Entrepreneurs are busy, creative and dedicated people. To try to keep some semblance of work life balance, many go to great lengths to keep their personal and professional lives separate. As a result, is easy to overlook unexpected areas where they may overlap. For example – it may not have occurred to you that divorce (whether your own, or that of your fellow founders) could have an impact on your business.
England is one of the most (if not the most) generous places in the world to the financially weaker person on the breakdown of a marriage or civil partnership. On divorce, the court has a free hand to redistribute all the assets of either party of the marriage in whatever manner is necessary to provide a “fair” result. Anything owned by either spouse is available for distribution to the other including, for example, shares in private companies.
There are very few mathematical rules or formulae that determine how assets are divided, but the court will be guided by three principles: the parties' and any children's financial needs; compensation for relationship-generated economic disadvantage; and the equitable sharing of the wealth built up during the course of the marriage (the marital assets), which can include business interests or growth in value during the marriage of a pre-existing business.
The judge must simply reach a “fair” result by reference to those factors.
A judge can therefore order the transfer of shares from one party to another. Where one party is a shareholder, it is not common for the court to order a transfer of shares to the other spouse because the court will try and achieve an end to the relationship between the parties rather than extend their relationship beyond divorce. Nevertheless, such orders are made. For example, in the recent case of Versteegh the judge awarded the wife a shareholding in the husband’s business, and this was upheld on appeal.
Third Party Interests
The court will have regard to the interests of third parties such as other shareholders, but will nevertheless make the orders it considers necessary in order to achieve a fair outcome.
Provisions in the articles of association or a shareholders' agreement may have the effect of deterring some courts from making share transfer orders on divorce due to concerns about subsequent implementation or enforcement, but these provisions would not prevent the court from making such orders or finding an alternative solution in its quest for fairness (for example by making orders against the individual spouse) which may have the effect of that spouse requiring assistance from family shareholders or trustees to enable compliance.
What protection is available?
So what can business owners do to protect themselves?
A pre-nuptial agreement is a crucial tool in the preservation of wealth as a means of ring-fencing assets brought into a marriage and should be given serious consideration. Entering into a pre-nuptial agreement is frequently a condition of a spouse or next gen being issued or granted options to acquire shares in a company.
The English court will give effect to a pre-nuptial agreement if it was freely entered into, if the parties had a full appreciation of the implications of the agreement and if it is fair to hold the parties to the agreement in the circumstances prevailing on divorce. Therefore, if entered into in good time before a wedding, if the parties each have the benefit of independent legal advice and financial disclosure, and the agreement itself makes appropriate provision for the financial weaker spouse, they are undoubtedly a strong tool in the armoury.
The company’s constitutional documents (its articles of association and shareholders’ agreement, if any) should be carefully tailored to accommodate the specific needs and circumstances of different shareholders. For example, it may be appropriate to prevent shareholders from being able to transfer shares to their spouse / close family without either the prior consent of the other shareholders or without that shareholder first having to offer those shares to the other shareholders. A prescribed method by which the shares in the company will be valued at any given time, and on what basis (e.g. at a discount to market value, for a minority stake) is also good practice.
It can also be useful be create separate classes of shares. For example, one class might be allocated to management (perhaps direct family), with voting and enhanced dividend / capital rights. Another class might be allocated to (perhaps indirect family) shareholders who are not involved in the day-to-day running of the business, with limited dividend / capital rights and no voting rights. In this scenario the documents should provide that a shareholder can move from holding one class of shares to another, for example if they move into a managerial role.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, January 2020