Divorce – Can the Business Remain Intact?

Divorce – Can the Business Remain Intact?

By Douglas C. Alexander

When a new business is formed, all eyes look ahead. Although business owners usually carefully evaluate the risks and challenges that the new business might face, they often assume that they will continue to get along and that internal dissension among the owners will not impair the business’ success. Nevertheless, most owners also conclude, at the start of the business, that it makes good sense to negotiate and enter into an appropriate Buy-Sell Agreement, while everyone agrees on its terms.

Well-drafted Buy-Sell Agreements can help business owners avoid disagreements in the future. They address a variety of issues, including the following:

  1. Should the shareholders be restricted in their rights to transfer their shares to others?
  2. Should the shares of a shareholder be subject to purchase upon the death, disability, bankruptcy, or termination of employment of a shareholder?
  3. Under what circumstances may a shareholder elect to leave the company and force a purchase of his or her shares?
  4. Upon a buy-out, what will the terms of purchase be?

These issues apply to members of an LLC just as they apply to shareholders of a corporation. A careful evaluation needs to be made of the issues and the potential solutions, and then an agreement must be prepared to accurately reflect the intent of the business owners. However, one issue which is often overlooked, or inappropriately addressed, is what will happen if one of the shareholders becomes divorced. Can the shareholder transfer shares to his or her spouse in the divorce? Can a court order such a distribution? What means are available to avoid or restrict these possible transfers? Most shareholders agree that they do not want to do business with the spouse of a shareholder unless the spouse has also been an active participant in the business.

Unfortunately, courts are somewhat unsettled on this issue, and there is little case law to provide real guidance. In the absence of clear rules, people often resort to unique, and possibly, unenforceable solutions. For instance, we have seen people suggest that if a transfer of shares occurs in a divorce situation, then the shares should be repurchased for $1.00. It is highly unlikely that any court will conclude that the purchase value set in the Buy-Sell Agreement in such a circumstance will represent “fair value” in the divorce analysis.

The key to effectively addressing the divorce scenario is to indicate in the general restrictions on transfer that all “voluntary and involuntary transfers” are restricted. To be really sure, one can add that this phrase is intended to “include without limitation transfers to the spouse of a shareholder incident to divorce.” Most commentators would agree that including this type of specific restriction should limit the ability of a court in a divorce proceeding to order a shareholder to transfer the shares to his or her spouse, as it would result in a breach of the Buy-Sell Agreement by the shareholder involved.

However, often an abundance of caution is a good idea, and when it comes to divorce, that is certainly the case. In a divorce proceeding, the judge has broad discretion, and how that discretion is used may be highly dependent upon the makeup of the assets being divided. If the “non-business” assets are insufficient to satisfy the property division obligation, the court may then be forced to look to the “business” assets (i.e., the stock) to balance the ledger. Thus, as a backup, it is often a good idea to build in a right of the other shareholders to purchase any shares that are transferred in violation of the agreement, perhaps even at a discounted price and on favorable terms. However, great care must be taken in drafting the language to avoid implying that the transfer is therefore a “permitted” transfer.

Buy-Sell Agreements should not be overlooked, and at a minimum, the possibility of a divorce and its potential impact on the business should be considered. Each business is different, and the right solution in addressing the Buy-Sell issues is often different in each case. Nevertheless, in this case, an ounce of prevention is worth many pounds of cure it is far better to have asked and answered these tough questions in advance than to wait until the divorce looms on the horizon and then wonder how you will be affected. If you have not already addressed these issues, call us so we can help you with a Buy-Sell Agreement appropriate to your particular circumstances and needs.