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Considerations for the Family Business upon Relationship Breakdown

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It is a sign of the times that sadly a considerable amount of businesses, from sole traders to multi nationals, are failing.  But what happens when a company is owned in whole or in part by a husband and wife and their relationship breaks down?

Upon a marriage breakdown, all the assets of the marriage must be identified, valued and available for division in the fairest way taking into account a list of specific factors set out at section25 Matrimonial Causes Act 1973 including the needs of any minor children and all the circumstances of the case.  Any interest in a company whether in the sole name of one of the spouses, or jointly held by both is an asset that is included in that "pot".   In that event, it is also open to the Court to make orders in relation to the company that may conflict with existing provisions within shareholders agreement and/or articles of association, if it is required in order to meet the needs of the separated family.

The Court has power to order a transfer of shares in a company or certain assets of the company to be sold (although this is seen as a last resort).  However, consideration must be given to the interests of any third parties unconnected with the family.  Not only those who are directly involved within the management of the company but also the impact of any matrimonial dispute may have a knock on effect to employees, bankers, creditors and suppliers and the fall out of gossip and speculation must be managed.

Considerations for the Court

However, before any orders can be made, the Court must know as much as possible about the company, in particular its value. 

It is imperative that the value of the shares of the company are calculated as well as having an idea as to what scope exists for realising that value on any sale, or for raising funds in some other way.   Further what would be the consequences if the shares in the company were transferred?   In the ancillary relief process on divorce, both parties are required to provide full and frank disclosure which must include details of all business interests and the extent of any shareholding compared to the overall shares issued.   For many people, particularly the husband and wife, the company is the main income provider for the family and the key will be to keep it going, often beyond the conclusion of the proceedings, whilst ensuring that both parties achieve a fair settlement.  However, even if the company is clearly not going to be sold, it does not mean that it does not need to be valued.

Identifying the Ownership of a Company and piercing the Corporate Veil

Part of the Court's task in getting to the bottom of the assets of the marriage, particularly if there is a company involved will be to identify the value and ownership of the company.   A spouse cannot "lift the veil" to try to reach the assets of a company on the basis that they are actually assets belonging to the spouse.  This has been recently confirmed by the Court in Hashem and Shayif [2008] EWHC 2380.  The veil can only be lifted if there has been some impropriety linked to the use of the company structure to avoid or conceal liability.   If that is the case, the Court will only pierce the veil if necessary to provide a remedy for the particular wrong which those controlling the company have done.

Disputes in the Family Business

It would not normally be recommended that both husband and wife continue to play an active role in the company going forward unless they had a very good relationship with each other and therefore the Court will want to examine the possibility of one party buying out the other's interest\\shares.  

The liquidity of the company will therefore be an issue so that the Court can ascertain what funds can be drawn from the company in order to meet any financial lump sum order.  What effect would this have on the day-to-day running of the company?  Can it sustain a withdrawal of funds and still be maintained?  Should any withdrawal be on a piecemeal basis?  It may be that, to balance fairness of outcome between company and a separating spouse, payments have to be made from the company in instalments over a period of time.

If it is not possible to withdraw any or limited funds from the company in order to safeguard its position, the Court may favour giving the other party a limited ongoing interest in the company, or providing a party with a greater share in the matrimonial home or by providing a lump sum, rather than order or otherwise be the cause of a full sale of the company. 

If the parties are to remain involved it is essential for their respective roles to be regulated by the drawing up of shareholders' agreements (or if there is already a shareholders agreement in place reviewing the provisions to ensure they are still applicable/adequate) and for undertakings to be provided.

How to Protect your Business

It is prudent in any event - irrespective of its ownership - for any company to put in place an appropriate set of articles of association and shareholders' agreement, which amongst other things, will govern the mechanism for the transfer of shares by its shareholders.  It is recommended that pre-emption provisions are considered.  Such provisions are most commonly found in articles of association and ensure that if a shareholder wishes to transfer his/her shares in a company, the shares must first be offered to the existing shareholders pro rata to their current shareholdings in the Company.  In the context of a "family" company, it can be crucial.  Pre-emption rights therefore protect existing shareholders against the prospect of undesirable third parties acquiring shares in the company

However, whilst these documents (if effectively drafted) will be enforceable in a commercial context, they will not necessarily bind a family court.  The existence of such a framework dealing with the transfer of shares will provide the Court with useful guidance and/or alternative solutions to deal with the task of ascertaining what funds might exist for distribution or division, without potentially damaging the governance of the company.

Conclusion

The law relating to the distribution of the finances upon the breakdown of the marriage and the position of shareholders in a company could present a conflict.  Judges in the family courts have the power to order a transfer shares.  It is therefore important that expert advice is taken at an early stage in order to protect the company.  It seems that although family judges may, in certain cases, override the articles of association and shareholders agreements, they will however take factors into consideration relating to corporate governance, the effect of such a transfer on third parties and the intentions of the parties to the shareholders agreement.

It is therefore preferable upon the breakdown of a marriage to attempt to reach an agreement with the other party as to a financial settlement and for that agreement to be embodied within a sealed Consent Order rather than leave the matter to a judge to determine how the finances should be distributed. A Consent Order will remove the element of uncertainty in financial proceedings, particularly for a party who is a shareholder or director of a company. A shareholders' agreement will ensure that there is a mechanism in place for the transfer of shares and although not watertight in family proceedings or against a potential judicial order it is a good way of protecting a party's position in a company when they are facing divorce.

What is also clear is that expertise from both the family perspective and the company perspective is required in order to provide the court as many options for the company and separating couple as possible.

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