Families in business: what happens on relationship breakdown?
What steps that can be taken to limit the potential damage that relationship breakdown can have on a business?
In his recent article Weightmans’ Partner, Andrew Cromby, explores the difficulties that can arise when friends and family go into business together. He rightly points out that it is not necessarily what the parties do – but rather what they don’t do – at the outset of that business relationship that causes problems when fractures appear.
This articles continues that discussion, and explores the steps that can be taken to limit the potential damage that relationship breakdown can have on a business – whether a relationship breakdown between two owners of a joint business venture, whether they own the entirety of the business or with third parties – or between a business owner and their spouse/partner, or the next generation(s).
A business must always plan for contingencies. Protection must be considered for all of those with stakes within the business who may or may not be family members.
The joint business owners
In this scenario, the parties are the sole owners of their business, whether in equal shares or unequal shares.
Divorce (or Civil Partnership)
If they are married, the Family Court will consider all the resources available to the couple and award a fair and reasonable financial settlement, depending on that family’s circumstances at the time of the divorce.
But what happens to the business? The court will assess how the shares (or partnership interests) are held, and what documentation there may or may not be regulating what should happen in the event of a dispute. Do the Articles make provision for compulsory transfers of shares in the event of relationship breakdown? Is there any provision for valuing a shareholding? What are the parties’ future plans for the business? Is it realistic to expect both parties to continue to work together in the business? If so, what protection might be required? At that point, revisions to Articles, or the preparation of Shareholders Agreements might be discussed, together with Directors’ Service/employment contracts, if not already in place.
As a corporate vehicle is a separate legal entity to that of its owners, on divorce the Family Court will generally respect the express terms of any Articles/Shareholders Agreement. However, if it is solely owned by the parties, transfers of interests could still be made.
The underlying economic value of shareholdings will still be taken into account when assessing the resources available to distribute between the parties unless alternative provision has been provided for under the terms of a pre or post-nuptial agreement or cohabitation agreement as explained below.
If a couple are unmarried and their relationship breaks down, the Family Court does not have the wide discretion to order a fair settlement that it has on divorce.
Instead, assets and resources are divided in accordance with ownership, which in the case of shares within a business, would be regulated by the shareholdings, and in the case of a partnership, divided in accordance with partnership law principles.
In the event of a dispute, the commercial court could be called on to regulate matters in accordance with the governance documents (or lack of them).
If only one party held a shareholding/partnership share, they would retain that interest?
What steps could have been taken to assist this couple?
If there is a company structure, the parties should clearly define their shareholdings, roles and obligations to the company in a suite of governance documents including bespoke Articles of Association, a Shareholders Agreement, and Director’s service/employment contracts. It may also include a Family Charter.
If there is a partnership structure, a Partnership Agreement should be prepared.
Pre or post-nuptial agreements or cohabitation agreements should also be explored, as explained below.
Business ownership with third parties
Supposing one – or both - of a couple hold business interests with one or more third party. The couple’s relationship breakdown could have a significant effect on the business, at best resulting in business interruption/disruption whilst matters are resolved.
From a business perspective, the prospect of a divorce for a key player or shareholder can cause great concern, with implications for all of those involved within the business.
The business itself will come under considerable scrutiny and is likely to be valued by a jointly instructed forensic accountant appointed by the divorcing couple. The value of the shareholding of the divorcing shareholder(s) will also be valued. The accountant will give an opinion as to what valuation method is most appropriate and will also advise on the tax consequences of the shareholding being transferred or sold.
As well as determining the value, the court will be examining how much income it produces, whether it should be producing a higher yield and, whether any liquidity can be extracted from the business to meet the financial claims of the other party.
This can have a disruptive effect on the business in the short term as a key shareholder is distracted from their role, and/or the finance team is engaged in a lengthy process with the valuer, and long term can have a considerable impact on any plans the business may have for future growth. It may also have repercussions for any third party in the future, for example if their own marriage broke down, and their spouse seeks to rely on reports prepared for the other couple’s divorce.
Unless there are unusual circumstances, the court will not compel the transfer of legal ownership in contravention of the provisions recorded in a Shareholder’s Agreement or Articles when there are other co-shareholders with rights.
If only one party holds a shareholding/partnership share, they would retain that interest.
Matters would be regulated by the governance documents in the event of a dispute between a couple each holding interests in the business/resolved by the commercial court if necessary.
What steps could have been taken to assist this couple – and their fellow business owners?
If there is a company structure, clearly defining shareholdings, roles and obligations to the company in a suite of governance documents including bespoke Articles of Association, a Shareholders Agreement, and Director’s service/employment contracts, these will help protect all business owners from the impact of relationship breakdown for any of the owners and regulate arrangements. Likewise, an express declaration of ownership for a partnership structure, by way of a Partnership Agreement.
A pre/post-nuptial agreement or cohabitation agreement can mirror corporate arrangements and expressly declare the parties’ intentions as to whether or not any shareholding or interest should revert back to the other spouse/partner or to the company in the event of relationship breakdown, and/or whether, for the divorcing couple, that interest should be compensated by money’s worth as part of a settlement.
A pre-nuptial agreement or post-nuptial agreement can be extremely helpful in limiting claims against a business. Although not yet legally binding, since the Supreme Court judgement in the case of Radmacher v Granatino in 2010, the law has developed so as to provide significant protection to those seeking to protect their assets.
Although the courts are not obliged to give effect to the agreement and parties cannot oust the jurisdiction of the court, the court must give a pre or post-nuptial agreement appropriate weight when exercising its discretion, should there be a divorce. This is subject to certain safeguards being put in place when entering into the agreement. If safeguards are adhered to, the usual advice given to parties is that they can – and should - expect to be held to the terms of any pre or post-nuptial agreement if there were a future divorce.
As mentioned above, a pre or post-nuptial agreement could mirror corporate arrangements and/or provide for how a divorce settlement should be framed with reference to any business interests.
There is no such status as a ’common law spouse’ and cohabitees can be left without a remedy or method of resolution in the event of a relationship breakdown. Unlike married spouses or civil partners, cohabitees cannot claim maintenance for themselves or a share of their partner’s capital assets (including a business) or pension. This is regardless of the length of their relationship or whether the couple have children. Any property claims they may have will be limited to any interest they are able to establish under land or trust laws.
A cohabitation agreement can set out in black and white how any assets should be divided in the event that the relationship breaks down.
Provided both parties freely enter into a cohabitation agreement, it is drafted carefully with safeguarding criteria adhered to, it is generally understood that there is no reason why such an agreement should not be legally binding (although note there are no recent cases testing this point).
Transfer of shares to family members
What happens if our couple are content together, but transfers of shareholdings to family members have been made – only for the beneficiary of those transfers to suffer their own relationship breakdown?
The interests held by those entities, if gifted outright, are of course available for dispute on a divorce or relationship breakdown as outlined above.
What steps could have been taken to protect the business?
At the outset, and when considering governance documents, majority shareholders need to consider the pros and cons of permitting family transfers.
Family transfers are likely to arise as a result of estate planning. It is essential that all the corporate, governance and personal documents work together and do not conflict with each other. Advice from corporate advisors in conjunction with family and private client advisors is crucial.
Governance documents should always extend to what happens in the event of a relationship breakdown for any person with a stake in the business, and pre/post-nuptial agreements or cohabitation agreements should be discussed and entered into before transfers are made.
People, and their personal relationships, change over the years, and businesses may inadvertently fail to keep up with the personal aspirations or worries of their owners, despite consideration having been given to such issues at the start.
Businesses should always regularly review their arrangements, and this is especially so with a family business.