Divorce Proofing The Family Business
Divorce, or the breakdown of a relationship, is an emotional and challenging process. People often feel confused, fearful, and uncertain about how to move forward. Their world turns upside down, triggering distressing emotions that can have a devastating impact on the extended family.
Impact of Divorce on Family Businesses
Divorce can affect a family business in several ways: financial, legal, emotional, long and short-term goals, succession, and more. If the divorcing spouses have children, there are additional considerations beyond the economic aspects of the family business, which may influence how a separation agreement is drafted.
Nearly 50% of marriages in North America end in divorce. This rate rises to 60% or higher for subsequent marriages. Strategies are needed to help everyone, especially children caught in the middle, to move forward to a better life even when divorce seems inevitable.
On a classic rating scale of stressful life events, divorce consistently ranks second only to the death of a spouse or child. The process can be overwhelming, causing many to buckle under the pressure.
Why Divorce Proofing Your Family Business Is Essential
When a family business is involved, divorce suddenly becomes everyone’s business. Divorce may cause complications, reduced productivity, distress, and even disagreement among family members. It’s not only high-net-worth clients who need to worry—family businesses of any size, even small businesses, can be affected.
For most people going through a divorce, the most significant assets are typically the marital home, RRSPs, pensions, and investments. However, when a family business is involved, that business is usually one of the largest and most significant marital assets. The company may be at risk if the soon-to-be divorcee is an employee, partner, board member, or shareholder.
Family businesses are often difficult to divide, and without proper protection, your family might find itself with an unwelcome business partner. Divorce-proofing the family business with a clear strategy that all family members adhere to is a good idea. Without proper planning, the impact of divorce on a family business can be severe, making divorce one of the most destructive events a business owner may face.
Financial and Legal Considerations
To protect the family business adequately, it must be viewed as a business entity, stripped of all emotion and sentiment. This process can be complex and often requires the expertise of lawyers and accountants who specialize in commercial law. While it’s nearly impossible to guarantee that divorce won’t harm the family business, steps can be taken to minimize the impact.
Specific legal agreements, like a buy-sell agreement, can be set up to protect future generations who will benefit from the family business. These agreements should be used as a guide for discussion and planning. Family law varies by province, but prudent planning and strategizing are essential.
The Discretionary Family Trust
Wealthy families often use a Discretionary Family Trust to pass assets to family members. The Trust acts as a mechanism that benefits the Beneficiaries or Trustees. Here are some concepts to discuss with your legal counsel:
- If the trust beneficiary is divorcing, how will the monetary benefits be impacted in terms of child or spousal support payments?
- Should the beneficiary consider a prenuptial or postnuptial agreement to exclude the family Trust from their net family property (NFP)?
- Should the marriage contract be included in the Trust agreement to ensure that Trust benefits are excluded from the NFP?
- Do you want the Beneficiary of the Trust to be a trustee?
- What is the value of the Trust, and is it part of the NFP?
Shareholders work hard to build a successful family enterprise and want to protect it through multiple generations. However, issues like divorce and death require serious discussion:
- A shareholder agreement that outlines what happens in the event of divorce can help avoid renegotiation between lawyers.
- The business should set up preventive measures to protect itself.
- In the event of death, if a marital breakdown occurred prior and the separation agreement wasn’t finalized, protections might be needed to avoid distributing shares to the current spouse.
- Family members may want to protect the business so that shares are not distributed to an ex-spouse.
The Importance of a Shareholder Agreement
A Shareholder Agreement sets the ground rules for business operations, ensuring everyone knows their rights and obligations. It outlines how shareholders join, work together, and leave the business entity.
For family businesses, the agreement can limit shareholders’ ability to sell their shares, preventing strangers from buying into the business. This is essential for protecting the family from misunderstandings that could undermine and destroy the business.
Prenuptial and Postnuptial Agreements
Deciding how to divide financial assets in the event of divorce or breakup is incredibly daunting when planning a wedding or choosing to live together. Drafting a prenuptial or postnuptial agreement may seem like it takes the romance out of the relationship, but it’s a critical step in protecting family assets and business.
These agreements can:
- Avoid costly battles in divorce court.
- Ensure a clear understanding of who owns what.
- Protect assets for children from a previous marriage or relationship.
In my divorce consulting practice, I always advise clients entering a new significant relationship to consider a prenuptial or postnuptial agreement. The difference between these agreements lies in how the relationship is established. A prenuptial (prenup) agreement or marriage contract should be signed if the relationship is through marriage. If the couple chooses to live together without marriage, they should consider a cohabitation agreement.
These agreements must include an element of fairness and cannot be punitive. Additionally, each party should seek advice from separate legal counsel, most likely a family law lawyer. If one party is coerced or manipulated into signing an unfair agreement, it could be contested in court, leading to a costly battle. Therefore, retaining a family law lawyer with expertise in drafting these agreements and understanding the court system is crucial.
The Emotional Considerations
There are two sides to divorce: the emotional divorce and the legal divorce. Divorce is an emotional process, and if not managed properly, it will wreak havoc on both the legal process and the family business. Emotions and legal processes often cannot be clinically separated and must be managed simultaneously.
If a family member is running the business or plays a vital role, divorce can be a significant distraction, leading to loss of focus and mistakes. In high-conflict divorces, family members may be absent from the business for extended periods, tied up in lawyer meetings or court dates. Even amicable divorces can take time to negotiate through lawyers and mediation.
When there are children involved, the emotions and stakes are even higher. While divorce should be treated as a business transaction, the children’s best interest should not be reduced to a cost-benefit analysis. In a family business, anything that produces payments from the business often encourages family members to feel entitled to voice opinions or make decisions.
Key Questions to Discuss with Legal Counsel
When it comes to divorce settlements, several financial considerations must be addressed. Marital assets are generally divided equally, but there are exceptions. Here are vital questions to consider:
- How will the equalization payment be handled? Is the family Trust or another agreement exempt from inclusion, or can equalization payments be made through the business?
- What happens if a judgment creditor is involved? Can the family business be protected, or might the court order the transfer of shares or money to the party owed?
- How will the family business be valued? Is it exempt from the net family property (NFP) assessment?
Much of the negotiation surrounding the settlement is handled between lawyers. Still, when it comes to a family business, the financial impact can be complex and affect more than just the divorcing spouses. The implications extend to the entire family and even the estate planning process.
Lifestyle Issues and Divorce
The lifestyle of adult children funded by the family business can exacerbate divorce dynamics. The one divorcing may be accustomed to a particular lifestyle, but they may not be entitled to it post-divorce. Protections should be in place to ensure they do not receive more than they deserve.
Even without children, lifestyle issues can keep a battle raging and doing a cost-benefit analysis to evaluate the legal bills and consider a slightly higher payout to minimize conflict, save on legal expenses, and reduce emotional turmoil for everyone involved.
The Role of Family Members and Employees
Family members funding a divorcing adult child can make the process more stressful, as they often try to influence the outcome. This creates a “phantom Board of Directors” effect, adding pressure on the divorcing individual.
When both spouses work in the family business, the personal and financial effects of divorce can be more severe than if only one spouse participates. Divorce may cause business ownership conflicts, defamation, and financial disputes.
Divorce affects more than just the couple and their families—it also impacts employees. In a small business, employees may feel tension and uncertainty, affecting morale, productivity, customer service, and relationships with banks, customers, and suppliers.
Conclusion: Planning Is Key
To protect the family business from the potential fallout of divorce, it’s essential to start planning early. Legal agreements like prenuptial, postnuptial, and buy-sell agreements can provide crucial protection. The best way to safeguard your family’s future is to engage professional advisors with experience in family businesses, commercial law, and estate planning.
By taking these steps, you can help ensure that your family business continues to thrive, even if personal relationships take separate ways.
