Publication

Dividing a Business between Spouses: how to Mitigate Risks

15/03/2020

Daryna Lysyk

Associate

Private Client and Wealth Management

Oksana Voynarovska

Partner, Attorney-at-Law

Labour and Employment,
Private Client and Wealth Management

Business Assets at Risk

A family business is based on trust and common commitment to result of all family members, including spouses. However, no one is safe from family troubles, which can lead to divorce and subsequent division of the marital property, including business assets. Therefore, it is better to immediately foresee the risks and figure out what the other spouse can lay claim to in the event of a property dispute. It may be worth taking steps to eliminate these risks.

Holding an interest in a company. Often, during a marriage, one spouse becomes the founder of a company (limited or additional liability company) and uses marital funds or marital assets to contribute to the authorized capital of the company. In this case, the following rules will apply to the division of marital property.

  1. The funds and assets contributed by one spouse to the authorized capital of the company will become the property of the company. They are no longer marital property.
  2. An ownership interest held by one spouse in the company is non-marital property. The other spouse will not be able to effectively claim 50 percent of this ownership interest. This means that the other spouse will not become another founder of the company, nor will he or she receive the right to manage the company.
  3. The other spouse is entitled to monetary compensation. He or she may claim 50 percent of the amount contributed to the authorized capital of the company. If the authorized capital consists of property, then 50 percent of the market value of such property at the time of the dispute. Alternatively, if a contribution to the authorized capital of the company was made in the interests of the family and by mutual agreement of the spouses, then the non-founder spouse may claim compensation for 50 percent of the company’s income for the entire period of its operations. In this case, the spouse-founder of the company will have to prove that part of the company’s income was spent for the benefit of the family, e.g., to purchase real estate, pay for the children’s education, joint vacations, etc.
  4. Furthermore, the other spouse will also have the right to claim the division of other assets from the marital estate to his or her personal property, which assets shall be provided in lieu of the monetary compensation.
  5. The company’s assets will not be marital property even if one of the spouses is the sole founder of the company. In other words, the property that is directly owned by the company is not at risk when the marital property will be divided, meaning that the other spouse cannot lay claim to such property. However, if the company is liquidated at the time of the dispute, then the spouse who was not its founder will be entitled to half of the company’s assets remaining after liquidation.

The same rules apply to a private enterprise.

Shares. An algorithm for the division of shares between spouses is similar to that used for dividing ownership interests in a company. There are still some distinctions.

  1. If one of the spouses purchased shares in a company during marriage, such shares are presumed to be marital property. In this case, when the property will be divided, the spouse who is not a shareholder may lay claim to half of the shares of the spouse-shareholder.
  2. The other spouse is also entitled to compensation for 50 percent of the share value. In this case, the compensation will be calculated based on the market value of the shares at the time of the dispute. If neither spouse voices the preference that the market value be used, then the calculation will be based on the par value of the shares. Furthermore, instead of monetary compensation, such spouse may ask for other assets to be distributed to him or her as an offset against 50 percent of the share value. It is this scenario with compensation or distribution of other property that is usually encountered in case law. This is because courts often arrive at the conclusion that a bundle of corporate rights and obligations owned by the spouse-shareholder is indivisible.
  3. The other spouse may additionally claim 50 percent of dividends on the shares. In this case, the spouse-shareholder, similarly to an ownership interest in the company, may appeal to the fact that part of the dividends was used to meet the family’s needs.
  4. A non-shareholder spouse cannot lay claim to the assets of a joint-stock company.

Property of an individual entrepreneur. The legislation does not provide for the possibility to register property directly in the name of an individual entrepreneur, which could safeguard the property in case of family disputes (as in the case of companies). In the registration process, one of the spouses is usually specified as the owner of the assets in his or her capacity as an individual. This gives rise to additional disputes, which may arise between spouses in dividing the property used by one of the spouses as an individual entrepreneur for his or her business activities.

  1. The assets of an individual entrepreneur can be recognized as marital property and included in the marital estate when the property will be divided. This is possible if such assets were purchased using marital funds. 
  2. However, the property used by one spouse to carry out his or her business activities as an individual entrepreneur is actually not to be divided. Still, the market value of such assets is taken into account: the other spouse can ask for monetary compensation of 50 percent of the market value or demand that any other property is distributed to him or her as an offset against 50 percent of the value of the individual entrepreneur’s assets.
  3. However, the spouse-individual entrepreneur is the sole owner of the property that was purchased using the funds from entrepreneurial activities and is used to conduct such activities not in the family’s interests. Such property is solely owned by such spouse and is not to be divided between spouses.

Minimization of Potential Risks

At the same time, there are several legal tools to mitigate the aforementioned risks. The most widespread tools include a notarized statement, a postnuptial agreement, and a marital property division agreement.

Notarized statement. A notarized statement is a proactive step, a way to prevent a potential dispute in each particular case.

The point is that one spouse declares that the funds (assets) contributed by the other spouse to the authorized capital of the company, using which he or she buys shares or property for his or her entrepreneurial activities, are the personal ownership of the other spouse. Such language will allow to avoid the recognition of shares or assets of the individual entrepreneur as matrimonial property and the need to compensate 50 percent of the contribution or income of the company in the future. 

Such statement must be signed by the spouse personally and certified by a notary. This should be done in each individual case where business assets are in place and with as much specification as possible.

Postnuptial agreement. A postnuptial agreement is a mutual agreement between spouses aimed at settling their property matters. This is not an act of mistrust, but a real way of safeguarding assets and avoiding litigation.

Based on a postnuptial agreement, spouses can depart from the legislative presumption that property acquired during marriage is community property.

In the early stages of marriage, it is logical to enter into such agreement without specifying exact property. In other words, it is possible to just specify that all assets registered in the husband’s name will remain his personal property, and all assets registered in the wife’s name will be her personal property. This language is also seen as a way to avoid disclosing all assets to the other spouse.

Additionally, the spouses can specifically indicate in the postnuptial agreement to whom and what property will go in the event of divorce. The arrangements may become effective once the agreement is executed or will have a retroactive effect and apply from the moment of marriage conclusion.

In any case, the postnuptial agreement allows a spouse to withdraw his or her ownership interests in a company, shares, or assets of an individual entrepreneur from the marital estate. This guarantees that both existing and future businesses will be protected.

Furthermore, the spouses may enter into a postnuptial agreement only before the official dissolution of their marriage. The agreement must be notarized.

Marital property division agreement. The marital property division agreement is another tool ensuring the peaceful settlement of property matters, through which the spouses can divide marital assets between themselves, at their own discretion.

Unlike the postnuptial agreement, the marital property division agreement can be signed both during marriage and after its dissolution; the spouses are not limited by time.

Such agreement may concern all or part of marital property; however, the spouses should expressly specify in the marital property division agreement what property is to be divided. The spouses can also settle the division of business assets owned by each of them. In this case, the division of property not named in the postnuptial agreement will not be allowed.

The marital property division agreement concerning real estate and vehicles must be certified by a notary. If such agreement specifies movable assets only (they also include shares and ownership interests in a company, income and dividends), then the notarization of the agreement is not necessary, although, from a practical point of view, it is still desirable. 

Published: Simeinyi Biznes, March 2020

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