Whose Divorce Is It Anyway? When Your Business Partner’s Divorce Seems Like Your Own
You may think your marriage will last forever. But do you have the same faith in your business partner’s marriage? If your partner’s divorce gets ugly, it can cost your business money and cause the disclosure of confidential business information. At a minimum, if your partner owns thirty percent or more of the company, he or she will be required to provide the court with a financial affidavit and general statement of the company’s market value. Your company will be forced to turn over its tax returns and bank statements for the last three years as evidence of your partner’s income—but a court can require so much more.
INTRUSION INTO YOUR BUSINESS TO DETERMINE INCOME AND SET SUPPORT
Florida courts worry that shareholder-spouses will stop their privately held companies from making distributions in order to reduce their income, and as a result, reduce their alimony or child support obligations. Shareholder-spouses must therefore prove that their companies are retaining money only for corporate purposes, and not to shield money from non-owner spouses. Ordinarily, an accuser has the burden of proving a wrongdoing. But in a divorce case, the shareholder-spouse has the burden and expense of proving that the company did nothing wrong. The Florida Supreme Court placed this unusual burden on shareholder-spouses in the Zold v. Zold case.
In Zold, the shareholder-spouse complied with tax laws and claimed pass-through income from his S corporation on his tax return, even though the company never actually distributed the pass-through funds. The company retained the funds in corporate accounts. The Florida Supreme Court held that such undistributed pass-through funds are income for the purpose of calculating alimony and child support, unless the shareholder-spouse can prove that the company is retaining the funds only for corporate purposes. Since the Zold case, Florida courts have applied the same approach to undistributed funds for all types of corporate entities—S Corp or not. These disputes inevitably lead to a company retaining its own attorney and accountant to defend the company against overly-aggressive attorneys who try to pressure the shareholder-spouse by digging into private company records, and making life as difficult as possible for the company and its other owners.
INTRUSION INTO YOUR BUSINESS TO VALUE AND DIVIDE IT
If a spouse claims that he or she owns part of your business, or that he or she is entitled to share in another’s ownership interest, that claim will trigger additional corporate disclosure obligations. In both ownership and retained income disputes, everything that may be relevant to valuation or true income will be fair game. Court orders keeping this information confidential or under seal are very difficult to obtain. Here are just a few examples of what your company may be required to disclose:
1. Profit and loss statements, balance sheets; and other financial statements;
2. Patents, trade secrets and other valuable intellectual property information;
3. Contracts, leads, projections, and price lists;
4. Unannounced acquisition and merger plans; and
5. Pending suits and noncompliance with regulatory agencies/laws.
THE RISKS
In a best case scenario, your company will be forced to give the non-owner spouse’s attorney stacks of confidential financial and business information, at the company’s cost. In a worse-case scenario, a vindictive spouse will demand the depositions of the other shareholders and will issue subpoenas to your company’s major vendors and customers. But a vindictive spouse is not the only thing to fear.
A competitor can take advantage of the transparent and public nature of the divorce process, obtain the confidential information, and use it to sabotage your company in the marketplace. In addition, valued customers or vendors may learn information about your business that makes them feel insecure or threatened. The damage may linger for years. For example, statements made in a divorce regarding the company’s value (using legitimate methods to establish a lower value) may be inconsistent with later valuations for corporate purposes such as obtaining a loan (using legitimate methods to establish a higher value), rendering any reported valuation unreliable in a third-party’s eyes.
THE SOLUTION
A well drafted prenuptial or postnuptial agreement can render much of the most intrusive and damaging financial and corporate disclosures unnecessary in the event of an ugly divorce. They can also reallocate some of the financial burden. Your company bylaws should require that all shareholders get a prenuptial or postnuptial agreement that limits the business valuation process and addresses confidentiality issues. These agreements can insulate and protect the business by mandating that the shareholder-spouse, or the nonowner- spouse, are responsible for the company’s divorce-related attorneys and accounting fees. They can also give shareholders the right to buyout a divorcing shareholder’s interests, if the divorce proceedings present a threat to corporate control.
These are just a few examples of suggested prenuptial and postnuptial agreement terms that companies should require of their shareholders who marry or are married. A divorce attorney with experience representing small businesses can customize further protections to meet the unique needs of your company.
