Divorce is complicated, but there are protections to be put in place to ensure the viability of a family business both during and after divorce. During divorce proceedings, the court imposes an automatic restraining order restricting each owner from selling, transferring, encumbering, concealing, assigning, removing or disposing of business property, except in the ordinary and usual course of business. At the time of the divorce, all assets are divided, including business interests. It is, of course, challenging for a divorcing couple to continue to operate their business as co-owners and managers.
Even when one party owns the interest in the business, a court could grant the non-participant spouse an interest in the business, which could adversely impact the viability of the company. Business founders and owners can protect themselves from this dilemma with proper advance business planning and implementation of certain strategies prior to or at the time of the divorce. For example, they can set up buy-sell provisions and procedures in their operating agreement, stockholders' agreement or a buy-sell agreement. These provisions help define what might constitute transactions in the ordinary and usual course of the business. Additionally, owners can protect their business interests with either a premarital agreement or postnuptial agreement. These agreements would define each person's interests, in addition to how the business would be run both during and after a divorce.
Most businesses are formed as limited liability entities such as limited liability companies or corporations. An LLC should have an operating agreement, and corporations should have restrictions on transfer set forth in their articles of organization, stockholders' agreement or in a buy-sell agreement. For purposes of this article we will refer to the equity in any type of limited liability entity, such as an LLC or corporation, as stock and to the owners of the equity as stockholders.
Following is a non-inclusive list of items to be considered by stockholders for inclusion in the company's organizational documents or separate operating agreement, stockholders' agreement or buy-sell agreement:
- Restrictions on transfer of stock. In a two-person company, the simplest way to restrict transfers of stock is to provide neither stockholder can transfer any stock without the advance consent of the other stockholder. This broad type of restriction may not hold up under legal scrutiny – in some cases it has been held to be an unreasonable restraint on alienation of property. It is more advisable to provide that if a stockholder has a ready, willing, and able buyer for his or her stock, the stockholder must first offer the stock on the same terms to the company to buy back, and if the company declines, then to the other stockholder on the same terms. Only if both the company and the other stockholder decline the deal should the selling stockholder be permitted to sell the stock to the third party, and then only within a specified period of time. Payment by the company or the purchasing stockholder can be done fully or partially with a promissory note payable over time.
- Forced purchase or sale of stock upon the occurrence of certain triggering events. This type of provision is very practical in a business owned by a married couple. The agreement would specify that upon the occurrence of certain defined triggering events, either stockholder can force a purchase or sale of the other stockholder's stock. Triggering events could include the breakdown of the marital relationship, or just one stockholder deciding he or she wanted to get out of the business. The stockholder starting the process, Party A, would give a notice to the other stockholder, Party B, saying that Party A wants to trigger the process and would propose a company valuation. Party B would then have to either sell Party B's stock to Party A at a price based on that valuation, or purchase Party A's stock at a price based on that valuation. The result is that either Party A or Party B owns all the stock of the company. Again, the purchase price could be paid over time with a promissory note or other marital assets may be used as an offset.
- Purchase by divorced stockholder upon transfer of shares pursuant to divorce. A buy-sell agreement could provide if a stockholder is required to transfer any stock to a spouse in connection with a divorce, that stockholder must buy the shares back from the spouse at some agreed upon value, or a valuation based on a formula or determined by a third party appraisal. If the agreement purports to bind the spouses of stockholders, be sure to have those spouses sign the agreement.
- Mandatory resignation from all company positions upon sale of stock. The agreement should provide any stockholder selling all of his or her shares of stock must simultaneously resign from all positions as officer, director, manager, employee, and service provider to the company, unless the remaining stockholder elects otherwise.
There are many variations on the above and other arrangements founders can set up at the beginning of the business relationship that can help sort things out down the road, if and when a personal relationship begins to break down. Waiting until the time of divorce makes the implementation of these types of agreements more costly and uncertain. Business owners should ensure the provisions are clear, reasonable, and binding upon the right parties, to make sure they hold up if challenged.
Originally published by Worcester Business Journal
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.