How would your business assets be dealt with on divorce and how can they be protected?
When considering divorce finances, it is often difficult to determine a fair way of splitting business assets. This article explores how shares in private limited companies or interests in partnerships are typically dealt with on divorce, and the pre-emptive arrangements you can make to protect your company in the event of divorce.
The starting point in financial proceedings on divorce is for each party to give “full and frank” disclosure of all of their assets, with a view to having a clear picture of the matrimonial pot which is available for distribution. The ownership of a business (if a partnership or LLP) or the parties’ shareholding(s) in a company will usually be included within the pot of assets that are available for sharing unless they are non-marital assets. Non-matrimonial assets include those established before the marriage (although growth in the value during the marriage may need to be included) or after separation. It may be possible to argue that these assets should not be available for division between the parties and excluded from sharing.
The general principle is that the martial assets will be divided equally amongst the parties, although there may be a departure from an equal split for a variety of reasons, for example to enable the parties to meet their needs.
Valuing the Company
It is sometimes necessary to obtain a valuation of the business and it is common for parties to jointly instruct an independent accountant to value the business. Whilst the parties may be able to agree on a value based on the most recent business accounts, it is often recommended to obtain a professional valuation.
However, the Court will sometimes disregard an expert’s valuation if there is a broad variation of possible valuation methods, where the main value of the business is an income stream or where the value is theoretical. The variation between the valuation figures produced by the experts appointed by each party in the recent case of E-v-L EWFC 60 (Fam) demonstrates the subjective nature of valuing a business, particularly private limited companies. In this case, the Court determined that it would not be “hidebound by pure valuation theory” and would instead make a “broad analysis of fairness”.
Despite the challenges outlined above, it is important to have an agreed value for businesses owned or part owned by the parties in order for the parties to be fully advised in relation to any agreement they may reach.
What Kind of Orders Can the Court Make?
Transfer of interests in the business
The Court has the power to order the transfer of shares from one party to another. This is more common in cases where both parties are the only shareholders in the company (or the only partners in a partnership) and the parties are seeking to achieve a ‘clean break’.
However, where the interest in the partnership or shares in the company are held by the spouse who is actively involved in the running of the business, it is unlikely that the Court will order the transfer of shares to the other party. If the ‘uninvolved party’ also holds a share or shares in the partnership/company, the Court is likely to order that the interest/shares be transferred to the other party.
Lump Sum Payment
If only one party holds an interest in a business or shares in a company, the Court may look to place a capital value on the interest/shares, perhaps reduced to account for uncertainty and illiquidity. The party not holding the interest/shares may then retain other capital assets or savings, or be awarded a lump sum payment to offset the other retaining their interest/shares.
Order for Sale
If there is insufficient capital to offset the interest/shares being retained by one party, the Court can order that a business or shares in a company are sold. However this is rare, especially if the business is one or both of the parties main source of income. If there are other genuine connected shareholders the Court is highly unlikely to impose a sale given the risk of costly commercial litigation from other shareholders.
Piercing the Corporate Veil
Although the Court has the power to order the transfer or sale of a business/shares in a company, as set out above, this only applies where the interest/shares are held by a party to the marriage. If the interest/shares are owned by a company (or other corporate vehicle), even where the company is under the sole control of a party, the Court does not have the power to make such orders. This is because a company is a separate legal entity and is not technically a party to the proceedings.
However, there are rare circumstances in which piercing the corporate veil may be justified. Examples include: the case of Petrodel v Prest, in which the Court held that the assets in the company were held on a bare trust for the husband so that he had an entitlement to them; and the case of Akhmedove v Akhmedov in which the Court found that the husband had deliberately attempted to evade the enforcement of a financial remedy order by concealing assets in a complex web of off-shore corporate entities.
How are the Shares Governed?
For private companies limited by shares, the company’s the articles of association establishes and governs the basic day-to-day management and administrative structure of the Company, and the shareholders may also enter into a shareholders’ agreement (a private agreement between the shareholders, and sometimes the company is a party too) to supplement the provisions appearing in the publicly filed articles of association. The provisions typically provided for in these documents include:
- setting out the respective rights to each class of shares (if more than one);
- the procedure for the issue and transfer of shares, including:
- the restrictions on shareholders’ ability to transfer their shares;
- pre-emption rights entitling other shareholders to have the right of first refusal prior to the shares being transferred to a third party (such as a spouse);
- provisions to compel a spouse that has received shares in the company as part of a ‘Permitted Transfer’ or for tax planning purposes to transfer their shares back to their former spouse in the event of a divorce;
- the inclusion of “Drag” and “Tag” right so that a shareholder with a certain percentage of shares can force other shareholders to sell their shares (Drag rights) or compel a majority shareholder selling their shares to procure the third party purchaser makes the same offer per share to the minority shareholders (Tag rights); and
- a shareholders’ agreement might include a list of key decisions that a certain percentage of shareholders must agree in advance – then all shareholders (some or all of whom might be directors of the company) are to procure that the company does not take action on those key decisions (which might include the declaration of a dividend, selling key assets and so on) unless the requisite number of shareholders agree;
- provisions to compel shareholders to transfer their shares in certain circumstances – eg on the death or the shareholder, or if they breach the terms of the shareholders’ agreement or cease to be a director/employee – the inclusion of compulsory transfer events will usually mean that there is a mechanism set out in the articles of association and/or shareholders’ agreement for valuing the shares, which might include specific provisions around the methodology for valuing that particular business or the particular shares due to the reason for the compulsory transfer and/or provisions around discounts/premiums for minority/majority shareholdings; and
- proceedings for shareholder and director meetings (including voting powers).
Partnerships and limited liability partnerships (LLPs) can have similar agreements between business owners to govern how the business will be run, how money is extracted from the partnership/LLP and paid to the partners, and how or when the partners can retire/transfer their interest in the partnership/LLP (including provisions around how their interest would be valued). If there is not an agreement in writing between the partners, provisions of the Partnership Act 1890 and the Limited Liability Partnership Act 2000 will apply – which these are the legislative backstops to how partnerships/LLPs are to run, these are unlikely to be wholly suitable for businesses without amendment, so an agreement is strongly recommended to avoid the legislation applying in its entirety.
Given the significant importance of a company’s articles of association and shareholders’ agreement on defining how shares in the company are dealt with (and similarly for partnership/LLP agreements for regulating interests in partnerships/LLPs), any transfer of shares in the company or transfer of interest in a partnership/LLP contemplated by the Court will always be subject to the provisions of the relevant constitution documents and agreements between business owners (if one exists). Therefore, to avoid the likelihood of the Court imposing its power to sell or transfer the ownership of interests/shares in the business from one spouse to another, a company’s articles of association and shareholders’ agreement and a partnership/LLPs agreement between partners should be appropriately drafted to ensure the various eventualities of a divorce are provided for and clearly set out the process of how a spouse’s interests/shares will be transferred or dealt with prior to such events taking place.
It should be noted that although a company’s articles of association is a publicly available document because it is filed at Companies House, a shareholders’ agreement or partnership or LLP agreement is a private document, and such agreements often include a confidentiality clause. Such private and confidential agreements should, however, be disclosed within divorce proceedings.
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