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Will your business be safe from the rigours of marital collapse?

Michael Drake is co-author of Divorce and the Family Business, published by Jordans

Divorce is not only a major personal trauma, it can also be amplified by the complexities and sensitivities surrounding settlements. Michael Drake suggests that although unpredictable, it is possible for the outcome to be satisfactory to all affected parties

A High Court judge pronounced in 2001: "The court must be creative and sensitive to achieve an orderly re-distribution of wealth. Those old taboos against selling the goose that lays the golden egg have largely been laid to rest. Nowadays the goose may well have to go to market, but if it is necessary to sell her it is essential that her condition be such that her egg laying abilities are damaged as little as possible in the process."

The judge was concluding, and ordering, that a long established and successful family business developed and run largely by the husband would have to be sold off in order to meet the wife's financial claims in the context of divorce. He allowed a three-year period of grace for the husband to raise the funds, although the circumstances suggested that this would be an extremely difficult task; fortunately it was not the only business that the husband relied on.
 
In the past four years or so there has been uncertainty within the legal profession about how the court will distribute family assets on divorce. As a result it has been difficult for lawyers to advise their clients accurately about the likely outcome of cases. The family business has in the past been protected by the court relatively sympathetically, but in the current climate, where equality is now the rule rather than the exception in marriage, a divorce can be a threat to a business.

Breaking up is hard to do
If the business may have to be sold to achieve, then the court will have to consider the scope for realising sufficient value on a sale, or decide whether settlement funds can be raised in some other way. It will also need to assess the consequences for the family if the "goose has to go to market".
 
The first step may well be an investigation of the finances and structure of the business. It may be necessary to establish the value of the business, the level of income and benefits flowing from it the real value of business properties, stock, goodwill, brand names or other assets, the reliability of the information provided in the audited accounts, the workings of the company pension scheme, the likelihood of a future sale or floatation, and the options for raising funds from the company to buy out the other spouse without damaging the cash flow and capital base. The court will often appoint a single expert accountant to provide an independent report on the relevant aspects of the business while each client will have a lawyer to investigate the surrounding facts and circumstances and make sure that everything has been disclosed.
 
After this detailed and confidential procedure it will be necessary to decide how to treat the business in the context of the divorce. It is rare for the court to allow the break up of an established family business that is providing for the entire family. It will however still have to consider whether the husband and wife can continue to work alongside each other in the business, what other ways there may be of separating their business interests in the context of divorce, and how their involvement and contribution to the business should be reflected in the financial settlement between them.
 
Alongside this, the owners of a business also have to take into consideration the potential impact of their matrimonial upheaval and the investigation. This can affect not only other directors, partners and employees who may become uncertain of their prospects, but also customers and bankers, who will worry about the future of the business.

Share of assets
A variety of legal issues can arise. The lawyers must appreciate that their clients may be shareholders or partners, executive or non-executive directors, employees, investors or mortgagees, or indeed creditors. Clients may wear several or indeed most of these hats at different times and each role has to be understood and addressed carefully. The following example illustrates the type of issue that can arise. The wife had submitted forcefully that her additional role in making substantial and formal personal loans to the family business, alongside her role as a shareholder, entitled her to a greater share of the assets on divorce and she had produced detailed evidence in support, but to no avail. "It was in her interest to assist the company," said the judge. "Not an exceptional contribution," he added.
 
Some of the questions that need to be borne in mind in addressing these problems are not obvious. Have all employment protection rights been properly respected in the separation and divorce? Have the other benefits, pension rights and  share options also been understood and resolved? Has the resignation or removal of officers been dealt with? Is there a shareholders agreement in place or a suitable memorandum and articles or is a new one required to reflect the revised arrangements? Are the banking arrangements, guarantees, leases and other continuing liabilities and obligations identified and resolved; have indemnities or releases been provided where appropriate? If the parties are continuing their business roles has agreement been reached over the arrangements for board meetings, shareholders' meetings, the signing of accounts, and the circulation of information?

Against this background the court has been developing a wide menu of solutions to difficult cases. A typical problem can involve a family where a spouse's entitlement is to an equal share of the family assets, and where those assets are represented to a significant degree by the value of the family business, which may be providing for the family. To achieve fairness the court is faced with the problem of having to apportion a share in the family business to a spouse who have may no interest or involvement in it while maintaining the equilibrium – and the income. That can cause not only legal and logistical difficulties, but major commercial problems too.

Borrow, restructure or sell
In the case of the goose laying the golden eggs the judge gave the husband three years to borrow, restructure or sell the business, providing for staged lump sum payments during that period. In another case the judge ordered a transfer of a shareholding to a wife for her to hold on certain defined terms; such an arrangement is usually ring-fenced with an appropriate shareholders agreement and provisions concerning the requirement for co-operation in the event of a sale acquisition or merger.
 
In yet another case, the husband was left with the risk and responsibility of running a business that was by no means secure; in compensation he has awarded an increased share of the liquid assets, but to ensure a fair balance his wife was left with an opportunity to re-apply to the court if the subsequent success of the company justified it.
 
The court also acknowledges that assets fall into different risk categories. Funds in a deposit account are secure and defined; so are most pension funds; property is a reasonably secure investment and will sell at a relatively predictable price. In contrast, shares in a private family company (or even in a quoted company) may be far less predictable. Accountants will argue about their true current value, and proprietors will question projections of their prospects.
 
The court increasingly seeks to divide assets fairly, not simply as to hypothetical value, but as to risk level. In that context it will not necessarily leave one spouse solely with the shares in the business, and the other with a property and a pension fund, if it feels that this is leaving one of them with an unfair burden of uncertainty and risk. Having said that many spouses would rather take that risk, believing confidently that they can move the business forward, and would prefer to do so without their former spouse retaining a shareholding in it. In contrast, some spouses are deeply suspicious that once the divorce is over, the other will sell or float the company for a huge profit, and they will miss out.
 
Thus against this background the court has to design its solutions in ways that will reflect the fairness of value and risk, meet the needs of the family, and protect against uncertainty as best it can. Its role in analysing the issues and deciding on the appropriate order to make is a challenging one. It has to form a view of the value and structure of the business, decide in the context of legal thinking what would be a fair settlement for the departing spouse, and then look carefully to see whether it is necessary or possible for a realistic settlement to be funded without damaging the business. If a sale is not feasible then it will have to explore other options.
 
This is an especially delicate process if the family business is providing the income to maintain the family. It can be a difficult balancing act, and it is still by no means a readily predictable one. 

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