Dealing with a divorce is stressful at the best of times, but matters can become very complicated where one or both of the spouses are shareholders in a family company. The divorce can cause uncertainty amongst the wider family members and cause instability for the company. A basic understanding of how the company shares could be treated within the divorce can help the family to pull together to protect the company.
How are assets treated in divorce?
The shareholding will be one of the assets of the marriage. They can and often do form part of the assets to be divided between the couple. Generally, the net value (after deducting notional tax and costs of sale as if there were to be a disposal) of all assets are ascertained, regardless of how or when they were acquired. The court will then consider how best to divide the global value to achieve its view of ‘fairness’.
How is the shareholding valued?
Depending on the nature of the Company, there is often a ‘single joint expert’ valuation of the shares. Whilst the view of the company accountant may be helpful, the non-shareholder spouse will often require an independent valuation due to the subjective nature of valuations. If the parties cannot agree who should value the company shares, the court can make orders specifying whether a single joint expert should be appointed, identify them and specify the nature of the report required. The valuer will consider which method of valuation should be used and can address issues such as the value of the company, what discount should be applied to a minority shareholding, the tax likely to be due on sale or transfer of shares, whether any funds can be extracted from the company and likely dividend income.
How will the court address the shareholding?
The court has far reaching powers when dividing assets on divorce. In the context of a family business, the court can order sale or transfer of shares. However, this is often not the best outcome for the company or the non-shareholding spouse! The company is often the source of the couple’s income. The court can order the shareholder to pay a lump sum to their spouse, based on the report as to liquidity within the company by the single joint expert. It can order that the non-shareholding (or departing) spouse receive more of the other assets owned within the marriage to offset the shareholding. Frequently there is a series of lump sum over a set period of time, rather than a single lump sum if that cannot be afforded. In very limited circumstances, the spouses may continue to own shares between them after the divorce, perhaps with the assistance of an independent Director to protect their respective interests.
The approach adopted by the courts will depend on the overall circumstances of the case. For example, in a short childless marriage where the shares were owned prior to the marriage the value in the business may well be ignored, depending on the other assets available. In a long marriage, where the company was started or grew substantially during the marriage, the value of the business may play a more central role.
How do we protect the shares?
Transferring shares to a third party in order to avoid a financial claim against them is likely to make the divorce more complex. The court has the power to overturn such a transfer and to make adverse inferences as to the timing of the transfer of the shares. Courts take a dim view of this behaviour and it rarely ends well for the original shareholder. The court can also make adverse inferences where it is found that assets have been transferred out of a company without justification.
The best protection is to act early, before the shareholder(s) marry or whilst they are happily married. In the context of a wider family company, a shareholders agreement can persuade the court to value the shareholding in the context of that agreement. A pre-nuptial agreement before the shareholders marry or a post nuptial agreement being a condition before shares are transferred to family members can be very effective in protecting the company.
Obtaining legal and accountancy advice early can be invaluable. For example, if assets (including company shares) are transferred between spouses during a marriage or in the tax year of their separation, they can generally be transferred for ‘no loss no gain’ for Capital Gains Tax purposes. The latent CGT passes with the asset. Outside the tax year of separation, transfer can and often does trigger payment of CGT which can cause real issues with liquidity in many divorce settlements. Getting the timing of the separation right can be very helpful in mitigating tax.
It is imperative that a court order is obtained within the divorce to protect the company against future claims by the non-shareholder spouse: A divorce does not automatically sever the spouses’ financial claims against each other during their joint lives or on death without a court order providing for a ‘clean break’. Our Family team are on hand to assist with any queries you may have regarding this.
For further advice in relation to the practical first steps in the divorce or separation process, please contact Emma Brunning on 01245 211330 or [email protected]. Alternatively, please contact another member of the Birketts Family Law Team.