Securing Your Business Assets: Key Strategies for Entering and Exiting A Marriage: Part 2

Protecting business assets when exiting a marriage

So, what might happen if, unfortunately, your marriage breaks down and there is no nuptial agreement?

There are a number of things that a court would want to consider when determining how business assets should be divided and reflected in a fair financial settlement:

Valuing the business

• It is important for the court to understand what a business is worth, what income it can produce, whether it should be producing more, the liquidity in the business and whether there are assets realistically available for distribution. Specialist tax expert advice may be sought as well to work out the most tax efficient way of extracting funds.
• As part of the disclosure process, business interests will need to be valued. This can be a complex exercise and usually a Single Joint Expert (SJE) (often an accountant who specialises in valuing business and financial assets) would be appointed by the court to conduct the exercise with both parties having conduct of the instruction.

Valuation process

• As part of the disclosure exercise, a business owner is expected to provide all relevant financial information regarding their business in a Form E (a financial statement for the court). Not only should owners be transparent with the SJE about their predictions for the business and assumptions surrounding future performance and income but also potential liabilities need to be declared.
• There are a number of documents that will need to be provided to include management accounts, forecasts, recent sales and profit figures and minutes of board meetings.
• Once the SJE is instructed and conducts their analysis, they will provide a short report for the court. Both parties can raise questions on the findings including the methodology used. Business valuations can vary depending on the sets of assumptions the SJE relies on.

However, it is important to note that a SJE valuation is just a guide for the court rather than an absolute and the court retains absolute discretion over the value it might ascribe to a business.

The matrimonial and non-matrimonial nature of business assets

Business assets which were acquired prior to the marriage and then kept entirely separate throughout the marriage are unlikely to be treated as matrimonial in nature unless required to meet one party’s needs. If business assets have been acquired or built up during the marriage then they may be considered to be matrimonial in nature and the starting position would be an equal sharing of those assets.

Careful consideration should be given to the work undertaken by the business owning spouse pre-marriage and post-separation and what difference this has made to the business and therefore its value. A spouse could be accruing post-separation non-matrimonial assets immediately from the point of separation.

The passive growth in a business could be argued to be a part and parcel of the matrimonial element of the business, for example, a wife supporting her business owning husband to pursue his business endeavours throughout the marriage. Therefore, assessing what is matrimonial and non-matrimonial in nature is absolutely vital in cases involving businesses, as the non-business owning spouse may have a weaker claim against the value of the business, in circumstances where the value was generated prior to the marriage or following their separation.

The court’s approach and what the court can order

Family judges have much discretion when determining the division of assets – they can take either a formulaic or broad-brush approach. It is usually not a black letter accountancy exercise – which may be a surprise to some. The court applies the concept of what is fair – and the court is not restricted to a single way of determining what is matrimonial and non-matrimonial.

If the court determines that one party has made or will be making significant contributions post-separation towards increasing the business value before its sale then that might result in a greater share to that spouse.

The court is unlikely to order a company to transfer or sell assets because such assets are owned by the company and not the spouse. The court is also unlikely to order a sale of the business altogether as this may well destroy the parties’ future income, although this is dependant on the facts of the case.

Some potential options the court might consider are:

• Wells Sharing – This is a concept following the case of Wells v Wells which involves dividing the assets in specie to provide each party with a share of illiquid and liquid assets, applying a discount to illiquid assets or minority shareholdings. It does mean that both parties would hold shares in the business after the marriage has ended but both parties would share in the ups and downs of the business going forward and share the risk.
• A transfer of shares between parties – Shares in a limited company can in theory be transferred as they constitute property under the Matrimonial Causes Act. In rare circumstances, the court can award a non-owning spouse an award in shares – this is not an ideal outcome as the parties remain tied to each other (contrary to the “clean break” principle) but this remains an option if it is very difficult to value the business or it is entirely illiquid.
• Offsetting against other non-business assets – Commonly, one party will retain the business and the other will receive a lump sum to reflect the value of their share or a deferred lump sum equal to a percentage of the net proceeds of a future sale. This avoids an actual transfer of shares but gives credit for the potential that shares could be worth more in the future.
• Some more creative solutions – It might be preferable to defer lump sums payable to the non-business owning spouse and for the figures to be based on future performance or for any lump sum to be payable in instalments as this will allow for the possibility of variation in the future if needed and could help manage risk.

Company law considerations

Before agreeing to any settlement or submitting a draft order, it is crucial to consider the provisions in the business’ constitutional documents as they may already set out procedures that apply in the event of a marriage breakdown. The process, timings and the pricing for share transfers may already be determined in these documents.

For example, a company’s articles of association or shareholders’ agreement may stipulate that on the issue of a Final Order in divorce, shares held by a spouse for tax planning purposes must be transferred back to the original shareholder. The transfer price may be a price to be agreed between the parties and if not agreed, may be set on e.g. market value. In certain circumstances, the transfer price may be set at aggregate nominal value or at nil value.

Where the transfer price is tied to market value, the articles may also typically outline the valuation mechanics specifying who the valuer will be and the factors the valuer should consider such as the business being carried on as a going concern, the sale being at arms’ length, and whether minority discounts should apply.

The articles may also include pre-emption rights, requiring shareholders looking to transfer their shares to first offer them to the company or to the existing shareholders before transferring them to a third party.

If these constitutional documents are overlooked during settlement negotiations, complications may arise. Implementing orders could be more difficult if pre-emption rights are triggered or the price on certain transfers are fixed. Any attempt to vary the existing provisions may also require the consent of other shareholders or the board of directors of the company, creating additional hurdles to navigate.

Whether entering or leaving a marriage, it is important that both family and corporate advisors collaborate closely to ensure that a party’s commercial and financial interests in their business assets are safeguarded to the fullest extent and that is very much the approach we take at KN.