arises when a family business passes from one generation to the next. Trusts and other estate planning tools can also be used to ensure a smooth succession and deal efficiently with any possible estate tax related issues that may arise.
Corporate counsel with experience and a deep understanding of the dynamics of family businesses should be retained to draft such a contract. Each owner should also consider whether to engage his or her own attorney to represent his or her own best interests. The discussions can be difficult, but the time spent now will avoid potential problems later. There are a variety of tools available to help business owners mitigate the risk of having business decisions made for them by a family court judge in an acrimonious divorce or in a proceeding brought by disputing family members.