The Valuation Dilemma
The most contentious business issue in many divorce proceedings is the value of the business that must be divided as part of the divorce settlement. Valuation is an inexact science, and the divorcing couple can easily spend hundreds of thousands of dollars on expert and legal fees battling it out over the value of one or more private companies included in the marital estate. This challenging issue is not subject to any easy fix. But there are some options the couple may want to consider before engaging in an expensive and time-consuming valuation battle.
Marital settlement agreements are common documents used to mitigate problems with divorce litigation. While a pre-nup is more common, couples can also agree to enter into a post-nup that details a property division and removes any conflict regarding the valuation of specific assets. Texas statutes set forth strict requirements to follow for marital agreements be enforceable.
Jointly Held Assets
If the spouses agree to allow one spouse to retain ownership/control the asset after the divorce, the owner/operator will be designated as a “constructive trustee” over this minority ownership interest. This fiduciary status which imposes the highest level of fiduciary duties on the operator. In this scenario, the non-operator will be a beneficiary of the constructive trust with full protection that any/all distributions made by the company will be shared equally.
The parties can also agree to include put/call options into the agreement to allow for a future sale of their interest in the asset (subject to transfer restrictions in governance documents). Alternatively, as part of an estate plan, the couple can provide that their ownership interest in the company will passed to their children or grandchildren via a trust as part of an estate plan they have adopted.
The Other Party in the Room
When divorcing spouses transfer ownership interests in private companies as part of the divorce settlement, a third party—the business itself—may need to be a party to certain aspects of the divorce settlement. The potential involvement of the company in the divorce settlement based on transfers of an interest in the business are discussed below.
For example, in the divorce settlement, when a spouse transfers his/her interest in the company to the other spouse, it is common for the Buying Spouse to grant a broad release to the Selling Spouse. In addition, the Selling Spouse should insist, as well, on securing a release that is provided by the business, and not just from the Buying Spouse. This release from the business will ensure that the Selling Spouse will not face any claim or lawsuit that is filed by the business after the divorce. Similarly the Selling Spouse will also want to request the business to provide an indemnity for any post-divorce lawsuit or claim that may be filed by a third party against the Selling Spouse after the transfer takes place and divorce is final. The Buying Spouse will want to omit (carve out) any indemnity provided to the Selling Spouse, however, based on or relating to conduct by the Selling Spouse that results in a claim.
The important take-away is that both spouses should consider what claims and/or rights the business may have in connection with the divorce. One or both spouses may need to request the business to provide a release or grant other rights to a spouse in connection with the ownership transfer that takes place as part of the divorce proceeding.
Conducting a business divorce during a marital dissolution creates a number of complex challenges that must be resolved for the couple to achieve a successful divorce settlement. These issues are not insurmountable, however, and the tools that we review in this post offer guidance to help navigate some of the most common conflicts that arise in the divorce process. The true key is attempting to set emotions aside as much as possible and focus on optimizing the value of the marital estate in order to achieve an outcome that is in both parties’ best interests.