Linas Sudzius, J.D., CLU, ChFC is working on the book The Guide to Transferring Your Closely Held Business with some colleagues. Here’s an excerpt.
Transfers of a Business Interest in the Event of Divorce
The divorce or legal separation of a business owner can create financial heartaches for the divorcing owner, and can put incredible emotional, organizational and financial stress on the business. Usually divorcing spouses—or those who otherwise separate from committed long-term relationships—make financial claims on one another. For those whose valuable assets include an interest in a closely held business, the parties may argue about
- the value of the business interest,
- how to divide the business asset between the parties, and
- how to preserve the value of each parties’ interests and the overall business.
Those business owners who are working with co-owners should consider having a buy-sell agreement that has language dealing with the possibility of the divorce of one of the owners. In the absence of an agreement, a divorce fight can tie up not only the business owner going through the divorce, it can also handcuff the non-divorcing owner or owners.
The parties need to consider how to define “divorce” if they include it as a trigger in a buy-sell agreement. For example, is the filing of a divorce action a trigger for the buyout? What about if one of the owners becomes legally separated from a spouse? Should an owner in a long-term non-spousal relationship be included in the scope of the trigger?
Often business owners opt to include some type of buyout or contingency plan in the buy-sell agreement in the event of the divorce of an owner. Making divorce—or separation—a buyout trigger can make it easier on the non-divorcing owners of the business. It may not be so good for the divorcing owner, who may prefer to remain in the ownership instead of being forced out.
The potential for hard feelings when a divorce is occurring is one important reason the parties should evaluate whether a divorce trigger is warranted when the business (and the relationship) is running smoothly.
Insurance that pays off in the event of divorce is not available. Therefore, the parties to a buy-sell agreement with a divorce trigger must plan to provide funds for purchase in the event of divorce. Usually the parties choose to fund a buyout from the business’s cash flow through some type of installment (with interest) arrangement. The parties may also decide that the buyout price triggered by divorce should be different—usually lower—than the one triggered by death.
To make sure a divorce trigger in a buy-sell agreement is effective, the best practice is for the owners of the company to have their spouses consent to the agreement—before there is any trouble in paradise. The courts won’t always enforce an agreement for a divorce buyout if the non-owner spouse hasn’t signed on to the arrangement in advance.
In Barton v. Barton, 639 SE 2d 481 (Ga. 2007), for example, the husband owned half the stock in a closely held corporation. He entered into a buy-sell agreement with the other owner of the company. The buy-sell agreement provided that in the event of divorce of either owner, the non-divorcing shareholder would have the right to purchase the divorcing owner’s stock.
The wife did not consent to the agreement.
In its Barton decision, the Georgia Supreme Court ruled that the agreement did not bind the wife to the valuation in the buy-sell agreement. The court reasoned that because the wife did not consent to the buy-sell agreement, she could not be bound by the valuation in it. Thus, the original divorce court’s decision to use an arbitrator’s 50% higher value in dividing the marital assets was upheld.
The Barton decision reminds us that where possible, the spouses of parties to a buy-sell agreement should formally consent to the agreement’s terms.
Linas is an attorney who works with business owners from his office in Franklin, Tennessee. His first book, What Most Life Insurance Agents Won’t Tell You, is available on Amazon.com.