First Steps
Regardless of when you are brought into the case, the first steps in navigating a business-and-marital divorce are (1) identifying the relevant stakeholders and (2) identifying any agreements that may govern or have an impact on the process.
Identifying stakeholders can often eliminate the need for future litigation. While the business is not typically a party to any divorce, that does not mean that the business—and any other owners or executives—can be ignored. When people have built a successful business over many years and decide to split ways, the process of dividing this asset without damaging the business as a going concern is complicated and delicate, often with emotions running high. This process can involve many stakeholders beyond the spouses. Family businesses, even extremely large businesses with multimillion-dollar valuations, can be run as closely held concerns with family members and close friends in management positions. Dividing a business of this type can involve multiple stakeholders: the spouses, any children or other family members who are involved in the running of the business, and executives (who may have their own ownership stakes in the business).
Ignoring the rights of necessary parties can endanger the divorce settlement’s finality. For example, minority owners may have management rights. Or, if the business division diminishes the value of the business or minority owners are unfairly excluded from management decisions during the divorce process, potential liability from breach of fiduciary duty or minority oppression claims can easily arise. Because this ancillary litigation will often undermine the finality of any settlement agreement, taking stock of the relevant stakeholders may be necessary to develop a workable strategy to divide the business.
Another early step is to identify and carefully review relevant agreements, including postnuptial and prenuptial agreements, operating agreements that govern the business, and any buy-sell or other similar agreements. Prenuptial and postnuptial agreements may affect the process and outcome of any business division in a marital divorce. They may determine whether or not a business is marital or nonmarital property, govern the process for dividing assets, and dictate the forum where this division must be adjudicated.
Although pre- and postnuptial agreements may govern the division of assets in a marriage, management and control of business entities are generally dictated by the entity’s formation and governance documents. They may detail each individual’s fiduciary duties owed to business partners or to the other spouse. Fiduciary duties can also be limited in an operating agreement, but whether an operating agreement can limit common-law fiduciary duties depends on the duty and the jurisdiction. Operating agreements may also contain provisions governing how any ownership interests in the business can be transferred, including provisions that restrict transferring interests. In some operating agreements, all partners (if they include more than just the spouses) may need to approve any transfer between spouses. In those circumstances, any final settlement will also require approval from all the necessary parties.
Finally, operating agreements may also indemnify business owners, directors, and officers, or hold them harmless in the case of litigation. These clauses may also require the business to pay for attorney fees related to any claims that arise from the operation of the business. Depending on your client’s relationship to the business, indemnification could even protect your client if he or she is sued for actions taken related to the division of assets.
Another potentially relevant agreement is a buy-sell agreement. Many closely held family businesses have buy-sell agreements that govern how a partner’s share of a business may be reassigned if that partner dies or otherwise leaves the business (including through divorce). A typical buy-sell agreement requires that the available shares be sold to the remaining partners or to the partnership, but that is not always the case. A buy-sell agreement, if the parties have one in place, can govern the business division process and limit conflicts between the parties.
Each of these agreements should also be carefully reviewed to determine which agreement controls which portions of the process and if there is any conflict between any provisions in the various agreements.
Fiduciary Duties
Another area of consideration are potential fiduciary duties that these agreements could create. Each agreement should be read with a careful eye toward understanding any fiduciary duties the parties have to each other. Potential breach of fiduciary duty claims could also arise while the business is being divided during a divorce. Even well-meaning parties can expose themselves to such claims because married couples owe each other fiduciary duties. Indeed, all transactions between spouses must be fair and reasonable, and spouses have a duty to fairly disclose financial transactions to each other.
Marital fiduciary duties may end when the parties each retain counsel and initiate divorce proceedings. However, spouses who co-own a business may have additional or continuing fiduciary duties as business partners. They may also owe fiduciary duties to the other owners, shareholders, and partners. Depending on the jurisdiction, these include the duties of good faith and fair dealing, loyalty, and care, which require avoiding conflicts of interest and self-dealing and typically require fair disclosure of financial information relevant to the business. Further, in some cases, former spouses may still owe each other fiduciary duties if one spouse retains control of assets as a part of the finalized divorce settlement. For example, one Texas court found that a husband had a fiduciary duty to distribute to his ex-wife her share of distributions from business interests assigned to her under the divorce decree.
Avoiding Future Litigation
Besides protecting clients from breaches of fiduciary duties, litigators can also ensure that any agreement is final and not subject to future litigation. Whenever a spouse transfers his or her ownership in a business, for example, the transferring document should ensure that the spouse is conveying all of his or her interests and rights in the business. This is essential because an ownership interest in a private company may encompass many different rights, especially if the spouse was also an employee, including the right to receive distributions, compensation, and health care or other types of benefits. Any transfer document, including a divorce decree or settlement, should be written in broad and inclusive language that makes clear that the spouse transferring the interest will not receive any future benefits or financial considerations from the company or from the other spouse.
Another example is ensuring that any final agreement contains mutual releases. It is standard for a divorce settlement to include a mutual release. However, for the purposes of finality, it is also important to secure a release from the company, especially if your client is the spouse that is being bought out. A release solely granted by the ex-spouse likely would not cover claims held by the business. Securing a release from the company prevents the business from bringing any claims against your client after the divorce becomes final.
The spouse who is leaving the company should also seek an indemnity from the company that provides protection if a future lawsuit names the spouse as a party, to pay for counsel and cover any liability that results from this litigation. Similarly, the spouse who is leaving the business should ask the company to extend the protection of the company’s directors’ and officers’ insurance policy, if one exists.
Another potential agreement to include in any final business division is a non-compete/confidentiality agreement. The spouse who leaves the company may have confidential information valuable to the business and could pose a competitive threat after the divorce. If so, the spouse who retains control of the company may want to negotiate some type of confidentiality/non-compete agreement as a part of the overall business division and divorce settlement. The spouse seeking a non-compete agreement will likely need to provide additional consideration to compensate for this restriction on future employment or business opportunities. However, confidentiality agreements do not typically require additional consideration to be valid.
If the Parties Want to Fight
Each of the considerations outlined assumes that the parties are cooperating in the process of the business division. But what if the parties cannot agree on anything? If the parties are determined to fight, it is still possible to keep your client (and the business) from crashing to the floor. One possible avenue is to seek the appointment of a receiver as the business’s custodian to secure the asset and protect it during a divorce.
Although receivership is a drastic remedy, courts will appoint receivers in a marital dissolution upon a proper showing. There are many potential negative consequences following the appointment of a receiver. The cost to pay for the appointment of a receiver may be too high, or the process of putting the business into receivership could potentially destroy it as a going concern.
Yet, if a business can withstand the cost of appointing a receiver, a receivership may be a valid option in certain circumstances. If the level of trust between the spouses is too low to manage the day-to-day business without damaging the business and the process of division is necessarily lengthy, a receivership can actually retain the value of the business. In addition, a receivership may be a good option if there is concern about concealment or dissipation of business assets by the other party. If the assets of the business are cash, cash equivalents, or readily marketable, they could be easily spirited away by an unscrupulous spouse. A receivership can also be a way to protect your client from allegations of wrongdoing in managing the business. If your client is being wrongly accused of dissipating the assets of the business or other wrongdoing, a receivership is one method of opening the books of the business to the scrutiny of the court and protecting your client from having to defend baseless suits filed by a vengeful spouse. While a receivership may be a drastic and costly remedy, in some cases it may be the best method to ensure that your client can protect the value of the business.
A business and marital divorce may be an emotionally charged and difficult process. Litigation attorneys can help clients avoid pitfalls and smooth the division process, ensuring that neither the parties nor their business comes crashing down like that chandelier.