Business Law & Compliance

Preventing a hostile divorce: Six unfortunate family business considerations

6 min read

29 March 2018

If you are setting up a family business, it is sensible to consider what could happen to it if your relationship breaks down.

This can seem very alien in the optimistic and joyful days of planning a family business together but as a divorce lawyer, I have often been involved in unravelling these structures and if the relationship between a couple becomes hostile it is a very difficult scenario where nothing is going to be resolved easily.

(1) If the business is being run by one person

Let’s say it is by way of example the husband. I would advise that the wife is not a shareholder and is not named director. This may be contrary to the advice of the company accountant, but it can have adverse consequences in the event of marital discord. If the wife is going to work in the family business, she should be paid a salary commensurate with her role. This structure leaves the control of the business in the hands of the person who is actually running it.

It will also avoid situations where, say, a husband or wife has named their spouse as a 50 per cent shareholder without considering the hostility which can surround a marital breakdown where one could use their votes against the other. I have had angry spouses threaten and sometimes even contact the bank which can lead to important business loans, that were expected to be considered favourably, being refused.

In their capacity as director and 50 per cent shareholder a hostile spouse may contact suppliers, customers and employees and cause considerable damage. Corporate redress can be a slow and cumbersome method of dealing with situations like this and often the damage is already done. The question to ask is: “If I am giving my spouse a 50 per cent shareholding and they are a director alongside me, how much turmoil could they cause if they chose to do so.”

(2) If both spouses are involved

In this situation, the family business could be set up with a carefully crafted and pre-agreed exit mechanism. Husband and wife teams do not usually have shareholders agreements (SHA) but this is something they could consider. The SHA would include pre-emption provisions on share transfers; cover the situations where compulsory transfers could arise; and include a mechanism by which the shares could be valued.

If there are other shareholders then SHA should provide that the shares of the existing spouse should transfer to the spouse who is remaining in the business, rather than divided amongst all the shareholders. If they were, that would impact on the balance of interests within the company.

The SHA would have to dovetail with any pre-nuptial agreement. However, a couple with a pre-nuptial agreement rarely have a joint business without carefully considering the documentation needed.

(3) Husband and wife teams operating as a partnership

In such cases it is advisable to have a partnership agreement. Without one, on a breakdown in the relationship, the partnership would be governed by the Partnership Act 1890 and needless to say some of its provisions are outdated. For instance the Act enables either partner to dissolve the partnership without the agreement of the other. The consequences could be ruinous. If you are setting up a partnership with your spouse then have a one drawn up.

(4) Changing a partnership into a limited company or a limited liability partnership

As part of the proposal, the question should be asked “what will happen if we split up”. As part of this kind of re-structuring, a property, say commercial premises, might be owned by the company. If there are other family members who are also shareholders, they then have a financial interest in those premises. If a couple are divorcing, and one is seeking the sale of those commercial premises, it will affect not just the other spouse, but also the other shareholders and the business itself. This can lead to very significant problems and related legal costs.

(5) When one or more adult children join the family business

It often involves them being given a shareholding. The couple need to consider what would be the impact of a divorce, if the adult children take sides with one or other parent. They may then have a majority shareholding and associated control within the business.

(6) If third parties are promised a future interest

This is often done orally or by letter, perhaps saying to an employee that they would have a certain percentage interest if the business is sold. Such letters rarely set out all the details and whether this confers a profit share. If anyone is given an interest, this should be fully documented as it may otherwise create further dispute between a divorcing couple. The arguments and uncertainty might lead to these employees leaving the business and doing irretrievable harm.

Marilyn Bell is head of the family department, and Chris Wilks is head of the corporate and commercial department at SA Law