Divorce and Owning a Business Together Comes With Challenges
If you own a business with your spouse and have a divorce ahead of you, this article is for you
There is a divorce ahead and you and your spouse own a business together
What do you do? Divorce becomes complex when there is any business involved. This complexity reaches a higher level when you combine divorce and owning that business together.
We wrote this article for those spouses who own a business together and have a divorce ahead of them, or are already going through a divorce. We hope you enjoy this article.
Our California family law firm has offices in Orange County, Los Angeles and San Diego. Our team of experienced family law attorneys knows the business valuation and division process, and can provide you with advice regarding your specific situation. If you and your spouse expect a divorce or are going through one, and you own a business together, contact us for an affordable strategy session.
The three major issues with a divorce when you own a business together
Our experience shows three major issues arise when we represent a spouse who owns a business with the other spouse. They are the following.
- Management, operation, and control of the business during the divorce;
- Income distribution from the business during the divorce; and
- Division of the business at the end of the divorce.
During the divorce, how do spouses manage, operate, and control the business they own together?
Management, operation, and control are not the same thing. Spouses who own a business together may have different responsibilities. Some spouses may wear one hat or many.
Business management often includes a division of responsibilities.
For example, managing sales versus accounting requires a different skill set. Most spouses who own a business together separate these responsibilities. One spouse may manage all of the administrative and accounting. The other spouse may handle marketing and sales.
Business operations often include the boots on the ground.
If the business sells a product, who is doing the selling? Is it one spouse or a team of salespeople? If the business is a professional service business, who is providing the service?
Who is in "control" of the business?
John D. Rockefeller stated, "Own nothing, but control everything." In a philosophical sense, control is an adolescent allusion. In a business sense, control may be everything. If a spouse has significant control over the employees, the product or service, and the clients, it may not matter what the other spouse does. That control may dictate the direction of the business they own together during the divorce absent court involvement.
During a happy marriage, there is actual (or an illusion of) harmony in the management, operation, and control of the business. If it is an illusion, one spouse usually does not know about the other spouse's secret and nefarious misconduct. That illusion becomes reality during a divorce. That is why it is best that spouses who own a business together and are going through a divorce make clear each's obligations to the other and the business. Assumptions can lead to misunderstandings and greater problems later on.
- Yvette Ochoa, Partner
There are two ways for spouses to determine management, operation and control of the business they own together during divorce.
- The spouses will work together. They will be honest with each other. They recognize they are likely fiduciaries not just in a spousal capacity but in the business relationship. And, despite the challenges ahead, they allow the business to continue to thrive. I wish this was common, but the reality is the business often becomes another point of contention in a divorce.
- This brings us to the second option. If spouses cannot figure this out, then either spouse may file a request with the court and ask the court for exclusive or some other form of management and control over the business operations. We often see this in those situations where one spouse is intentionally or negligently engaging in conduct that is harming the business they own together.
The operational documents of the business become important in a divorce.
Limited Liability Companies (LLCs) should have operating agreements. Corporations should have shareholder agreements, bylaws, in addition to its articles of incorporation. Partnerships should have partnership agreements. Even a sole proprietorship should have some operational document that sets forth which person or persons serve what functions.
If the business does have such operational documents, they are instructive on management, operation, and control. A careful review of vendor agreements, client contracts, and names on accounts with financial institutions also help a divorce lawyer determine who is actually in charge of this business.
Professional service businesses create a greater hurdle. Typically, unless both spouses are licensed professionals, only the licensed spouse can operate the business. For example, if the business is a law firm, a non-attorney spouse cannot be a shareholder of the business nor can that spouse represent clients. The same is true with different types of professional corporations or companies that rely on a State or Federal license to operate the business.
For all of these reasons, spouses who own a business together and going through a divorce must set the table early on how they will manage, operate, and control the different aspects of the business during their divorce.
During their divorce, how will the spouses distribute income from the business they own together?
Who managed the accounts, and distributed the income during the marriage? Who will do it now that there is a divorce? The second is a critical question, because income distribution is a part of each spouse's economic stability during their divorce. Spouses who own businesses together sometimes attempt to create economic hardship for the other spouse during the divorce by controlling or mismanaging revenue, and therefore income.
One spouse may attempt to cut off the other spouse's income, or threaten to do so. One spouse may increase his or her own pay, without the other spouse's consent. One spouse may lie about income from clients/customers, open secret bank accounts, or even manufacture false business expenses to create the illusion of a business on the decline.
Spouses must communicate early about proper oversight of income, expenses, profit and loss.
A common situation we see is a business where one spouse has complete management and control over the financial aspects of the business they own together, while the other spouse works exclusively in operations, such as sales. If the spouse who handles the financial aspects shuts off communication with the other spouse, distrust and anxiety may result. This lack of trust can boil over into litigation, including the formal discovery process, and even a breach of fiduciary duty action.
Court intervention may be unavoidable if the spouses cannot come to resolution during the divorce.
If spouses cannot figure out their income distribution and cannot maintain a reasonable status quo during a divorce, a spouse can seek court intervention. This may include specific orders regarding accounting by a spouse to the other and a distribution of income. In extreme cases, the court has the power to appoint a receiver who will receive and distribute the revenue that comes into the business. This receiver is an independent person who has no prior personal or professional relationship with either spouse.
Receiverships are expensive. It should not be a first resort.
It is for extreme cases. With most businesses, especially those with small to
midsize operations, court ordered accounting, transparency, and specific orders
regarding distribution of income usually help while the divorce is pending.
At the end of the divorce, how will the spouses divide the business they own together?
This is the ultimate question. If the spouses who own the business together made it through the divorce and are now at the end, how will they divide the business? There are several options available.
- One spouse may buy out the other spouse's interest in the business;
- The spouses may choose to sell the business and divide the proceeds; or
- The spouses may choose to continue to operate the business together.
We encourage you to read the below linked articles to learn more about the business valuation and division process.
We have a couple of important thoughts regarding option number three: Continuing to operate the business together.
You must not navigate a continued business operation after divorce without legal and tax advice.
You will need legal advice by an experienced transactional attorney, and tax advice from a tax professional.
Transactional attorneys are those lawyers who review, advise on, and draft agreements for business owners so there is full transparency and predictability in how business partners will manage, operate, and control a business together.
Business owners or partners who start a business, or continue to operate a business together after a divorce, without the assistance of experience legal counsel, and without proper operational agreements, often face bitter and expensive battles if there is a breakup between the partners.
This is also why a tax professional is a necessity before spouses choose to operate the business together. The tax consequences to doing so, especially if there is a future division of the business, are not issues you want to learn about at the end. They are issues you want to anticipate and prepare for in the beginning.
For spouses who just went through a divorce and who cannot be married to each other, this issue is magnified.
It is foolish for spouses who just separated to assume everything will be fine as they continue to operate a business together. Operating a business together is akin to a marriage. The due diligence you exercise directly affects the time, money and stress you avoid in the future.
We hope you enjoyed this article on divorce and owning a business together. Check back often for new articles on relevant family law topics. If you found this article helpful, please give it a thumbs up below. We appreciate your feedback.