James F. Ogorchock's NH Legal Perspective: How to avoid ex-spouse becoming your business partner
MANY BUSINESS owners fail to plan for the impact divorce can have on their business.
If the issue is dealt with before a divorce commences, steps can be taken to prevent a disgruntled ex-spouse from becoming an unwelcome business partner.
In New Hampshire, usually all assets owned by either spouse comprise the marital estate that a divorce court must divide. This includes a family business operating as a sole proprietorship, an LLC membership interest, stock in a corporation, etc. When an owner becomes embroiled in a divorce proceeding, it is possible that some or all of the owner's interest in the business can be awarded to the owner's spouse.
This could result in an ex-spouse having all of the incidents of ownership that any owner has: the right to review the financial statements, the right to attend and vote at shareholder meetings, and possibly even a seat on the board of directors. This can create numerous issues for the business, but with some advance planning, these issues can be avoided.
If a business has more than one owner, it is critical that there be a shareholder agreement or some other mechanism that restricts the transferability of an owner's interest in the business. Owners can agree to require assent of all or most of the other owners before any transfer of an ownership interest can be effectuated. If there is a non-divorcing owner he or she will not be a party to the divorce and therefore a court could not order a divorcing owner to transfer an ownership interest to the non-owner spouse without improperly affecting the rights of third parties. (If the only two owners are the divorcing spouses, such as a husband and wife medical practice, this type of agreement is not likely to be effective.)
While your business partner may have to compensate his or her spouse for the value of the nontransferable ownership interest, the business is saved from having an owner that may be more interested in inflicting pain on their ex-spouse than pursuing the best interests of the business.
Another mechanism to keep a business out of a divorce is to require all owners to execute a buy-sell agreement that requires an owner who wishes to transfer an ownership interest to first offer to sell the ownership interest to the other owners of the business. Again, this allows the other business owners to buy out the divorcing owner's share to avoid being in business with someone they did not select.
Prenupstial agreements, postnuptial agreements and trusts
For years, New Hampshire courts have recognized the validity of properly executed prenuptial agreements. More recently, the New Hampshire Supreme Court confirmed that it will recognize properly executed postnuptial agreements as well. By using these agreements, whether before or after marriage, parties can agree to exclude a business interest from the divisible marital estate.
Such agreements can be effective mechanisms, not only for the divorcing parties, but also for non-parties to the divorce who fear dilution or diversion of business interests. For example, the founder of a family business who wants to make annual tax-free transfers of portions of the family business to the next generation pursuant to an estate tax planning strategy may insist that the recipient present a prenuptial or postnuptial agreement before making the transfers to increase the chances of the business staying in the family.
Alternatively, the owner could transfer the interest into a trust for the benefit of the child to prevent a divorcing son-in-law or daughter-in-law from acquiring an ownership interest.
Even if there has been proper planning to avoid transfer of an ownership interest to an ex-spouse, businesses may still be dragged into a fight over valuation of an owner's interest. To avoid becoming embroiled in such a fight, business owners can enter into an agreement that values the company pursuant to a formula that might avoid an extensive valuation fight that could require the business to turn over sensitive information and spend significant time responding to discovery.
In conclusion, with appropriate planning, business owners can avoid ending up in business with a disgruntled ex-spouse.
NH Legal Perspective is a bi-weekly column sponsored by Sheehan Phinney Bass + Green PA. This column does not provide legal advice. We recommend that you consult an attorney for specific guidance on legal questions.