Divorcing the spouse and the business

Divorce is by far the most calamitous event that can strike any family business. In Australia, every third marriage will end in divorce. And while the divorce rate has been declining, the latest figures from the Australian Institute of Family Studies show that the divorce rate after 20 years of marriage is on the rise with parents waiting for their kids to move out before they split up. By that stage, they could well have established a family business with one of them as the CEO and the other as the mover and shaker.

It’s inevitable that some family businesses will be affected by divorce. More to the point, divorce affects not just the couple and the family, but everyone in the business with claims against the family wealth, which includes the business, dragging members of the family and perhaps non-family employees into litigation.

And in litigation, everything is open game. The company could be forced to divulge details like the financial statements and tax returns over the last five years, the company’s investment plans, its product mix, channels of distribution and markets, its forecasts for the future, details of distributions to shareholders, its banking and lending relationships including details of all the loans and details of compensation. This is the sort of stuff that most family business owners would say is nobody else’s business. Divorce changes that.

Another consequence of the breakup of a marriage is the possibility of remarriage, the triumph of hope over experience as Samuel Johnson called it. In such cases, the marriage bond second time around can come into conflict with the family bond as people’s loyalties are pulled away from the family’s centre of gravity. In cases like that, the spouses more often than not turn up the conflict’s volume.

Most family businesses don’t have contingency plans for divorce, remarkable really when you consider that one in three businesses will end up in shareholder fight over the spoils.

Every family business needs a divorce strategy. The first, and most obvious, is that if a couple are going to be spending all their time together, they have to know how to work as a team. If they don’t, it can be a recipe for divorce. Clear role definition separates business and family issues. They have to decide how to share the workload, allocate power and share the rewards. When it comes to defining roles, there’s no hard and fast formula, everybody’s different. Some husband and wife teams work better with joint decision-making, others divide decision-making responsibilities according to each other’s strengths. Whichever way they decide to go, the bottom line is there has to be a high degree of communication and the talents and attitudes of both parties have to be complementary – qualities that you find in the best marriages.

The other solutions are not easy. Because most owners would struggle to come up with cash to the value of half their business without destroying the company or putting it up for sale, some family business owners go for a prenuptial or postnuptial agreement protecting their shares and assets. The postnuptial agreement has to be signed by both parties. It also has to contain a statement that both parties obtained independent legal advice.

However, these agreements are not necessarily rock solid guarantees that the assets won’t be carved up.

Murray Landis, a partner at global law firm K&L Gates, says the courts might take a different view if there is a change in the circumstances after the agreement.

He says the family business can be protected if it is placed in a company or a unit trust where the trust’s interests are fixed and held in accordance with the units, much like shares in a company. The individual family members have their interest in that company held through a discretionary trust.

“For example, you might have four family members with each holding 25 per cent of the units,’’ Landis says. “If there’s a matrimonial breakdown, then all the spouse can get their grubby hands on is the 25 per cent interest that that particular person has but they cannot interfere in the conduct of the whole business.

“What you’re trying to do is quarantine the interests of a particular family member.”

The divorce strategy should also cover how the principals decide on the valuation of the business. The key here is to get an agreement first off between all the parties on how the business should be valued by an independent expert at the relevant time. So a valuation expert is brought in to appraise the business in an impartial manner, free from input from husband and wife. Once that agreement is in place, Landis says, it is difficult for any court to turn that around.

In the end, the best way a family business can cope with the unthinkable event of a divorce is to plan for it. Even then, it’s not fool-proof. Divorce can still destroy a business. But the parties would still be better placed to deal with it by having a strategy. And when it comes to a divorce strategy, it’s better to formulate one when the business is starting out and everything is still hunky dory. Once the business has grown, it becomes more problematic.