Published in Portsmouth Herald (3/8/2020)
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, 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 a 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. 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 (“shareholder agreement”), will help protect what are, likely, 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 a 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 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.
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).
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.
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. 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. The other spouse will be paid cash for his or her share in the business or receive a note payable over years, generally not 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.
Gena Lavallee is an associate in McLane Middleton’s Corporate Department. She can be reached at (603) 628-1387 or [email protected]. Jacqueline Leary is an associate in McLane Middleton’s Litigation Department and is vice chair of the firm’s Family Law Practice Group. She can be reached at (603) 628-1178 or jacqueline.[email protected].