A divorce can wreak havoc on your privately held business. Corporate control issues, valuation, and individual income issues can force you to expend precious time and money protecting your company’s confidential information and other interests. Even after a short marriage, divorce can cause your company to disclose almost everything. Think you’ll be married forever? Great. But how much faith do you have in your fellow shareholders’ marriages? Prenuptial and postnuptial agreements can protect you and your company.
Why Must My Privately Held Company Disclose Anything when a Shareholder Divorces?
Before we get into what confidential company information can be disclosed in an ugly divorce, let’s first discuss why courts force companies to disclose that information. In a Florida divorce, if you own thirty percent or more of a company, you must provide a financial affidavit and a general statement of the company’s market value. At a minimum, the business will be forced to turn over tax returns and bank statements for the last three years as evidence of the owner’s income—but a court can require so much more. This is true even if you started the business,or acquired shares of the business,before you got married.
Florida courts worry that shareholder-spouses will stop their privately held companies from making distributions to reduce their income, and as a result, reduce their alimony or child support obligations. So you—or the company as a third party—must prove that the company is retaining money only for corporate purposes. You must prove that you are not shielding money from your spouse by keeping it in the company. In other types of cases, if someone accuses you of wrongdoing, the accuser has the burden of proving that you committed the wrongdoing. But in a divorce case, you have the burden (and expense!) of proving that you and the company did nothing wrong. The Florida Supreme Court placed this unusual burden on shareholder-spouses in the Zold v. Zold case 911 So. 2d 1222 (2005).
In that case, the Court analyzed whether pass-through income from a sub chapter S corporation, which was claimed for tax purposes, but never distributed to the shareholder, should be considered income for alimony and child support purposes. Fortunately, the Court recognized that income reported on the individual tax return for a shareholder-spouse of an S-corporation is not necessarily the same as the income the shareholder-spouse has available for support purposes. This is because a company may retain funds—rather than distributing the funds—to uphold the company’s obligations to creditors, employees, and all shareholders. Companies may also retain funds in excess of current liabilities for a variety of other legitimate corporate purposes, such as expanding the business, purchasing new equipment, or reserving funds in the event of a natural disaster. But if you or the company cannot prove that the undistributed funds are being withheld for corporate purposes—and not to shield them from your spouse—then a Florida court will considered the undistributed funds your income for support purposes.
What Can My Company Be Forced to Disclose?
Florida court now apply this Zold approach to undistributed company funds regardless of whether the company is an S-corporation, limited liability company, or partnership. To determine whether you have met your burden of showing that undistributed funds were retained for a corporate purpose, a court will consider:
- the extent to which you have access to or control over the company’s undistributed funds;
- whether distributing the funds will cause the company to become insolvent and unable to satisfy its obligations to its debtors and shareholders; and
- the purpose for which the company is retaining the income.
When weighing these three factors, however, a court will give more weight to purpose for which the company is retaining the income.
If a spouse claims that he or she owns part of the business, or that he or she is entitled to share in the other’s ownership interest, that claim will also trigger additional corporate disclosure obligations. In both ownership and retained income disputes, everything that may be relevant to valuation or true income will be fair game, and court orders keeping this information confidential or under seal are very difficult to obtain. Here are just ten few examples of what the company may be required to disclose:
- Profit and loss statements, balance sheets; and other financial statements;
- Contracts and customer lists;
- Patents, trade secrets and other highly valuable intellectual property information– including works in progress– that may evidence the present and future value of the company’s assets;
- Sales leads, projections, and price lists;
- Employee compensation including bonus and commission structure;
- Unannounced acquisition and merger plans in infancy;
- Tax liens or other tax trouble;
- Pending suits and disputes;
- Noncompliance with regulatory agencies/laws; and
- Company crises and public relations problems that had been kept under wraps.
In a best case scenario, the company provides this information- at the company’s cost—by providing the non-shareholder-spouse with voluminous documentation that is turned-over to a court-appointed accountant or receiver. In a worse, but legally permitted case, a vindictive spouse demands that it receive information by deposing other shareholders and by issuing subpoenas to your company’s major vendors and customers. It most instances, the company will need its own lawyer to deal with the barrage of demands for private company information. But a vindictive spouse armed with a good attorney is not the only thing to fear.
A competitor can take advantage of the transparent and public nature of the divorce process, obtain the confidential information,and use it to sabotage your company in the marketplace. In addition, valued customers or vendors may learn information about your business that makes them feel insecure or threatened. The damage may linger for years. For example, statements made in a divorce regarding the company’s value (using legitimate methods to establish a lower value) may be inconsistent with later valuations for corporate purposes such as obtaining a loan (using legitimate methods to establish a higher value), rendering any reported valuation unreliable in a third-party’s eyes.
How Can I Limit the Damage to My Company from a Shareholder Divorce?
It is unlikely that a privately held company can avoid any harm when one of its shareholders experiences a difficult divorce. However, a well drafted prenuptial or postnuptial agreement can render the most intrusive and damaging disclosures unnecessary, and can limit or attribute the related costs away from the company. In some situations, these agreements can save the business itself.
A recent case involved three partners who built a profitable service business together. Two of the partners were married to each other, and they eventually separated. The fight over the control and value of the company was so acrimonious that a court appointed receiver took over the business. The receiver discovered and reported regulatory record-keeping violations to the government that eventually caused the business to be shut down permanently. If there had been a prenup or postnup in place, perhaps a receiver would not have been necessary, and the parties could have resolved the regulatory issues confidentially without closing the business.
Protect your business’s privacy. Require that all owners of your business get a prenuptial or postnuptial agreement that addresses business valuation and confidentiality issues.Require that the agreement insulates and protects the business by mandating that the company’s attorneys’ and accounting fees’, related to a shareholder’s divorce,shall be paid for by the shareholder-spouse or the spouse demanding the disclosures—not the company. Build in buyout clauses so that threats to corporate control can be met with a mandatory buyout of the divorcing shareholder’s interests by the other shareholders.
These are just a few examples of suggested prenup and postnup language that companies should require of their shareholders who marry or are married. More protections may be available in your state. You should consult a divorce attorney licensed in your state who has experience representing businesses. That attorney can customize a prenuptial or postnuptial agreement to meet the unique characteristics of the company and state law.
Chantale Suttle is the Managing Attorney and Founder of JustPrenups.com, which is headquartered in Celebration, Florida. She has been in the exclusive practice of family law for over 21 years and has served countless small business owners in divorce court. Drafting prenuptial and postnuptial agreements for small business owners, using the experience she gained in litigation is her favorite work.
Warning: All posts on this website and its partner website, the DADvocacy™ Law Firm, contain general information about legal matters for broad educational purposes only. This information is not legal advice and should not be treated as such. This blog post does not create any attorney-client relationship between the reader and JustPrenups.com or DADvocacy™ Law Firm.