Protecting family businesses from the impact of divorce
By Marika Franceschi
Posted: 26th September 2016 08:23
The overlap between family law and corporate work might not be immediately obvious. Family lawyers deal with relationship breakdown, division of assets, maintenance, disputes regarding children and so on. Surely none of that has anything to do with corporate law?
It is estimated that there are 4.6 million family businesses in the UK ( Institute for family Business Report 2015-2016 ) making up 87% of private sector firms in the UK and 92 % of private sector firms in Scotland.
Depending on the plans for the business, the principals may well be taking professional advice on succession planning, the most tax efficient way to pass the business on to the next generation or business continuity in the event of sudden death but how often do they consider the impact of divorce of one of the partners or shareholders?
Does the company’s shareholder agreement contain pre-emption rights or are there permitted transfers that require to be considered in the context of divorce? Should the Agreement state that transfers between spouses are to be automatically transferred back in the event of separation?
And then there are employment rights to consider. Family businesses often engage several generations and couples whether married or cohabiting. Are there legitimate contracts of employment in place? One might have to consider the potential for claims for constructive or unfair dismissal, disputes regarding pay and the like.
Perhaps the most worrying is the possibility that an asset that had the potential to be ring fenced from any claims on divorce could have unwittingly fallen within the definition of matrimonial property, thereby dramatically increasing the value of a spouse’s claim.
Depending on the other resources available to a business owner who find themselves in this position, there could be no option but to use the business as security or, worse still, sell off certain business assets in order to meet the claim.
Needless to say, even the most supportive of families would find it difficult to absorb the emotional and financial fall out from such an event.The definition of matrimonial property and how it is applied differs significantly between Scotland and England.
In Scotland, the definition, found in s.10(4) of the Family Law (Scotland) Act 1985, is restricted to assets acquired by the parties during the period of the marriage with limited exceptions found in subsections 10(4)(a) and 10(5). The assets should be acquired by the parties’ own efforts and therefore assets acquired by way of inheritance or gift from a third party are generally excluded from the definition provided they have remained in the same form.
It follows that there is an obvious opportunity in Scotland to protect generational wealth passed down from one generation to the other or assets acquired prior to the marriage and it is often the case that family business interests fall into one of these categories.
However, the protection which is automatically provided by the Scottish legislation is placed at risk if an asset changes form and this can come about in a number of ways that are often led by a desire to improve tax or management efficiencies. Typical examples include:
- Cash sums gifted as a potentially exempt transfer and reinvested by the recipient in a new asset such as a share portfolio or to reduce a mortgage
- Restructuring of a company and share-for-share schemes giving original shareholders shares in the new company
- Gifting shares to a spouse in order to make use of additional personal allowance and lower tax band for the payment of dividends.
This is not an exhaustive list but all of the above examples come about as the result of sound business or tax advice. Unfortunately, they all involve the creation of a new asset and if the change occurs after the date of marriage and before the date of separation, this has the effect of introducing the new asset to the matrimonial property which requires to be valued and divided on divorce.
It is not uncommon for interests in multi-million-pound family businesses to accidentally fall into the 'matrimonial pot' in this way. The business owner is then left having to argue that special circumstances apply to the new asset as a result of it having derived from non-matrimonial assets. However, such an argument invokes the considerable discretion available to the courts and even when successful, following costly litigation, is unlikely to involve the exclusion of the new asset.
Clients considering such reinvestment or restructuring within their personal or private affairs be best advised to consult a family law specialist to consider the potential implications and whether a pre or post nuptial contract might be appropriate.
Post credit crunch and Brexit, all investors are more aware of their financial vulnerability. Individuals are marrying later, having built up assets along the way, and some have children they wish to protect from previous relationships. Others, feel the responsibility and pressure of being the custodian of family heritage, be it a country estate or family business. All of this has led to an increase in the reliance upon pre and post-nuptial contracts on both sides of the border.
While the restricted definition of matrimonial law in Scotland makes it much easier to protect assets acquired prior to marriage or inherited/gifted from a third party during marriage, the automatic protection is lost once the asset changes form.
It is unrealistic to expect dynamic businesses or active personal investors to retain all assets in their original form indefinitely and the use of pre and post nuptial contracts and, in some cases, the use of trusts can help ring fence the value in these assets for future generations whilst liberating them for further investment.
The definition of matrimonial property in England can extend beyond the confines of the period of marriage and is, in some of the more extreme cases, sufficiently far–reaching to include the likes of discretionary off-shore trusts.
The obligation of spousal maintenance is also far more onerous in England and so the overall impact of a divorce on an individual’s capital and revenue is arguably greater south of the border. There is, therefore, also a greater need to take such an eventuality into account when giving advice, not only in relation to personal investment, but also in relation to business creation, restructuring and sale.
While the definition of matrimonial property might differ between Scotland and England, both jurisdictions recognise the distinction between assets acquired during the marriage through the spouses’ efforts and those acquired prior to marriage or by succession or gift from a third party.
The impact of divorce on a family business will depend on its structure, the relationship between its principals and the extent to which such an eventuality has been considered and planned for. Ideally, family law advice would be sought at the point of drafting a partnership or shareholders’ agreement and certainly before any restructuring takes place.
Obtaining counsel concerning family law matters at the same time as getting sound corporate law advice is a real opportunity to minimise the disruption and upset caused by acrimonious divorce and to protect family businesses for future generations.
Marika Franceschi is a solicitor Accredited by the Law Society of Scotland as a specialist in Family Law.
Marika joined the firm in November 2012 as a Partner in the family law department. She has specialised in complex family law matters for over twelve years. Although she has particular experience advising on complex ante-nuptial contracts and high value claims for financial provision on divorce, she also deals with a wide range of issues including child residence and contact disputes, child relocation and Petitions under the Hague Convention on International Child Abduction.
Marika can be contacted on 03700 868059 or by email at firstname.lastname@example.org