Considering the high percentage of marriages that end in divorce, a prenuptial agreement (also commonly referred to as an antenuptial or premarital agreement) is a prudent way to protect a family-owned business, its income stream and its assets from exposure. A premarital agreement proactively imposes restraints on a non-owner spouse’s ability to delve into the finances of the business, seek a piece of the entity, procure a support award and/or procure attorney fees based on business-related income.
Insisting on such an agreement does not imply that you or your family members distrust your future spouse. The overriding goal is to protect the long-term survival of the business and its owners. While there are other means of providing some degree of security in the event of a divorce (including various trust devices and stock agreements), the prenuptial agreement can address issues beyond mere ownership that arise in a divorce matter or upon death. To the extent possible, it should be viewed as a business transaction.
The degree of potential risk in the absence of a preunuptial agreement varies from state to state. For instance, residents in a “community property” state generally face an equal division of assets, while residents in an “equitable distribution” state face a division of assets based on a notion of fairness defined by that particular state’s statutes and cases.
Generally speaking
As many readers already know, a prenuptial agreement is a contract between two people intending to marry, executed by them before the marriage, and in which the parties’ financial rights (including, but not limited to, spousal support and asset distribution) are determined in the event of the marriage’s future dissolution and, perhaps, upon death. All legal contracts require an offer, an acceptance, a meeting of the minds and a form of consideration. In the case of prenuptial agreements, the consideration is the marriage itself, which is why agreements often provide that they do not become effective until the marriage occurs. While the agreed-upon contractual language will vary in each case, depending on the nature of the assets at issue and the parties involved, an ideal agreement will provide a definitive, concrete method by which to distribute assets, address spousal support and minimize conflict between the spouses, as well as the legal fees incurred.
The legal requirements guiding the enforceability and validity of prenuptial agreements vary by state. The Uniform Premarital Agreement Act provides a basis upon which states can rely in crafting, interpreting and enforcing such requirements. At present, more than 25 states have in place some form of the Act. Notably, the Act does not cover postnuptial agreements, which are executed after the marriage occurs and, like prenuptial agreements, are designed to determine the spouses’ financial rights in the event of a divorce or death. As with prenuptial agreements, the validity and enforceability of postnuptial agreements vary by state but, unlike with prenuptial agreements, postnuptial agreements may be subject to heightened concerns about the consideration exchanged and other circumstances involved.
Disclosure
The enforceability of a prenuptial agreement often hinges on the following fundamental concepts:
1. Each party to the agreement voluntarily entered into the agreement without any concerns regarding potential coercion or duress.
2. Each party to the agreement had access to independent legal counsel.
3. Language was included that carefully and explicitly detailed the rights being waived by each party entering into the agreement. This requirement is of critical importance, especially in situations where one party does not have an attorney.
4. Each person provided sufficient financial disclosures as to his or her respective income, assets and liabilities. While the sufficiency of financial disclosures varies by state, disclosures are commonly made through the preparation of schedules that are reviewed and acknowledged by each party, and attached to the agreement.
Thus, it is imperative that business ownership be disclosed during the negotiation process so that the non-owner spouse cannot later claim that he or she was unaware of its existence at the time the agreement was executed.
To the extent possible, disclosure should include a value for the business. If a business valuation exists, disclosing the determined value and underlying report may make sense. If a valuation does not exist, your significant other may want to speak with a forensic accountant and have one prepared. Doing so may involve a lengthy and costly process whereby the accountant examines company financials and performs tasks that may otherwise seem invasive and unnecessary, especially to the other business owners who do not want to be involved. To avoid delving into that process, the parties instead may simply agree to expressly waive any investigation into or analysis of the business and, in connection therewith, any value determination.
‘Separate property’
While assets existing at the time of the marriage, or received as an inheritance or a gift, are often exempt from asset division upon divorce, there are many components of such assets that may still be subject to discussion. These components potentially include, but are not limited to, an increase in the value of the asset during the marriage and, perhaps, even the full value of the asset due to its commingling with marital assets.
A prenuptial agreement can serve to broaden and more firmly define the assets and related components of said assets that will be exempt from division through their designation as “separate property.” For instance, a home owned by one spouse at the date of marriage can be deemed “separate property,” as well as any income generated by the home during the marriage, any passive or active increase in the value of the home even if due to the efforts (monetary or otherwise) of the non-owning spouse, any home purchased from proceeds realized from the sale of the premarital home, and more.
Similarly, a business existing at the date of marriage can be designated as “separate property,” as well as any increase in the value of the business during the marriage, any income or compensation of any kind earned from the business during the marriage, any proceeds realized from the potential future sale of the business, and any subsequent business formed or purchased with such sale proceeds.
A divorcing non-owner spouse in an equitable distribution state will often argue that he or she should receive a larger portion of the business, or a larger payout of the marital share in the business, because of efforts he or she performed to help the business grow and increase in value. As with the other protections noted above, the agreement can provide that the business (and any increase in its value) is deemed separate property and exempt from division no matter what efforts the non-owner spouse undertook during the marriage.
The agreement can also designate as “separate property” potential future businesses developed or acquired during the marriage. Thus, if you are in talks to purchase an interest in an entity during the marriage, the agreement can include language protecting even that potential acquisition in the event of divorce or death. Particularly relevant to a family business, the agreement can protect any business interest inherited, gifted or otherwise provided to you during the marriage.
Spousal support and attorney fees
Without a prenuptial agreement in place, you will be subject to your state’s laws regarding spousal support. As set forth above, an effectively crafted prenuptial agreement can protect not only the family business interest and its related assets, but also its income stream. Similarly, the agreement can provide for what the precise spousal support arrangement will be in the event of a divorce. You and your spouse can agree to mutually waive spousal support, although a court may more closely scrutinize such a waiver depending on the parties’ respective financial circumstances and whether, for instance, the financially dependent spouse will be receiving some other form of payment in lieu of spousal support.
In the event that you are unable to agree on a support arrangement, the issue can also be left open for a court to decide should a divorce proceeding commence. While this eliminates the level of certainty sought in executing a prenuptial agreement, it may be unavoidable.
Many agreements prohibit spouses from seeking an award of prospective attorneys’ fees that will allow the spouse to litigate the divorce matter. The non-owning, perhaps financially dependent spouse may envision the business as a source of legal fees that can fund the divorce and, more particularly, a challenge to the prenuptial agreement’s enforceability. For that reason, many agreements also contain language requiring a spouse who unsuccessfully challenges a prenuptial agreement’s enforceability to pay for any legal fees and costs incurred by the opposing spouse.
Ownership status
In certain situations, the parties may intend on the non-owning spouse procuring an ownership interest in the business during the marriage. To aid in avoiding the battle that may ensue as to what happens to that spouse’s interest in the event of a divorce, the prenuptial agreement can provide a roadmap as to what will occur. A properly drafted ownership or buy/sell agreement can also provide greater certainty in the transition process. Using such methods can prevent the divorce from threatening the very existence of the business under such circumstances.
Decisions, decisions
Only you can determine whether you need a prenuptial agreement. Although there are emotional considerations involved in entering into such an agreement with a person you care for and plan to be married to for the rest of your life, it is critical to recognize that the decision you make will affect not only you, but also your family members and the potential long-term success of your business.
Robert A. Epstein, Esq. is a partner in Fox Rothschild LLP’s nationwide family law practice. He practices in New Jersey and New York (repstein@foxrothschild.com).
Copyright 2016 by Family Business Magazine. This article may not be posted online or reproduced in any form, including photocopy, without permission from the publisher. For reprint information, contact bwenger@familybusinessmagazine.com.