Shares and divorce: How divorce could impact your company

Whilst a divorce can of course be hugely challenging personally, it can also have significant implications for a company if one or both spouses are shareholders. Whether you’ve transferred shares to your partner for tax planning purposes or you’re business partners, it is important to consider how the future of your company can be protected in the event of the breakdown of a marriage. Without proper planning and shareholder protection, issues can arise such as disputes over share ownership or even the unwanted involvement of an ex-partner when it comes to business decision making.

The risks for companies and shareholders

Within a marriage, assets can be sorted into matrimonial and non-matrimonial assets. Matrimonial assets are those which are considered joint, regardless of whose name appears on the legal title, while non-matrimonial assets are considered to belong to one individual, this will usually apply to any assets acquired before the marriage or brought in from an external source. Shares are often treated as a matrimonial asset, particularly if they were acquired or increased in value during the period of marriage. When dividing matrimonial assets, the court usually starts with an equal split however this will be adjusted to ensure the proportions are fair in the context of the respective positions between the two individuals and meet both parties’ needs.

It is important to note that business interests may come into play in a divorce settlement when the resources available from the marital pot (being the combined assets and financial resources) are insufficient to meet the financial needs of each party or to achieve a fair distribution. The court is required to consider various factors under section 25 of the Matrimonial Causes Act 1973 including the financial resources of each party, their needs, obligations, responsibilities and the standard of living enjoyed during the marriage. Therefore, if a party’s shares in a company constitute a significant asset, the courts may treat them as a resource to fund the settlement.

How to plan ahead

While divorce settlements are decided by the courts on a case by case basis, from a company perspective at least, it is possible to take measures to prevent or reduce the commercial risks which flow from a shareholder divorcing. These risks can include:

• An ex-partner having an unwanted say in the business affairs of the company or even frustrating a sale of the company.
• An unwanted third-party becoming a shareholder.
• Disruption to business continuity and a breakdown of shareholder relations.

These risks can be prevented or reduced by considering and dealing with the following points early on:

• Seek family and corporate legal advice - particularly in high net worth relationships or where a business is the main family asset.
• Implement bespoke articles of association and consider including compulsory share transfer provisions to apply in the event of a divorce.
• Put in place a shareholders’ agreement that prepares a company for significant personal events affecting any of its shareholders.
• Incorporate drag-along and tag-along clauses in the company’s constitutional paperwork.
• Implement a prenuptial agreement which includes protection of business interests.

Compulsory transfer provisions

One way to mitigate risk is to include compulsory transfer provisions within the company’s articles of association. This is a clause which requires a shareholder to transfer their shares in certain circumstances, such as divorce, to keep control of the business within the intended ownership group. For example, the provision could require an ex-spouse to sell all of their shares back to the company, to the other shareholders or to a pre-agreed buyer in certain circumstances.

If a compulsory transfer provision is drafted in good faith and incorporated well before a marital breakdown, it is likely to be considered valid and enforceable. The courts will also generally uphold the principle that a company is a separate legal entity from its shareholders. Therefore, if the company was set up for legitimate purposes, its assets are usually protected from direct court orders. The needs of both parties are a priority when the family court determine a financial settlement and therefore all forms of financial resource will be considered, however they will only interfere if necessary for the purpose of needs.

To add further protection, it would be beneficial to put a prenuptial agreement in place to reiterate the aim of provisions in the articles and add weight if the matter was to go to court. It is important to note that the family court retains the power to override and depart from the terms of a prenuptial agreement where necessary to meet the parties’ needs, which may include redistributing assets, such as shares.

While pre-existing compulsory transfer clauses will generally be enforceable, provisions introduced or amended during divorce proceedings may be scrutinised by the court as an attempt to frustrate the financial claims of the spouse and may be deemed inequitable. Therefore, it is important to plan ahead and ensure both bespoke articles of association and a prenuptial agreement are put in place early on.

Drag-along and tag-along provisions

Drag-along and tag-along rights can also become relevant in post-divorce scenarios if a party wants to sell their company.

Drag-along rights allow majority shareholders to force minority shareholders to sell their shares to a buyer wanting to purchase the entire issued share capital of the company. In the context of divorce, this would prevent an ex-spouse from frustrating a company sale and ensure a smooth transaction.

Tag-along rights give minority shareholders the right to “tag along” on a share sale by the majority shareholders. In divorce scenarios, this would protect a spouse who owns a small share of the business by ensuring they have the opportunity to sell their shares along with the majority seller on the same terms.

Together, these provisions maintain fairness, encourage efficiency and avoid future shareholder disputes.

Deadlock provisions

In companies where divorcing spouses both hold significant shares, there is a risk of reaching deadlock if both parties cannot agree on a certain topic. Deadlock provisions in shareholders' agreements are designed to set out clear steps to resolve disputes when shareholders (often with equal voting rights) cannot agree on a way forwards. A variety of mechanisms can be included to resolve these situations however common provisions include escalation to mediation or clauses enabling parties to offer to buy each other out. In the context of divorce, deadlock provisions can be crucial where ex-partners can no longer collaborate effectively.

Conclusion

While it’s important to plan ahead for growth and development in both business and personal life, it is equally important to have a plan in place for unanticipated challenges. Divorce can be emotionally and financially tough but with the appropriate legal advice and protections in place, it’s possible to at least ensure continuing business stability during this time and beyond.

Please contact our corporate and family teams for further advice.