No one enters a marriage planning for it to fail. We all know about divorce, though, at least in a vague sense. If a couple splits, assets are divided and they go on their way, right? But what if that couple also owns a business together? How are business interests valued and distributed in a divorce?
This is an important topic for all married and soon to be married business owners to consider and plan for in the event their marital bliss falls short. The key issues are: “what business interests are classified as marital property”, “how are those interests to be valued” and lastly, “how they will be distributed between the parties.”
Since Michigan is an “equitable distribution” state, the Michigan Supreme Court has stated that one’s “business property and interests” acquired or appreciated during the marriage constitute “marital property”, and shall be equitably divided in the event of a divorce. Unfortunately, the process of dividing the business interests is often difficult and impractical, since no one wants to be in business with an ex-spouse, in addition to the prospect of lower employee morale, lack of quality and attention to detail and losing customers. As a result, courts often employ the “Buy-Out” principle, which is basically one spouse (usually the one with the controlling interest) buying out the other spouse based on an equitable formula. Courts will look at the valuation process and purchase terms within a Buy-Sell Agreement signed by the parties as evidence of what the parties wanted (assuming there is one). However, the courts are not bound to those terms. They have the equitable discretion to have an independent valuation conducted and to look at other relevant evidence and testimony to determine how much the parties are entitled to.
All of this legal uncertainty has implications when it comes to the use of pre-nuptial agreements, mainly: will the business interests be part of the marital estate or will the parties agree to offset the business interests with other marital property, such as the home, cottage and other property? Also, the parties need to address these questions in a business succession plan, especially if non-family members are involved. As a result, here are some basic recommendations to consider:
- Have an “updated” Buy-Sell Agreement signed by the parties (spouses and non-spouses);
- Limit transfers (gifts and sale) of business interests to only lineal descendants -your children (this will exclude spouses, significant others, cousins or other third parties from having any contractual rights);
- Reference an “equitable pricing formula” in the event of a divorce in the Buy-Sell Agreement;
- Follow all Buy-Sell Agreement terms in all non-divorce situations to validate the agreement;
- Consider using a pre-nuptial agreement that references the terms in the Buy-Sell Agreement;
- Determine how to finance the Buy-Sell terms in the event of a divorce.
Hopefully, none of you will ever have to experience the anguish of divorce. However, a little foresight and planning might go a long way if this unfortunate event occurs.
Please feel free to comment on this topic as your input and thoughts are always appreciated.