Divorce and Business Partnerships – Minimising Risk for Your Clients

For your clients who are business owners, divorce, even if not their own, can cause great disruption. Of late, I have been receiving enquiries not by people who were in relationships, but by people who are concerned about a business partner’s relationship breakdown. In this article, we explore what we know to be the issues that arise for other owners or shareholders and the steps you or your clients can take to proactively minimise the impact of a divorce on a business.

Key Issues For Owners Or Shareholders

In our work as family lawyers we see three ways in which a business and its owners can be affected when a business partner is going through the separation and divorce process.

1. The Disruption

   The first issue we often hear of is that the owner going through divorce is often distracted and unable to undertake their duties. It is also not uncommon for them to go AWOL for a period. As trusted advisors to business owners, you will understand the impact these behaviours can have on the business, other owners and the broader team.

2. Invasion of Privacy
   

   The next issue relates to the financial disclosure process. For the person going through divorce, to begin the property settlement process, there is a requirement for disclosure of financial documents and often valuations to be made of any interest in a business, be it a partnership, company or trust. 

   The process of valuation is often intrusive, particularly for the non parties to the relationship. The financial affairs of their business being reviewed, typically by a forensic accountant or others who are looking through the accounts with a fine tooth comb, can be hard to tolerate. Particularly confronting for partners when the professional appointed to review all of the finances of their business, may be known to them.

3. Impact From Requirements Of The Property Settlement
   

   The other key issue, which can be the most significant of all is, once it has been determined what the divorcing owner’s interest in the business is worth, how does their former partner or spouse get access to that money? And, what does that mean for the business?

The Outcomes

In the event there is a need for the divorcing partner to sell their share of the business to pay out a property settlement; if there is no partnership or shareholder’s agreement in place, this can mean that share to be transferred to the former spouse or sold.

Typically however, the people that would want to buy that interest in the business are the other parties to the business. However, if there are disagreements about how the share is to be valued and there is no agreement in place that details how it should be valued, this could become an issue for the remaining partners. Most importantly is the timing of payment in an6 such sale.

The other significant consequence, is that this can put a hold on any intended plans for the business, due to property settlements sometimes taking years to be finalised. Additionally, the flow-on effect can also result in other partners having to hold off on financial decisions in their personal life.

As a trusted advisor to business owners, you are privy to the forecasting and plans for the businesses you assist. The impact of a divorce can put more than a spanner in the works. It could change the trajectory entirely.

The Additional Risk For Family Businesses 

In the case of family businesses, a divorce can cause even further-reaching consequences.

To illustrate, imagine a scenario of three brothers and one sister who all have an interest in a manufacturing business. One brother is going through divorce and needs to sell his share in the business, but the other siblings don’t want to buy him out.  

If the most significant asset the brother has is his 25% interest in the family business, if he can’t get his siblings to buy him out, then the siblings may end up being drawn into the proceedings as the former spouse seeks to get the Court to give Orders to force the sale of the property. 

The subsequent issue? The three siblings are not only facing the stress of being drawn into these proceedings, but they are also now facing tens of thousands of dollars in costs for their legal representation.

For all of these reasons, a comprehensive partnership agreement or shareholder’s agreement is essential.

The Intersection of Smart Business Planning & Smart Relationship Planning 

The disruption, the invasion of privacy, the effect on business and the personal finances of other business partners do not need to be at risk in this way. Here are the two ways to reduce the risk that divorce brings to a business and its shareholders:

1. A comprehensive Partnership or Shareholder’s Agreement; and
2. A Binding Financial Agreement

Partnership Agreements or Shareholder’s Agreements 

While I am not a commercial lawyer, in my work as a family lawyer I see partnership agreements and  shareholder’s agreements with varying provisions.

As an example, if there are five shareholders in a business, the agreement should prescribe that if one partner needs or wants to sell their interest in the business, then they must offer it to the other four partners first. 

The agreement should also include a provision that if the other four partners do not wish to buy out the partner, or they do not have the capacity to buy out the fifth partner, that the remaining partners must provide their consent to the new shareholder before a sale can proceed.

Further, the agreement should provide for how the business is to be valued and whatever that price is, the agreement will typically provide the terms of how it is to be paid out. For example, paying out over a five-year period.

I’ve also seen agreements with extreme clauses where, in the event a spouse files proceedings in the Family Court for a property settlement, then the partner in the matter is required to sell their interest in the business to the other partners.

So, having a shareholder’s agreement or partnership agreement is about ensuring that if somebody has to get out of the business, there are clear guidelines on how the business is to be valued. Because if, for example, the formula in an agreement values a business at X, an expert accountant could argue that if the formula wasn’t in the agreement, and they were selling it on the normal market, it would be worth 2X. While that valuation formula is not binding in a Court, the method of recovering funds for a property settlement is limited by what that person can get out of the other shareholders. 

However detailed, it is important to know that even if the terms of the shareholder’s agreement are very tight, the business is not protected from a property settlement. 

That is where a good Shareholder’s Agreement can be supported by a good Binding Financial Agreement.

Binding Financial Agreements (BFA’s)

A BFA will prevent any partner’s de facto partner or spouse from making claims in relation to the valuation of the business.

A Binding Financial Agreement is a formal agreement between two people in a de facto relationship or marriage. It details the terms of any future property settlement, in the event the relationship ends.

As business partners enter personal relationships (or enter businesses with existing personal relationships), they can also enter into Binding Financial Agreements. In this context, the BFA serve to protect the integrity of the businesses’ shareholder’s agreement (along with any other personally negotiated terms by both parties).

It is in this agreement that the business interests can be protected, by way of documenting that the business interest in question, is effectively quarantined from being considered as property available for division.

Protection in Divorce and Business Partnerships

Business partnerships of any kind need to be protected with the right agreements, because there are multiple persons who are putting their financial lives at potential risk by going into business with others. Making sure everyone is on the same page, and that legal agreements prevent a change of heart from affecting business relationships, are both very important. 

Divorce and business is complicated, at the best of times. For any clients you have that are not the sole owners of a business, ask about whether they have a partnership or shareholder’s agreement in place that takes into account provisions like those above. And, consider suggesting the additional protective mechanism that a Binding Financial Agreement can bring.

My experience is that many businesses in Australia, be it partnerships or companies, do not have Partnership Agreements or Shareholder’s Agreements. Most business owners haven’t thought about half of the issues they could potentially face – including at the more extreme end – being parties to litigation.

While these details may not seem necessary for your clients when everyone is getting along and business is running smoothly; protection isn’t for those times. It is for the times when something goes off-course, and protection measures should be in place, long before those times arrive.