Insulating your company from the fallout of a partner’s divorce

Business partners often fail to recognize that their business ownership interest is also a marital asset that will be valued and divided in a divorce. 

“When someone has an ownership interest, it will be appraised by experts and divided in the final divorce judgment,” says Katie Arthurs, a principal at McCarthy, Lebit, Crystal & Liffman Co., L.P.A. “A forensic accountant will obtain certain financial documents from the company to determine its value.”

Divorce cases that do not settle are tried in front of a judge. At trial, financial documents, as well as testimony from people within the company, become public record. That’s why partners should recognize the company’s potential exposure when business interests are not protected from a spouse.

“The information brought forward at trial could lead to sensitive information being disclosed to the competition,” says Richard A. Rabb, a principal at McCarthy, Lebit, Crystal & Liffman Co., L.P.A. “Other legal or tax issues could also be exposed, such as a tax oversight, which could trigger an audit from the IRS. It could also have effects on the business owners’ estate planning if the values used in the trial are applied to gift planning, or they could be used in another partner’s divorce proceedings.”

Smart Business spoke with Arthurs and Rabb about how divorce can affect business partners and their companies, and how to insulate a business from potential fallout.

When is the best time for business partners to address divorce? 

Address it as early as possible. Similar to death provisions and buy-sell provisions, divorce provisions are best handled at the onset of the business. Spell out and document how an owner’s interest in the company would be valued and bought out in the event of divorce.

What should be done to insulate the company from any negative impact of a partner’s divorce?

Operating agreements can outline how divorce will be handled. Often these agreements are boilerplate and don’t contain enough detail. Provide restrictions on the transfer of ownership and specifically disallow spouses as owners. Use lawyers when setting up the business and consider the input of domestic relations counsel. 

A confidentiality agreement or protective order is also valuable, as the divorcing partner will need to turn over corporate documents. These types of agreements/orders will protect documents from being disclosed to third parties, or worse, becoming public record. Depending on the nature of the business, the divorcing partner can ask to seal the court record to prevent information from becoming public.

If divorce becomes imminent, the company should retain its own legal counsel, independent of the divorcing partner, to protect the company’s interests. 

If business partners discover they haven’t covered divorce, how should they address it?

The discussion is better late than never. Business partners who don’t have existing documents that address divorce need to discuss and amend their buy-sell agreement or operating agreement. Address the possible issues and update the corporate records before there is trouble on the horizon.

Unmarried business owners should agree to execute prenuptial agreements prior to marriage. These agreements can exclude the spouse from the business altogether, including any marital appreciation.  

What advice would you offer partners as they approach the conversation of divorce?

Have an open and honest discussion when things are good. That conversation is far less emotional when partners aren’t in the thick of divorce. Meet with counsel and an accountant to seek advice and direction. Divorce is a reality. Business partners should be proactive.

Insights Legal Affairs is brought to you by McCarthy, Lebit, Crystal & Liffman.