What You Need to Know About Family Business and Divorce
Issues often arise when both spouses are owners
Many of Colorado’s most successful business people run small, closely-held businesses, which often include family members. Some prefer family businesses with relatives that they trust and the ability to pass on a legacy to their children. However, these relationships can become very complicated in a divorce where love flies out the door, and the spouses begin arguing about the business assets.
Although there are many ways that family businesses can become involved in divorce, the issue commonly arises: (1) where the business is owned by the two spouses; (2) where one or both of the spouses are part of a larger family business where they may or may not have a controlling interest; and (3) where spouses enter into loan agreements with family members.
Even if you are not the family member going through the divorce, it doesn’t hurt to understand how judges in divorce cases view these sorts of businesses. Many family businesses and transactions are often scrutinized by judges who are suspicious of interfamilial dealings. This should not come as a surprise as it is human nature to assume that family members will “circle the wagons” to help each other in times of crisis. There are also heightened disclosure requirements in divorce cases, which many business partners find invasive, even in traditional business relationships. Most business owners could benefit from having a basic understanding of how family business dealings could be viewed in a divorce.
Optics are Everything
When it comes to family-owned businesses, optics matter! Judges in divorce cases often treat family business interests with suspicion and assume that family members will treat each other differently than third parties in a business transaction. At a minimum, you can expect that the opposing side will try to persuade the judge to scrutinize family dealings and assume that family members will self-deal to protect each other. When valuing a business in a divorce, judges can apply “discounts” to the value of the business based on (1) a lack of control, and (2) a lack of marketability. The lack of control discount is applied when someone owns a non-controlling interest. The lack of marketability discount is applied when a person’s interest would be difficult or impossible to sell—either due to the closely-held structure of the company or some other reason.
Where family businesses are concerned, a Colorado judge may refuse to apply these two discounts even though the same judge would have applied discounts to any other business. This is because judges may assume that the remaining family members in the business will simply vote in favor of the divorcing spouse or purchase the spouse’s shares at full market value. Of course, there is a sense of irony here as many owners in business with family members know that sometimes family members are harsher on each other than third parties. Indeed, there are even occasions where family members are outright hostile to one another and are less cooperative than a third party would otherwise be.
Although many factors go into the analysis about whether a court ought to apply discounts for lack of control and marketability, it is generally true that companies that observe corporate formalities and operate in a commercially reasonable manner will be viewed with less suspicion. With that principle in mind, there are certainly steps that businesses owners can take to ensure that family businesses are viewed and treated similarly to other businesses. First, you must look at the optics of the business. When you transfer money from one account to another, you should account for it correctly. When you transfer money from the business to an owner, the reason for the transfer should be clearly documented. If the business loans money to an owner, you should record the transfer as a loan and should memorialize the agreement in writing with a promissory note. If you distribute money from the company, then the paperwork reflecting this should be present.
Trace Every Penny
Although optics also rely on documentation, you should document each transaction for another purpose: tracing. Tracing is the process of accounting for money over time and as it transitions in form. A proper tracing would track the movement of money as it transfers in form. For example, the money could begin as cash in a bank account and then be transformed into stock and then into a real estate investment.
Occasionally, a court will attribute an asset to a spouse that does not truly belong to them because the Court determines that the asset was improperly given away or suspects that the asset belongs to that spouse, irrespective of who holds legal title. If the court can trace the money and assets easily, the court will be more likely to view each transaction as legitimate. By tracing each transaction, you can also ensure that that court does not improperly attribute an asset or a liability to you.
Whether the business is owned by a family or owned by third-parties, courts will often scrutinize transfers from the business to the individual. In a divorce case, judges carefully scrutinize every monetary transaction that a family member makes with his or her business. This is true whenever a family member either takes or receives a loan or distribution, whether individually or on behalf of the company. Without formal procedures in place, courts may view legitimate loans as gifts solely because the loan is between the business and a family member.
Family businesses are common and often a great way to do business. In doing so, however, you should be mindful that these businesses are often treated with suspicion when love flies out the door and someone seeks a divorce. The attorneys at Griffiths Law have encountered all types of family-run businesses from one side of the spectrum to the other. On the one hand, we have seen family members follow corporate formalities to the letter and often more precisely than large businesses. On the other hand, we have also seen companies that conduct business on handshakes and use text messages or emails to memorialize loans. In our experience, there are certainly better ways to do business to avoid paying the price in the event of a divorce. By the time spouses appear in front of a judge, it is often too late.
(This sponsored content was provided by Griffiths Law PC.)
Christopher Griffiths is a shareholder at Griffiths Law PC and focuses his practice on complex civil litigation and family law matters. His civil litigation practice focuses on construction, insurance, real estate, commercial, and business disputes. His family law practice focuses on divorce and related domestic relations matters.
Duncan Griffiths is a Shareholder at Griffiths Law PC and focuses his practice on difficult and complex civil litigation and family law matters. He has significant experience in a variety of fields including construction defect, insurance, real estate and commercial litigation. He also assists with complicated domestic relations matters, and is especially useful in complicated property situations.
Kim Newton is a law clerk at Griffiths Law PC. Kim obtained her Juris Doctor in May 2018 from Syracuse University College of Law where she graduated Cum Laude and was a member of the Justinian Honor Society and Syracuse Law Review. She received her B.A. from the University of California-Berkeley in May 2015. She is focused on gaining experience in many different practice areas to broaden her exposure.