Businesses and divorce – what approach does the Court take?

Many family solicitors are all too familiar with the disputes that can arise on a marital breakdown. Issues can materialise and cases can become more complex when there is a business or businesses to consider. So, how does the family court treat businesses in proceedings for a financial remedy on divorce?

When considering financial provision on divorce, the court must consider a range of factors detailed in s25 of the Matrimonial Causes Act 1973 (MCA 1973). These factors include, amongst others, the needs of the parties, the standard of living enjoyed during the marriage, income and earning capacity and contributions made during the marriage. Throughout proceedings for a financial remedy, there is an ongoing duty of full and frank disclosure and the court treat business interests as a resource of the parties under section 25(2)(a) of the MCA 1973. Quite often business interests are central to the negotiations and often a single joint expert is instructed to determine value(s), issues of liquidity, maintainable income etc.

Often on divorce, it is the family court rather than the commercial court that will determine what happens to a business or business interest. However, there can be, and there often is, a cross-over between company proceedings and proceedings in the family court. For example, there might be a family dispute over the business and how it should be run following a marital breakdown until the final determination on divorce. Do measures need to be put in place to ensure the business can continue trading in the intervening period i.e. is a company receivership necessary? There can also be common arguments of non-matrimonial property.

When considering the distribution of matrimonial property, the court, in respect of businesses needs to: –

1. establish what the value of the business is – does it have an underlying capital value or it is merely an income-producing asset. Valuing a business will not be appropriate in all circumstances and a proportionate approach, mostly from a cost and time perspective, should be taken. There needs to be consideration as to whether a forensic accountant needs to be instructed.
2. determine how that value should be reflected in the outcome.

Each case involving a business will turn on its specific facts and circumstances.

Valuations?

It is helpful to think of the valuation of a business as not a science, but an art. Valuations are a guide and not always a true representation of what a business will sell for on the open market.

Valuing a business, whilst not something that family lawyers become inherently involved in, can be a complicated and costly process. It can depend on several factors that include: –

1. the structure of the business i.e. is it a limited company, is one dealing with a sole trader or a partnership;
2. what assets does the business have and do those assets need to be valued i.e. plant and machinery belonging to a farm or a commercial property from which the business operates. Is the commercial property subject to a mortgage;
3. what does the balance sheet say, what are the liabilities of the business;
4. what is the liquidity of the business;
5. the underlying profitability of the business, what are the earnings and the ability of the business to generate cash;
6. what are the tax implications for extracting resources out of the business, is both capital gains tax and dividend tax payable?

In terms of the court, they will typically use a current and up-to-date valuation of the business. Only in exceptional circumstances will the court look at a future valuation of a business.

Whilst the court has to consider and know the value of all the assets in the case in order to exercise its discretion properly, given the expenses involved in instructing an expert, this is something that should be given careful consideration.

Orders the Court can make

How the court treats a business will very much depend on its make-up, its value, and the wealth it generates. Consideration is also given for whether the business has an intrinsic capital value or whether it is merely an income-producing asset. If a business is just an income-producing asset, it is important not to double count any capital award.

Whilst a business might have a value, in reality, are shares not worth what someone will pay for them, if a business is run by one person that then cuts ties doesn’t that render the business worthless? In financial proceedings, the value of a business is down to the expert’s opinion, but that opinion does not always reflect the reality.

An impending divorce is an uncertain time for a business, particularly where there are employees to consider, suppliers, investors (potential or otherwise) and anyone else who might have an interest in its smooth operation. However, the court can make a variety of orders in respect of a business, for example:

1. An order for sale (uncommon in practise). Option for a deferred lump sum, depending on the other assets;
2. Transfer of shares;
3. A deferred lump sum from the sale of shares at a future point in time;
4. Periodical payments.

Order for sale

In practice, the courts are generally reluctant to order the sale of a business unless there is no other way of achieving fairness. However, the court does the power to do so under section 24A of the Matrimonial Causes Act 1973. Again, and with this approach, there are tax consequences to consider.

Why are the courts reluctant to take this approach? Well, often, a business will be a source of wealth for the parties that, if sold, would bring an end to the income that it generates. Also, if a substantial part of the family wealth is the business, its liquidity might make it difficult to effect a clean break.

Transfer of shares?

Under section 24(1)(a) of the Matrimonial Causes Act 1973, the court can order a transfer of shares from one party to another.

Where there are co-shareholders, to achieve so far as is possible a ‘clean break’ on divorce, the courts will often transfer shares from one party another. Again, there are tax consequences that need to be considered and advise will need to be taken.

It is uncommon for the courts to transfer shares to a party who is not already a shareholder, as this would be contrary to the clean break principle. Not only this but it is likely to impact on the smooth operation of the business and corporate advice should be taken i.e. should a new class of shares be created and/or a shareholders agreement be drawn up to prevent any improper behaviour that could be detrimental.

There can also be situations whereby a business has third party shareholders, and a share transfer may be restricted by the company’s articles of association. Again, corporate advice should be taken.

How can a business be protected?

This will depend on the circumstances on the case and the matrix of the business and its company structure. There are various ways to protect business assets, for example by entering a pre or postnuptial agreement that reflects the company structure of the business. The agreement can reflect how the shares in the business should be held, and by who, in the event of a marital breakdown.

Rachel Nicholl is a Senior Associate Solicitor and Collaborative Lawyer in our Horsham team.

If you would like any further information on how the court treats business assets on divorce, then please do not hesitate to contact a member of the team for a confidential discussion about your personal circumstances.