Structuring family companies to protect against divorce and separation

Family companies will often overlook their constitutional documents.  It is frequently the case that articles of association (“articles”), which are the rule book of the company, will have been left unchanged since the company was formed.

This will be the case, despite the businesses growing and share ownership becoming more widely spread in the family. Good intentioned tax advisers may also have encouraged shares to be gifted to spouses, to make use of tax allowances and lower tax bands. But what happens if a shareholder gets divorced?

The impact of divorce on a business

In many cases, the divorce of a shareholder will be very disruptive for the family business, even if the shareholder only has a minority interest.  There will be requests for lots of information about the company’s profitability and distribution history, taking up management time.

A valuation of the shares will have to be carried out and to agree that valuation there will be some negotiation between each party’s experts.  If the divorcing spouse has shares, there’s likely to be a desire for the shares to be returned to the family.  If there’s a shortfall of alternative funds, the divorcing spouse may want to retain some shares in the family company, to be able to receive an income in the form of dividends.

How can businesses protect against that impact?

There are ways to reduce the impact on the business of the divorce of a shareholder.  The key is to consider what the family would like to happen and to draft that into the rules of the company. I’ll go through them below.

Articles of association

The most important document is the articles, it has the effect of creating a contractual relationship between the company and its shareholders. It’s a public document as the latest version must always be filed at Companies House. Companies are free to adopt bespoke articles, although consideration has to be given to the requirements of the Companies Act. For example, under the Companies Act, a company cannot fetter its ability to amend its articles with a special resolution passed by shareholders.

A key concern for a family will be to retain control over who can be a shareholder. To do this, the articles should include bespoke provisions that set out rules on who a shareholder is allowed to transfer shares to, whether in lifetime or on death. Thought should be given to preventing shares being given to spouses, notwithstanding the potential tax benefits of doing so. 

It’s also helpful to consider including some provisions where a shareholder could be compelled to transfer their shares. We are familiar with provisions where shares held by employees must be transferred if they leave employment, but the same mechanism to transfer shares can be used in other situations, such as a shareholder divorcing a family member. The articles will set out the procedure for transferring shares and the directors can be given discretion to determine the best approach in the circumstances.

If a shareholder is compelled to transfer their shares, the articles can also set out the method of valuing the shares. This can be very helpful to support the basis for valuing shares held by a divorcing shareholder. It’s probably sensible to adopt a fair value approach, which takes account of a minority discount rather than requiring a transfer of the shares for a nominal sum, which may be disregarded by the Family Court.

Shareholders agreements

In addition to the articles, it can be very helpful to have a shareholders’ agreement. This is also a legally binding contract, but it’s a private document, which can take priority over the articles. Under a shareholders’ agreement, it’s possible to agree additional provisions, such as a change of articles needs all shareholders to agree.

Pre and post marital (or nuptial) agreements

The best way to protect the shares in a Family Company from being taken into account on a divorce, is for all the shareholders to have pre or post marital agreements. If this is considered desirable, the articles or shareholders agreement can assist.  Articles can include a provision that requires all shareholders who are getting married to enter into a marital agreement that seeks to protect the family company shares.  Failure to do so, can trigger the director’s right to compel a transfer of shares. 

The shareholders’ agreement may go further, giving the directors an opportunity to comment on any draft martial agreement and to have their reasonable comments taken into account. It may also include a requirement for the marital agreement to be reviewed during the marriage to ensure it remains appropriate.

Employment law considerations

In addition to measures protecting the shares, consideration should also be given to the appointment and dismissal of directors, although care will be needed to take account of appropriate employment law.

Key actions and conclusions

A family business can pre-empt and protect itself from much of the disruption that a divorce can have by:

• Setting out the rules and processes for dealing with the shares of a divorcing shareholder in bespoke articles and/or a supporting shareholders agreement before an issue is encountered.
• Taking employment law advice both in relation to the drafting of director employment contracts for family members, as well as upon relationship breakdown and proposed dismissal.
• Require all shareholders to enter into a marital agreement prior to marriage (pre-marital agreement) as well as those who are already married (post marital agreement).

At Mills & Reeve we have a team of lawyers that can help you protect your business in the event of divorce or separation. Speak to our team today.