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Divorce: Considerations for the Entrepreneur

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The divorce of a business owner can decimate 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, director's loan accounts, cash and income streams, or even force its sale. 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.

It was thought better that the business be allowed to continue to operate, so it could provide a source of income in the long term. However, the approach of the courts in recent leading cases has been to treat the family business in the same way as any other family asset and as such it can difficult to prevent business assets being taken into account.

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.

The overriding principle guiding the courts in deciding how matrimonial assets should be divided was set out in the landmark divorce case of White v White in 2001. This case established the principle that although both parties may make different contributions to the marriage, those contributions should be considered equal.

The role of homemaker is therefore considered no less valuable than that of the breadwinner. This is especially true of long marriages.

Subsequent leading cases have clarified that the starting point principle is that matrimonial property should be shared in equal proportions. In the absence of compelling reasons why this approach should not be followed, it could mean a 50-50 division of all assets.

The resolution of most court applications relating to financial matters on divorce is a two stage process. First comes the exercise of gathering the financial information and ascertaining the facts and figures.

Secondly, the relevant legislation and case law is applied to formulate a range of possible settlement proposals. A resolution may be achieved through mediation, collaborative law, negotiation through solicitors or through court proceedings.

The information gathering stage can be particularly complex when business interests must be valued. Depending on the size and complexity of the business, accountants may need to be jointly instructed to investigate the open market value of the business, future profitability, the value of the parties' respective interests, whether funds can be extracted from the business and the tax consequences of doing so. If neither party can agree on the outcome of the valuation, further evidence may be required.

When it comes to funding a final settlement, the party wishing to continue the business may need to consider transferring a larger share of non business assets to the spouse to offset that against the spouse's interest in the value of the business, but consideration should be given to the fair sharing of risk and illiquidity. It should also be noted that it can be possible to negotiate that any capital lump sum is to be paid in instalments.

If there are insufficient liquid assets, aside from the business itself, to satisfy a spouse's claims then it becomes necessary to consider whether and how the liquid assets of the business can reasonably be made available in a tax efficient manner. 

If there are insufficient liquid assets either within or outside the business, the business may be vulnerable.  

So what can be done?

We all take out insurance against things we hope will never happen, so why not have an agreement to deal with the possibility of marriage breakdown? When a court is asked to decide how matrimonial assets are to be divided between estranged spouses, the court must "have regard to all the circumstances of the case, first consideration being given to the welfare while a minor of any child of the family who has not attained the age of 18".

The provision of "all circumstances" can include the existence of a prenuptial agreement. Contrary to popular belief, prenuptial agreements are not binding in English law, although the court will consider it and decide in the circumstances what weight should be attached to the agreement.

Prenuptial agreements will hold more weight if both parties are properly advised when the agreement is drawn up, if they both understand the terms of the agreement, give full financial disclosure, were not subject to any pressure to sign and if the agreement is signed at least 21 days before the date of the marriage. 

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

A recent Privy Council decision confirmed that post-nuptial agreements are enforceable and will only be interfered with in very limited circumstances. Pre-nuptial agreements may be converted into a post-nuptial agreement to ensure that they can be enforced in the courts.

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, for example in a Partnership Agreement, by determining how shares are going to be held or through careful drafting of the articles of association to include the mechanism for valuing shares.

It is important for a business owner to ensure that the company books and records are run independently. If historically, the owner has been able to draw substantial benefits from business on a whim, court will assume that benefit can continue and the business is therefore more likely to be drawn into the matrimonial 'pot' and be made available for division.

Conclusion

The court has become much more likely to make orders which could ultimately demand that a family business is sold in order to meet one party's liability to another. Consequently, one can expect lawyers to concentrate on the value of family businesses and how those businesses could contribute towards any capital settlement fund.

Given the developments in divorce case law with regards to business assets, it is advisable that any business owner contemplating marriage or divorce should seek specialist legal advice at the earliest opportunity.

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