What happens to your business interests on divorce?
Business interests can form a significant part and be a central focus within divorce proceedings. They are often the most valuable asset and, as such, receive the greatest amount of attention. Equally, they are often the most complex asset too, and a great level of skill and attention is required when determining what is to happen to them.
Whether you or your spouse own a business outright, or a shareholding within a business, distributing those interests as part of any financial settlement creates many problems. A liquid resource like a bank account, for example, is easy to divide. On the contrary, business interests, as illiquid resources, are not.
Valuing the business
First and foremost, it is necessary to undertake a valuation exercise in relation to those interests, as part of the process of quantifying the totality of the matrimonial resources that are available for distribution. Valuations of business interests, like businesses themselves, come in all shapes and sizes, with different methodologies being used, depending on the nature of the business. As with all valuations, it is a purely hypothetical exercise; its true valuation can only ever be realised upon its sale, and hence valuations are, by their very nature, imperfect.
The company accountant will assume an important initial role, assuming the spouses are happy to use them to provide their thoughts on a valuation. As they are likely to understand the business the best, how it operates and how it has been performing, it would be worthwhile and sensible to engage them early in the process, to get an idea of what a likely valuation is. They will also be able to advise on liquidity, methods of extracting funds from the business if needed to fulfil certain terms of any settlement, and the various tax consequences that come into play. Having your solicitor and company accountant working in tandem from the outset, if you are the owning spouse, will be of huge benefit.
However, it is not always considered appropriate for the company accountant to be approached to provide a valuation, and, in those instances, a wholly independent expert can be engaged instead. This can be done either voluntarily (if the spouses are exploring negotiations and settlement options outside of court proceedings), or by an application for the court to appoint an expert (usually a single joint expert) within proceedings.
Any application will need to be made before the first court hearing (the First Directions Appointment) that has been fixed as part of those proceedings. The procedure and what is required for this application are set out in Part 25 of the Family Procedure Rules 2010, and its accompanying Practice Directions, all of which provide for a number of important, key steps to be taken in anticipation of instructing an expert.
A valuation will look at a number of factors, such as the quantity of shares held, the class of shares held, the accompanying voting rights, any restrictions within the company’s incorporation documents and/or shareholders agreement, and the available market for the sale of the shares. There are several potential nuances to a particular shareholding, each of which could affect its value.
Orders the court can make
Transfer of shares
If shares in a business are owned jointly by the spouses, whether in equal or unequal proportions, whether the same or different class of share, and whether there are other shareholders or not, one of the first considerations will likely be transferring all of the shares into one spouse’s name, and how that should be achieved.
Naturally, the transferring spouse will want to ensure that they are adequately compensated within any settlement for the loss of that asset, and a significant level of reliance will therefore be placed on the expert valuation evidence that will have been obtained. That evidence should hopefully ensure that both spouses are happy with the ‘trade-off’ that will take place.
One key consideration if there is to be a ‘trade-off’ within the settlement is the element of risk associated with a valuation for the business against the other resource(s) the transferring spouse will be receiving instead. For example, if a transferring spouse is to receive, say, a greater share of the equity in the family home, this will be considered much more secure and certain than the spouse who retains the shares, whose interest is likely to have been calculated based on future performance of the business and hypothetical assumptions that have been made. A like-for-like distribution of those assets may therefore be inappropriate. A distinction has famously been drawn in case law previously between ‘copper-bottomed’ assets versus ‘risk-laden’ assets.
It would be rare (although not inconceivable, nor impossible) for the court to order one spouse to transfer some of their shares to the other, if that spouse is the sole owner of the business. The court is under a duty to consider a clean break at the earliest opportunity, and an order of this nature would run contrary to that fundamental principle.
Furthermore, there would likely be unnecessary and avoidable tax consequences in achieving this (especially if the transfer took place outside the financial year in which the spouses separated), and retaining a financial tie that connects the spouses moving forward is fraught with risk and danger, as it opens up the potential for ongoing conflict and litigation.
So, whilst this is one option that is technically available to the court, it is unusual for it to gain much traction.
Lump sum payment
If one spouse wishes to retain their business interests, or have their spouse transfer their shares to them, there will naturally need to be a reflection elsewhere in the settlement in favour of the other spouse. This is typically accommodated with a lump sum order or an order for maintenance.
The lump sum payment may derive from other resources, or from the business itself if the other resources are insufficient in value. If the lump sum is to derive from the business itself, a key consideration will be its liquidity and the ability for the spouse retaining those interests to pay any lump sum.
It should be noted that the court is able to be a little more creative in these circumstances by, for example, providing for a lump sum to be paid in instalments over a number of years, and deferring any clean break between the spouses until such time as all instalments have been paid, to provide the spouse receiving the lump sums with a degree of security.
As alluded to above, the court may also require the spouse retaining ownership to pay the other maintenance, either as part of, or separate to, a lump sum order. There are separate legal arguments and considerations around spousal maintenance (it is an income claim, after all, whereas a lump sum in this context is obviously a capital claim), but it is possible, especially where liquidity is an issue and/or the business is largely considered income-generating in nature, for the court to award the non-owning spouse with a degree of ongoing maintenance.
There is always a danger the spouses will look at the business interests only as an asset, rather than what sort of resource it has been for the family, and it will continue to be moving forward. If it is more income-generating in nature, it will be better viewed through the lens of any potential income claims, and how the business’s revenue going forward can be used to meet the spouses’ needs.
Sale of business
Ultimately, the court can order that the shares be sold, and provide for how any tax liabilities arising from the sale should be met by the spouses, and how the proceeds of sale should be divided. This is not a decision that is reached lightly, and would be something the court would be keen to avoid.
In the unlikely scenario that the court decided the business should be sold, it will, more often than not, usually try and include a provision for the owning spouse to buy out the other spouse’s interests (similar to the above in relation to making a lump sum order). It will also likely give the selling spouse time in which to sell the business interests, to ensure the maximum sale price can be achieved (or as close to it as possible), as opposed to a fire sale at a much reduced value.
The information contained in this post is for general guidance only, and does not constitute legal advice. For bespoke and tailored advice in relation to your personal circumstances, please do not hesitate to get in touch.