Protecting Your Client’s Business in Divorce

Divorce can be bad business for your client.  Mixing a business and its assets with a divorce can become financially and emotionally devastating for the divorcing couple and for its family, as well as for the business’ employees and co-owners.  Division of property is usually the chief issue in divorce, and the business is usually the most valuable asset in a divorce.  Planning can avoid this principal source of contention that occurs in a divorce. Avoiding a court battle will minimize the pitfalls.

Michigan law requires that assets acquired during a divorce be valued so that the marital estate can be equitably divided between divorcing spouses, including any businesses. The law governing the distribution of assets upon divorce gives the family courts considerable discretion to divide and redistribute assets according to the particular circumstances of the case. As a business owner, planning is something your client must do before he or she considers ending his or her marriage or finds oneself as a defendant. When your client makes the correct decisions in his or her marital planning and divorce process, everyone benefits.

In most divorces any business suffers. This is due to the distraction of, and inattention from, the business owner, the owner not taking advantage of business opportunities, the loss of customers, uncooperative co-owner(s), or the additional expense of legal and accounting services. Also, the court’s options may be limited, as it has no power to influence or to make orders in respect of third parties.

Your client should protect his or her interests and reduce expense in the event of divorce, taking preventative measures. One solution is not to get married at all if the client is concerned about defending his or her assets. More realistically, clients should put policies in place to address the rights of owners, including rules that apply if an owner transfers his or her interest due to a property settlement or a court order. If your client is facing a divorce, he or she needs the right advisors for legal and business valuation advice. Your client must have an attorney who knows the client’s business and also understands how to be tactful in helping both parties understand the value of making mutually-beneficial decisions. Counsel must be knowledgeable, with common sense and an interest in helping the client solve the problems, not creating conflict. Help your client understand the importance of legal documentation in order to protect everyone involved. Your client’s decision on a family law attorney and/or forensic accountant is just as important as his or her decisions in the boardroom.

Client and counsel have to plan and execute business planning and/or divorce procedures with the same attention to detail as a multi-faceted business plan or the company’s budget. Your client’s legal counsel and financial advisors need to explore creative alternatives to help minimize disruption and protect the long-term stability of your client’s business. If there is litigation, the strategy should control the conflict and permit your client’s business to function.

Shareholder, operating and/or partnership agreements may contain protective provisions in the event of divorce. A family-owned business may require pre-marital agreements, restrictions, and/or waivers intended to prevent other owners from selling or giving their interest to anyone outside the family. If your client owns a business and is about to get married, draft a pre-nuptial agreement for the client prior to the marriage. Provide therein that the business is your client’s separate property. If the parties are already married, then consideration should be given to entering into a post-nuptial agreement, i.e. an agreement entered into during marriage that regulates what should happen if the relationship breaks down. Another possibility is that, if a divorce is probable, the company can be sold prior to the divorce. The proceeds from the sale will be at issue, and the participant spouse may possibly continue to play a role in the management of the company.

Consider compromise on how the business should be valued and on reasonable income for support. This can be done with trusts, as well as with life insurance. Much of the apprehension of a prenuptial agreement that keeps a valuable business in your client’s name can be reduced with a comparable life insurance policy on your client’s life, with his or her spouse named as owner and beneficiary. Furthermore, there may be ways in which you can legitimately limit your client’s personal financial risk, if not that of the business. For instance, alter the structure of the business entity (such as reorganizing it as an LLC or corporation). Also, to assure that a business stays within the family if a member divorces, consider a Family Limited Partnership Agreement or LLC. These versatile estate transfer tools can specify that business interests are not subject to division in divorce.

In divorce litigation involving a business there almost certainly will be a valuation thereof and a cash flow analysis performed by a forensic accountant and opposing counsel. Valuing the business is a significant source of conflict. This valuation and/or due diligence will likely entail a review of your client’s company’s historical books and records. The company could face problems in a divorce situation because of such recordkeeping. Your client’s company’s books and records should be maintained according to generally-accepted accounting principles, going back a minimum of five years, so as to minimize the destructive impact of divorce. Be prepared to produce your client’s records if compelled. A protective order, confidentiality agreement, order under seal, in camera review, or other precaution may have to be employed so as to attempt to protect your client.

Business valuations are essential and cost effective. Efforts to skimp in this area will likely cost your client significantly more. Your client’s appraiser must be experienced, credentialed, ethical and able to produce a written forensic divorce accounting report that will withstand scrutiny. Most probably, thousands or millions of dollars are at stake with the result of this report. Consider also that this valuation may later come into play post-divorce if your client is selling interests in the business or seeking financing.

Irrespective of the size and/or nature of the business, your client must first retain a family law attorney with experience in complex property issues. This attorney will have a relationship with many valuation experts, and will work closely with the qualified appraiser to achieve a fair business valuation and advise as to the legal consequences. Together, they will work on a strategy and valuation methods, considering the applicable statutes, current case law, evidentiary rules and market trends. They may also collaborate on the drafting of an offer, settlement agreement, and/or judgment of divorce. This will include the timing of the divorce, and whether the non-participatory spouse can be paid his or her interest with a promissory note or with tax-advantaged spousal support. Business interest payments are “property” and therefore non-modifiable. Moreover, property distribution obligations are not subject to discharge upon the payor’s bankruptcy filing, as a result of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.

Your business-owner client will be tempted to divert profits, or otherwise act unscrupulously. Do not allow your client to hide assets from his or her spouse and/or the court. This conduct is illegal, intentional nondisclosure, and may result in contempt of court or perjury. Efforts to decrease the amount which will be provided to the other spouse will almost always fail and could result in significant adverse consequences.

In conclusion, as counsel you need to mind your client’s business from and in divorce. A business owner’s careful planning for a divorce is sound business practice. A negotiated and discreet resolution is often more advantageous in deciding the division of or sale of your client’s business than having a judge decide it, especially if your client is prepared. Your client needs to make correct choices. This begins with the hiring of a pre-eminent, experienced business and family law attorney, and then an experienced, sophisticated forensic divorce accountant.

If you have questions regarding protecting a business during a divorce or other asset protection and family law matters, please contact John Schrot at (248) 645-9680.