Minimizing divorce's impact on a family-owned business

By Norman S. Heller

Once a divorce commences, a family company should take proactive measures to minimize its involvement.

Divorce—the disintegration of a marriage and family—is devastating. The separating spouses and their children suffer emotional trauma, and the family’s finances undergo serious strain. There are now two households to support, rather than one, and the process by which the family’s assets are distributed is often contentious.

By far, the most challenging asset to value and distribute in a divorce is a family business. There is no easy way to sell shares or partnership interests in a closely held company, and most family businesses are not publicly traded. This article will focus on a business owned primarily, if not entirely, by the members of one spouse’s family. In the case of a business owned solely by one spouse, only the divorcing family is affected, though many of the valuation issues are similar to those in businesses with multiple family owners.

In some cases, spouses share a family business after their divorce, in lieu of the business being valued and the non-titled spouse receiving a cash payment for his or her interest in the value of the business. Two examples follow. (For purposes of this article, we will refer to the business owner as the husband, though by no means is that always the case.)

In the first case, the husband purchased a business in which the wife actively participated as an executive officer during the marriage. In fact, the wife had an important role in running the business, since the husband devoted most of his time to other business endeavors. Pursuant to the settlement agreement, each party retained an equal ownership interest in the business, but the wife was to stay and run the business after the divorce. The parties trusted one another enough to permit this otherwise very rare type of resolution.

In the second case, as part of the divorce settlement, the parties continued to hold their equal ownership interests in a company that owned commercial real property. There were other owners as well. After the divorce, the prime tenant —the husband’s premarital business—declared bankruptcy.

Document production is costly

Now let’s discuss how a business is dealt with in most cases. Assuming, as we do for this article, that the husband holds the ownership interest, the wife’s attorney will ordinarily retain an accountant with expertise in business valuations to value the husband’s interest. It is not our purpose in this article to discuss valuation methodologies but rather to describe some of the problems business owners face during this process.

It is imperative to maintain the confidentiality of the business’s records to the extent possible. Since the wife’s expert must have access to these records to value the business, the husband’s attorneys should demand that the wife and her attorneys and experts sign a confidentiality agreement barring them from revealing the documents, or disclosing information contained therein, outside the divorce litigation. The business’s outside counsel should insist on such an agreement if the husband’s attorney fails to do so.

In most states, the non-titled spouse (in our example, the wife) will be granted broad access to the company’s records. Those records are now usually maintained on computers. It is critical, therefore, to determine what documents exist, how they are organized and what problems may arise if they are given to the wife.

There may be audited statements by a major accounting firm that accurately summarize thousands of pages of documents. It is worthwhile to try to have the wife’s attorneys accept the audited statements. Should they refuse, the company may well be advised to ask the court to limit what it must produce, since the cost of compiling and producing the original documents (which can run to the thousands or tens of thousands of pages) could be prohibitive. Further, the staff time required to produce massive quantities of documents can adversely affect company operations, especially in smaller family businesses.

It is reasonable to expect the wife’s experts to demand that in lieu of producing hard copies of the documents, they be given a computer disk or electronic copy of the documents. Although this would eliminate the paperwork burden, it does not obviate the need for the company to expend a substantial amount of resources to review these documents to decide what is responsive to the wife’s demand.

Moreover, the requisite documents may be interspersed in many different computer files so that it may take many hours of effort to find the right ones. In addition, with respect to e-mails, text messages, cell phone records and other electronic means of recording and transmitting information, it can be an almost insurmountable obstacle for a modestly sized family business to comb such records to find responsive documents.

There are several strategies a family business can use to minimize the cost of disruption caused by document production in a divorce. We recommend bringing the company’s outside counsel and accountants into the process as soon as possible. That way, when the wife makes her document demand, the company will be in position to raise objections as soon as possible. The company’s attorneys and accountants should be in contact with the husband’s counsel and financial expert to ensure they understand that there may be valid objections to the document demand.

Another useful approach is to offer to meet the wife’s attorney and her expert on an informal basis, meaning a deposition is not involved. Such a meeting allows important information to be provided and keeps open lines of communication between the parties. This can facilitate resolution of discovery disputes, rather than forcing the parties to ask the court to decide what documents and information the company must provide.

A third option is to choose a knowledgeable attorney to mediate discovery disputes. In more complicated business situations, the mediating attorney would also retain his or her own valuation expert to provide independent advice on what documents are really necessary for the wife’s expert to complete the business valuation.

Delays cause problems

If there are valuation issues—meaning that the parties cannot agree on what the business is worth—matters quickly become more complicated. Complexity in a divorce means additional costs in expert and attorneys’ fees and substantial delay in resolving the matter. Delays and heavy costs put more strain on the parties and cause more animosity between them.

Once the value of the family’s assets, including the family business, are agreed upon by the parties or determined by the court, the range of the percentage of the property to be awarded to each spouse is relatively narrow (although often hotly contested). The length of marriage, existence of separate property (usually inherited or premarital property), the financial situation of the parties and other factors set out in statutes and case law generally provide sufficient guidance to the attorneys to allow a fair settlement based on the approach taken in the state where the couple reside.

It is to be expected that the business-owning spouse will retain his or her interest in the business and pay to the other spouse an amount equal to the spouse’s portion of the value of the company. This payment may be a lump sum, or payable over a period of years. It is often offset by other valuable assets given to the non-titled spouse.

As we have discussed, family businesses can protect themselves from some of the problems that arise when an owner gets divorced. There should be early and open communication between the company’s and the owner spouse’s attorneys to ensure the company’s interests are protected in the discovery process. The company should also be proactive once the divorce commences. It should assess its obligation to provide documents and information and consider how to protect privileged or confidential information. Finally, it is important that the company’s accountants be made aware of the divorce case and brought into the document discovery process. These steps will help minimize the company’s involvement in the divorce and protect it from abusive discovery obligations.

When an owner gets divorced, there will inevitably be stress on the management of a family business. The process, however, can be made better if certain steps are followed early in the case.

Norman S. Heller is a partner and Matrimonial Group practice leader at the law firm of Blank Rome LLP (www.blankrome.com).

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Spring 2011

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