Businesses in Divorce

There is no standard formula for a court to apply when making an order in relation to financial proceedings connected to a divorce. Instead, when exercising its broad discretionary powers, the court is obliged to consider the statutory factors set out in the Matrimonial Causes Act 1973 and must look at the entire circumstances of each case.

If there are any children of the family, the court must give first consideration to their welfare. This means therefore that the court will ensure that any order it makes will also provide for the needs of the dependent children of the family by ensuring that there is suitable accommodation for them.

The court will also look to provide a clean break between the parties. This means that the court will attempt to sever the parties’ financial interdependence by, for example, looking to provide a lump sum rather than maintenance. Whilst the court should always consider whether a clean break is achievable, the court is not obliged to order one wherever possible.

Once consideration has been given to any children, the court will then turn to the statutory factors when making a financial order for a spouse. These include the parties’ financial resources and financial needs, the standard of living enjoyed during the marriage, the parties’ ages and duration of the marriage, any disability, contributions made to the family, conduct of the parties and potential future loss of the parties because of the divorce.

So, how does the court deal with business interests?

There are many forms a business can take, including but not limited to a sole trader, a partnership, or a limited company.

Firstly, it must be considered whether a business is a matrimonial asset. Whilst there is no hard and fast rule, a court will generally look at:

• When the business was created/acquired. A business which was ‘brought into’ the relationship may be seen as an asset which is separate to the marriage, whereas a business which was created/acquired during the marriage will be seen as a matrimonial asset.
• Whether a business created/acquired prior to the marriage has ‘matrimonialised’. That is, whether the business, despite not originally being a matrimonial asset, has become one (in whole or part) because of development during the marriage.

Many factors might lead a court to determining that a business has matrimonialised, such as:

• Whether it would be just for the court to impose the Standish principle. That is, where the parties have treated a non-matrimonial asset as matrimonial. For example, whether marital funds were invested into the business (where family money was used to keep the business afloat or develop it), or business funds invested into the marriage (business money was used to pay a mortgage on the family home or for family holidays) will give rise to an argument that the business has been treated as a matrimonial asset.
• Whether the ‘non-owning’ spouse has contributed to the business in any way, such as working for free or taking up employment in the business or taking up a homemaker or caregiver role to any children of the family to allow the ‘owning spouse’ to focus on the business.

In any event, the court will likely determine that the business has matrimonialised to some degree if it has grown and developed during the marriage. The longer the marriage, the more chance this will be the case.

It is also worth noting that where a spouse is given shares in a business so that they can receive dividends as a way of maximising tax efficiency, the spouse will be a legal and beneficial owner of the business.

Regardless of whether the court deems the business to be matrimonial, if the court determines that it is necessary to include the business on the basis of needs, the court may draw it into the pot to meet both parties’ needs.

How is a business valued?

If it is established that a business is indeed a matrimonial asset, the next issue that arises will be valuation. If a business is merely an income stream, and has no significant value, then a valuation will not be necessary. If it is a simple, low value business, it is likely that a desktop valuation can be provided. If it is more complex than that, it may be necessary to instruct a specialist, such as a forensic accountant, to produce a valuation. The specialist will look at the assets and liabilities of a business, its income (including future potential income) and market trends. A specialist will also be able to help provide information on any tax implications which might arise out of a sale or transfer of a business interest in matrimonial proceedings, such as stamp duty, capital gains tax or inheritance tax.

Once the business has been valued, the court will treat the business according to its structure.

For example, in cases of a sole trader business, it will be the value of the assets and income that the court will consider.

A limited company owned by one party will be treated as a marital asset if created during the marriage and will likely have matrimonialised to some extent even if created before.

A business owned by both parties will be considered as a joint asset and therefore the court will asset it as such when dividing up the matrimonial pot.

Where a business is owned by a group of people and a divorcing spouse is a minority shareholder, it is simply the valuation of the spouse’s shareholding which is relevant.

What if a spouse is intentionally devaluing or disposing a business?

Where one partner is attempting to dispose of or has disposed of assets to reduce the value a business interest, this will then reduce the value of the marital pot and therefore the total amount that can be divided between the parties.

In such situations, it may be necessary to obtain injunctions. In situations whereby a partner is attempting to dispose of assets, a freezing order can be applied for to freeze certain assets and prevent the party from moving or dissipating the value of their business interest. Alternatively, where assets have already been disposed of, an avoidance of disposition order can be applied for to set aside a disposition that has already been made.

What happens next?

Many business owners going through a divorce are often worried that the court will order them to sell their business or transfer their interest to their ex-spouse to satisfy their liability to them. Whilst this is an option available to the court, it is generally a route of last resort, and the courts have shown a willingness to leave business structures intact. This is because the consequences for ordering a party to transfer their business interest can be complicated and have serious implications for the business itself.

It may also provide impractical in circumstances where there is a partnership or shareholders agreement regulating the ownership of the business or where a company’s articles of association dictate how and when shares can be transferred. Similarly, where a party to divorce proceedings is a minority shareholder, the court recognises the difficulty a business will face if it orders the shares to be transferred to the other party.

Given then, that the court are reluctant to order a transfer or sale of a business, how will the court approach the situation?

Having established that the court recognises the difficulty posed by a transfer or sale of a business, the court will strive to achieve a fair result by other means.

It may be ordered instead that the business owning spouse provides lump sum, or that spousal maintenance should be paid, in lieu of the value of their business interest. It is likely in these circumstances that the court would favour a lump sum in circumstances where it believes a clean break is achievable.

The business owning party may also need to consider ‘asset swapping’ or even selling other assets of value to meet the payment in lieu of transferring a business interest.

Where the parties own the business together, the court also recognises the difficulty that may arise in the parties continuing to run the business following a marital breakdown. In such circumstances, it is usual for spouses to negotiate as to which party will buy out the other and on what terms. Where the parties cannot agree a deal, the court will attempt to determine what is fair, however in a situation whereby neither party is willing to sell to the other, the court may have no option but to order the sale of the business.

Where the parties do decide to continue running the business together, additional protection may need to be put in place by way of a partnership or shareholders agreement and/or updated articles of association to govern a potentially hostile situation.

How can you protect your business?

A prenuptial or postnuptial agreement is an agreement entered into either prior to or following a couple’s marriage which can determine how assets (including business assets) should be divided in the event of a divorce or separation. Whilst the court should give effect to a nuptial agreement that complies with general contractual principles, the agreement itself does not oust the jurisdiction of the court, and the court retains discretion as to the effect of and weight given to nuptial agreements. If the court does not believe that it is fair to enforce the nuptial agreement, it will not seal an order reflecting its terms.

As outlined previously, it is common to for small owner-operated businesses to issue shares to a spouse for tax purposes or employ a spouse to provide them with a salary. This however gives rise to a spouse arguing that they have an interest in the business, and as such they may have a legitimate claim against it. It is prudent therefore for business owners to consider the consequences of involving their spouse in the business.

It is also wise to keep business and family finances separate, otherwise a spouse may be able to claim that the two are intertwined and therefore the business is entirely a matrimonial asset.