How Divorce Can Affect Business Ownership
Going through a divorce is often a stressful and worrisome process for both parties involved. Dividing possessions, particularly business assets, without the assistance of a well-designed business agreement can breed further resentment and legal problems if you and your spouse are unable to decide who gets what property.
If you’re a business owner filing for divorce, you need to be aware of how it can affect your company’s assets and business partners. Knowing your state’s laws, as well as taking necessary legal precautions before divorce happens, can prevent serious damage to your company’s long-term health and longevity.
Fair Market Value
Before deciding whether your spouse is entitled to a portion of your business, your attorney must first determine the company’s fair market value. For small companies, which are often closely held corporations, attorneys must consult a reputable appraiser for a written appraisal of the company’s assets.
Assembling the documentation necessary for the appraisal will not only help your attorney get an accurate picture of the health and direction of your company, but it’ll also help protect your company’s privacy and best interests. The following are some of the documents you should include:
- Corporate tax returns
- Payment records for business loans
- Property titles
Terms of Agreement
According to Pepperdine University’s Graziadio Business Review, one of the most expensive mistakes that business owners – particularly family business owners – make is neglecting to document a formal partnership agreement. Without a formal agreement explicitly defining the relationship between the business partners, including their obligations and contributions to the business, the spouses will be subject to their state’s system of corporate law (also known in some states as the Corporations Code). Each state’s system of corporate law dictates the legal responsibilities of creditors, directors, employees, shareholders and any other stakeholders of the company. See an example of the California Corporations Code here.
Lack of a formal agreement can also delay the processing of a spousal consent/waiver agreement to keep the business operating without the introduction of new business partners.
To protect your business in the case of divorce, file a spousal content/waiver along with your partnership agreement to:
- Ensure you and your business partners can run your company without obtaining your spouse’s consent.
- Issue automatic payments, rather than partial ownership, to your spouse in the event you die before the divorce is finalized. This is usually done with a buy-sell agreement, which sets the payment amount your spouse is expected to receive.
- Avoid situations where owners are forced to enter into a business relationship with your non-partner spouse in order to continue business operations.
Moreover, if your spouse demands 50 percent of your stake in the business, a spousal consent/waiver can prevent your spouse from influencing your company’s operations.
A spousal consent/waiver in the absence of a prenuptial agreement is especially helpful if you live in a community property state. Unlike states that follow a “common law” system of property ownership, community property states view both spouses as equal owners to any property, money or other assets earned during marriage regardless of who earned those assets. You can visit the U.S. Internal Revenue Service website for a complete list of community property states.
Business Income as Spousal Support
During a divorce, your spouse’s attorney may try to claim that your company’s retained earnings qualify as income for spousal support. Your company’s retained earnings count as income only if two conditions are met:
- You, the business partner, must be able to exercise control over or access the undistributed earnings.
- A court of law must conclude that you have no valid business reason to retain the earnings in the company.
If the company’s retained earnings are needed to run the business, then those funds can be excluded as income during a divorce. Corporate distributions paid to shareholders for the sole purpose of paying pass-through taxes can also be excluded as income within the context of divorce.
Unfortunately, divorce proceedings can take a turn for the worst when one or both spouses take advantage of the other due to unresolved disputes or grievances. Keep in mind that the law states business partners have a fiduciary responsibility to act in the best interests of their company. This also applies to spouses who are business partners and going through divorce.
Although you may be tempted to punish or reprimand your spouse for his or her bad behavior, your fiduciary duty as a business partner requires you to treat your partner spouse fairly in business dealings.
Disregarding fiduciary responsibilities and trying to handle disagreements outside of court will not only endanger your company, but also expose your business to punitive damage claims if you have other business partners. In community property states, even non-partner spouses can seek legal redress if you violate your fiduciary duties.
Rather than taking matters into “your own hands,” seek legal assistance to resolve outstanding disputes between you and your spouse. Moreover, a court of law can provide relief by:
- Imposing/assigning a receiver to manage your business affairs if your business cannot meet its financial obligations or is pending dissolution or facing bankruptcy.
- Issuing a temporary restraining order against the offending spouse.
- Ordering the offending spouse to pay for damages.
Ideally, marriage is meant to be a trusted and lifelong partnership in your personal and, in some cases, professional lives. Nevertheless, if you’re a married business owner, take liberties to protect yourself and your business interests in case you end up divorcing your spouse. Filing a succession plan or buy-sell agreement will help prevent the unhappy scenario of having your ex as a business partner or shareholder of your company.