In family law property settlement proceedings all assets and liabilities of each party, (whether they are owned jointly or separately) are combined to form what is commonly known as the “matrimonial property pool.” This pool of assets and liabilities is then subject to scrutinization and possible division by the Court upon separation.
A business interest, owned either separately or jointly, and whether in a partnership, sole trader, company or trust structure, can be treated by the court as “property” as defined in the Family Law Act 1975 (Clth) (“the Act”) and will fall into this asset pool. Each spouse’s business interests will need to be valued (if a value is not agreed to).
In the case of a small business operated as sole trader or a partnership between the spouses, it is generally the assets of that business that largely determine its value. If the business has little by way of assets, and generates income though one or both spouse’s efforts, skills or trade (e.g. a plumbing business), its value may be very little (nominal). Other businesses may have a corporate and/or trust structure, extensive assets and goodwill, and each spouse’s interest in that business will need to be valued. This may involve a valuation of the entire business enterprise, with the value of the share owned by the spouse (or spouses) then calculated.
If one spouse wishes to retain their interest in any business, they should be aware that the value of that interest will be attributed to that spouse’s portion of the overall split and will give them a financial resource to offset future needs.
Each spouse has an ongoing obligation to give full and frank financial disclosure of all documents relevant to the valuing of any business interest. This includes business records, financial statements, bank records, BAS and tax documentation
Different Types of Business Structures
A sole trader (like a tradesperson or professional consultant) is a “personal exertion” style of business, with few employees, if any.
Generally, the Court would order (and it is common sense) that the spouse who runs this business will retain the business, as he or she has the necessary skills and training to continue with the business.
A value needs to be attributed to the business, because it is an asset that the sole trader is keeping. Because a sole trading business generally just relies on the personal reputation and skills of a sole trader, a modest value is normally applied to such a business interest.
However, if there are multiple employees and the business has goodwill such that it may be sold as a going concern, then the value of business will be determined by the usual valuation processes by a business valuer, and full disclosure of the books and records of the business will need to be made.
It is also possible that in addition to being an asset retained by that spouse, the court may take the business into account as a future financial resource of the spouse retaining the business.
Partnership businesses may be constituted by both spouses in partnership with each other, or partnerships with a third party or parties.
Spouses in Partnership
When spouses are in partnership, they are normally running a “personal exertion” style of business. If one spouse wishes to retain the business, a value will be determined for the business, like valuing a sole trader business.
However, if the business has employees and goodwill and has been operating for several years, it will need to be formally valued by a business valuer.
For one partner to buy the other out of the business, the partnership will be dissolved and (often in exchange for paying to the other spouse half the value of the business), the continuing spouse will be operating the business as a sole trader.
Partnership with Others
Where the partnership involves third parties, the other business partners will be impacted by separation. The partner who has separated will be going through a tough time and may lose focus on the business. Third parties are also very uncomfortable with the obligation on the spouse partner to make full and frank disclosure of the business, its assets and its dealings.
There will usually be a written partnership agreement, which will generally say what is to occur if one partner was to leave the partnership, if one partner wants to sell his or her interest to the other partners, and what is required to bring the partnership to an end. Separation of a partner may trigger a buy/sell arrangement between the partners. These clauses will generally have been drafted to preserve the business and maintain its value.
If you are not separated and you are in a partnership with your spouse or third parties, I strongly recommend that you contact us with instructions to prepare a partnership agreement (if you do not already have a professionally prepared agreement), so there is certainly as to what will happen to the business if one or more of the parties go through a separation.
Company Owned Businesses
Where a company owns and operates a business, and that company is a “family company”, with the spouses being the only shareholders and office holders, then the Court will generally deal with the business as a type of partnership between the spouses. The business will need to be valued, and it will either be sold, or the party with the requisite skills to keep the business running may buy out the other party, and a share transfer between the spouses will be effected.
However, if the company has third party shareholders as well, it will again be necessary to determine the value of the shares in the company, by valuing the business and any other assets of the company. The value of each parties share in the company will then be determined by the Court, considering the company’s share structure to see if there is an equal or an unequal shareholding, and what rights and benefits attach to different classes of shares.
During the valuation process, director’s loan accounts will need to be considered, and whether the loan is in credit or debit. Repayment arrangements for these director’s loans will generally be made or suggested in the valuation process.
If one party has a majority of the shares in the company, that may affect the way the company is operated and valued.
If the separating spouse shareholder has a minority shareholding with a third party, then the value of the minority shareholding may be given a lesser value as the minority shareholder is unable to make determinations about the operations and the future of the company.
If the separating spouse shareholder has a majority shareholding with a third party, then that spouse will be able to exert a majority influence and control the operations of the business.
Any shareholders agreement entered between the shareholders will also be carefully securitized. Shareholding Agreements may include method to determine value and trigger events (such as separation from a spouse), leading to the implementation of a buy/sell arrangement.
Again, if you are reading this and you are not separated and have shares in a company with your spouse and/or third parties, I strongly recommend that you contact us with instructions to prepare a Shareholders Agreement, to give certainly as to what will happen to the company and business in the event of one or more of the parties going through a separation.
The company constitution may also be relevant.
Discretionary Trusts and Unit Trusts
“Who is in control” is the most important aspect of a Trust Structure.
In a discretionary trust, which includes what is commonly known as a family trust, the Court will consider the trust deeds, the identity of the appointor of the trust, and the history of use of the trust. The Appointer has the power to replace the Trustee, so the Appointer is the “Controller” of the Trust. If the Appointer is a spouse, then it is likely that the Court will treat the Trust as “matrimonial property” rather than a financial resource.
Family Discretionary Trusts are usually set up to hold a family’s assets or to conduct a family business. The Trustee of the Trust will own the assets and operate the business on trust for the beneficiaries.
The beneficiaries of discretionary trusts are usually immediate and extended family members, other family companies and charities. In a discretionary trust, beneficiaries have no interest in the trust property unless the trustee exercises its discretion to distribute to them.
The trust deed will need to be examined to determine how the Trust can be varied to remove a beneficiary spouse who will no longer be involved in the business due to separation. Generally, one spouse will take over the business, which will require a Deed of Amendment to be prepared and executed to remove the spouse as beneficiary, and possibly also to provide for a share transfer by that spouse of any shares owned in the Trustee (if the Trustee is a company).
If the trust is a unit trust, it may be treated with the same principles that apply to a company. The units in the Trust will be valued, and the trust deed examined to see if units can be transferred between unitholders. The trust deed (and any unitholders deed) must be examined carefully as to the duties, powers and obligations on the Unit Holders. The financial records of the business must also be considered.
So, what will happen to your business on separation?
Where both spouses have worked in the business and then go through a separation, this will have obvious and significant repercussions and likely impacts on business continuity and profitability. It may also affect the staff.
In most situations, one of the separating spouses will seek to retain the business free of the other spouse. If that agreement is reached, then orders will be drafted to make that happen according to the type of business structure. The transfer of interest in the business from one souse to another may also be accompanied by payment to the exiting spouse of a “settlement sum” which will often be the value of the exiting spouses share in the business. Otherwise the business will be an asset that one spouse is keeping, so its value will need to be considered in determining a just and equitable division of all assets between the parties.
Whilst it is quite uncommon for a business to continue to be operated by two spouses who have separated, it sometime does happen, generally for an agreed number of years, after which the spouses will meet to decide its future or sale and the division of sale proceeds. Whilst a Court would not make that order (the Court makes a “once and for all” property settlement so that all financial ties are broken), the spouses could agree to implement such an agreement in a Financial Agreement made under the Act.
If neither party wished to retain the business then the business (or their shares in the business) will need to be sold, and the sale proceeds divided in a just and equitable manner. Appropriate orders will be prepared by your solicitor for the sale or transfer of shares, according to the type of structure that operates the business.
As the spouse who retains the business will also have a continuing financial resource at their disposal, the court will take this into account when considering the “future needs” of the spouses before adjusting property between them.
Please contact our family lawyer Gary Mallett for any further information on what will happen to your business upon separation, and for legal assistance with
- Property settlement negotiations and mediations;
- Commencing property settlement proceedings in Court;
- Drafting the necessary orders to deal with your business as you have agreed;
- Prepare a Shareholders Agreement (for a company or unit trust); or
- Any other legal advice on separation.