Family Business Week: Keeping it in the family - divorce and the family business

By Connie Smith, Family Law solicitor at Irwin Mitchell

Family businesses are different; they have a long-term outlook driven by ensuring success for future generations, and an emotional and sentimental tie which cannot be understated. There are over five million family firms in the UK, employing over 14 million people, and their continued success is vital to the UK economy. However, one of the biggest risks to the success of a family run business is a lack of family cohesion. The perfect storm of divorce can have a significant impact upon the success of a family run business.

The impact of divorce upon family businesses can be wide ranging and in some cases catastrophic. Whilst we as family lawyers try to make what can be a difficult process as easy for our clients as possible, sadly clients often find that the process of reaching a financial agreement upon their divorce from their spouse is complicated by their interest in the family business, and that their family business suffers due to this process.

During the process of attempting to reach a financial agreement the court will often order a valuation of the family’s interest in the business. Opening your business’ books to a forensic accountant for the purposes of a valuation not only causes your finance team a significant headache over and above that caused by external auditors, but also will require the detailed scrutiny of the financial health of a business. There are further practical impacts to consider on the running of a business during the separation, to include boundaries between the family’s personal bank and the organisation’s finances being blurred, and your directors’ loan account being subject to significant scrutiny.

This is before we even begin to consider the emotional impact upon a family of separation, and how this naturally leaches into their business. Owners sometimes find the process of reaching an agreement upon their divorce takes much of their time and energies, and that they aren’t able to give the attention they would like to maintaining and growing their business, particularly where their businesses are family owned and delineation between work and family is challenging.  

Clients are often surprised at the breadth of orders which the court can make when considering the family business, and how both spouses should be provided for. The outcome will depend upon the specific facts of the case, but can include:

• One party retaining the business and the other being compensated with capital, monthly maintenance paid by the business owner, or a combination of the two;
• Both spouses are made (or continue as) shareholders within the family business. The court has the power to compel the transfer of shares between the parties; the fact that shares are held within a company does not offer protection. This could mean that there are restrictions placed upon your ability to deal with the business in the future, and raise the risk of future conflicts if you are compelled to continue in business with your ex-spouse;
• Compelling the sale of the business. In the vast majority of cases, the court will seek to will preserve the family business as a going concern. However, if the needs of the parties cannot be met without the family business being sold, then the court may in some circumstances force a sale.

There are however steps which you can take to manage the risk to your family business upon the unfortunate circumstance of a divorce. The vast majority of our clients come to us when they are going through a divorce and ask what they can now do to protect the business. At that stage, the options open to clients have narrowed. Any attempt to dissipate assets during a divorce, for example by way of transferring shares within the family or moving them offshore, can be seen by the court as conducted with the intent to place assets beyond the reach of the court and can be reversed by the court. Sacking your wife of 20 years as company secretary upon receipt of a divorce petition is not going to change the views of the court as to whether the assets of the company should be shared, and is likely to incur only the wrath of the court.

Well-intentioned tax advisors will often encourage shareholder/directors to make their spouse a secretary or director, pay them a salary, and gift them shares for tax purposes. However this holds risk. In the event of a divorce, the other shareholders will doubtless want those shares back. If there isn’t sufficient capital in the pot, or if the future success of the business is difficult to determine, the court may, as above order that your ex-spouse retains the shares in the business.

Where the family business was founded prior to your marriage, by generations preceding you, you can sometimes argue that your interest in this business should be treated as non-matrimonial, and therefore treated differently by the Court. However this argument is much harder to make if your spouse has been involved in the running of the business during the marriage, and has been a part of its success. . The more prominent your spouse’s role in the business the stronger the argument which could be made that they should share in the financial success of that business.

We do however recognise that to exclude your spouse from being a part of that family business due to the risk you may later divorce is a practically difficult step to take. This advice is therefore often hard to implement, particularly when it comes to a family business.

There is however a crucial tool that owners of family businesses do have at their disposal – pre and post nuptial agreements. There is no getting around the fact that nuptial agreements are not the most romantic of suggestions, and suggesting that your children obtain such an agreement before their marriage, or that your soon to be spouse enter such an agreement with you, can be difficult.

However, nuptial agreements offer family businesses the ability to protect their shares – for example specifying that in the event of a divorce between a shareholder and their spouse, shares in the family business are to be ring-fenced.  When entered into freely with a full appreciation of the circumstances (unless it wouldn’t be fair to hold parties to their agreement at the time of the divorce) and if several criteria are met, nuptial agreements can be effectively binding and can exclude shares in the family business from the full force of equal sharing. You can even include, having taken corporate law advice, a provision in the articles or shareholders agreements of your family business that all shareholders who marry must enter into a nuptial agreement to protect the family shares.

This is why it is so important for those who have family businesses to consider taking family law advice for the family as a whole when everything is going well, as a wealth protection tool. By only accessing family law advice as a distress purchase, the options which we can offer to family business owners and shareholders are restricted, and the latent risk within your family business is increased.

Taking early family advice from firms such as Irwin Mitchell who are specialised in succession planning and resolving disputes, in conjunction with your commercial lawyers and tax advisors, can protect your business and give you the reassurance that should a relationship break, your family’s legacy need not.