27 Jan 2017Whether you are married or in a de facto relationship, divorcing or separating from your spouse is stressful and can have substantial impact on your business. It creates challenges not only for the spouse(s) running the business, but also for any partners or other shareholders in the business, and for the continuity and value of the business.
Small to medium businesses are usually affected the most as a consequence of a separation.
Accurate record keeping makes financial disclosure easier
Each spouse has an ongoing obligation to give full and frank financial disclosure. (Please see Disclosure requirements in family law – what am I meant to provide?)
This means that business records, financial statements, bank records, BAS and tax documentation is to be compiled and provided to each spouse. This could be required several times during a court process.
The disclosure task is often very time consuming and can best be handled by the business’s accountant or bookkeeper.
All business interests, whether in a partnership, sole trader, company or trust structure, can be treated by the court as “property” as defined by the Family Law Act and must have a value attributed to them.
It is important to understand that the business structure and the control of the business entity will have significant influence on how the business is dealt with during a separation. So keep up-to-date and accurate records.
Sole trader businesses usually given a modest value
In the vast majority of circumstances, a sole trader like a tradesperson or professional consultant is a “personal exertion” style of business, with few employees, if any.
Most of the time the business will remain with the sole trader who has the skill and training, and a value needs to be attributed to the business.
Ordinarily the value of the business hinges almost entirely on the personal reputation of that individual. Usually a modest value would be applied to such a business interest as a “value to the owner”.
The books and records of the business will need to be disclosed to the other spouse. The court will take the business into account as a future financial resource of the spouse retaining the use of that business.
If there are multiple employees, the value of business will be determined by the usual valuation processes.
How does the court treat partnership businesses?
Partnership businesses can be broken into two categories – spouses in partnership and partnerships with a third party or parties.
Spouses in partnership
This is also usually a “personal exertion” style of business. Usually one spouse will retain the business. A value will be determined for the business the same way as for a sole trader, ie value to the owner.
Similarly, if the business has employees and has been operating for a number of years, it will need to undergo the normal business valuation process.
Obviously, in a situation where both spouses have worked in the business and then go through a separation, that will have a significant impact on business continuity and will affect the staff. It would be rare for a business to continue to be operated by two spouses who have separated.
Partnership with a third party or parties
A separation will have an impact on the other business partner(s). Not only will there be a change of focus by the partner who has separated; there will also be the requirement to give disclosure, which is often not welcomed by the third party partner(s).
The court will take into account any partnership agreement with the third party partner(s) and will consider the effect of the separation on the partnership and the third party’s rights.
It is highly recommended that all partners in a business enter into a partnership agreement prior to the separation. Such an agreement could stipulate the method to determine the value of the business and the actions to occur in the event of a separation – for example, trigger provisions to enliven a buy/sell arrangement between the partners. These clauses can work to preserve the business continuum, as well as maintain the value in the partnership.
Company held businesses – are there any third party shareholders?
If the business is owned by a company, and that company is a “family company”, where the shares in the company are held by the spouses, then it will be considered essentially an alter ego of the spouses and dealt with as a quasi-partnership (see above).
If the business is owned by a company which has third party shareholders, because the business is an asset of that company, it is necessary to determine the value of the shares in the company.
In either scenario, the business will still need to be valued, and disclosure given, but the value of the shares will also depend on the balance sheet of the company. Often a common entry on the balance sheet is a director’s loan account. Whether it is a credit or debit, that loan will also need to be considered in the valuation of the shares and the determination of repayment arrangements.
Who has control of the company?
The court will also have to consider the company structure to determine the control of the company, eg whether there is an equal or an unequal shareholding and the different share classes.
The control of the company is a key factor, eg one party may have a majority (simple) or a special majority, which may ultimately affect the manner in which the company is operated and valued.
If the separating spouse shareholder has a minority shareholding with a third party, then that minority shareholding will probably have a lesser value attributed to it for practical purposes, because the minority shareholder is unable to make determinations about the company. The opposite applies if the separating spouse has the majority shareholding and is therefore able to exert a majority influence and control the operations of the business.
A well-crafted shareholders agreement is advisable. This may include determining a value and specifying trigger events such as separation from a spouse, leading to the requirement for a buy/sell arrangement. The company constitution could also be important to consider.
If the separating spouses are directors or secretaries of a company, they must remember that they are still required to comply with the Corporations Act and their duties and obligations as an office holder, to act in the best interests of the company and the members as a whole, even though they are going through a separation.
Discretionary trusts and unit trusts
In a trust arrangement the first question is, who has control of trust? Much also depends on the type of trust.
In a discretionary trust (also often called a “family trust”), it is necessary to consider the trust deeds, the identity of the appointor of the trust and the history of use of the trust. (For more information please see Testamentary trust or discretionary trust – which is best for you?)
If the trust is a unit trust, it may be treated similarly to a company. It is the units in the trust which need to have a value attributed to them. It will also be necessary to consider whether those units can be transferred between the other unitholders. Much will depend on the content of the trust deed and the powers contained within that document, or any subsequent unitholders deed.
The trust deeds and registers are important in disclosure, along with the financial records.
Safeguard your business with proper legal planning
In all of the above scenarios, in most situations, one of the separating spouses will seek to retain the company and will therefore have a continuing financial resource at their disposal. The court will take this into account when considering the “future needs” of the parties before adjusting assets between them.
In some instances, the court may be able to order that shares are sold if, for example, there is an impasse over the business and there is a market for it to be sold.
The primary concerns for most SMEs when parties separate are the disruption to business continuity and the effect that such a separation may have on staff morale and the reputation of the business. Other concerns arise if one spouse acts recklessly or divisively, such as frivolously using company funds or resources, doing business in a reckless or indifferent manner, allowing the business to deteriorate or starting a phoenix business after separation.
Proper legal planning can be a valuable exercise to minimise or avoid such risks. Spending time planning appropriately when you are not on the verge of separation may provide a useful layer of asset protection for the future and may also insulate third party business participants from any woes in your personal life.
For more information, please see The vital importance of a business exit strategy.
