In this part, let’s look at buying spouses out and corporate assets.
Whether you are a business owner, the spouse of a business owner, or in business with another family, you may be curious about what impact a divorce can have on the business. If your business partner is divorcing or you are considering going into business with another family, there are also steps you can take to protect the business.
How is a spouse bought out?
There are many potential solutions, such as:
- When we are dividing family property, we typically look at all the assets and all the debts. That means that we do not need to address the company and every other asset separately. For most small businesses, there are enough other assets that the business can stay with one spouse, and the other is compensated with more of the remaining family property.
- Spouses might also receive credit for property they had before the relationship, or property that was inherited, received as a gift, insurance proceeds, or a personal injury settlement. There are complex rules about what qualifies and the amount of the credit. The point is that sometimes only part or maybe even none of the business’s value is shared with the other spouse.
- Sometimes a spouse might get bank financing or a loan from family or friends to buy out the other spouse. Or maybe there are enough liquid assets in the business to buy out the other spouse. But buying out the other spouse may not be possible where there are other shareholders or doing so would not be financially feasible, maybe because of the size of the loan payment, lack of available financing, or because taking out funds would leave the business with insufficient funds to operate. Withdrawing assets also leads to significant tax consequences, although those can sometimes be addressed with the help of a tax professional. If the spouse being bought out has no interest in ever starting their own business, we might use up their lifetime capital gains exemption, which minimizes the eventual tax liability of the business when it is eventually sold or liquidated.
- Where a buy-out is not possible, spouses might both become shareholders. This is usually a last resort because spouses are generally looking to sever ties. Courts might also refuse to keep them in business together where there is a high risk of a spouse being mistreated by the company due to a history of corporate misconduct.
- Sometimes a Unanimous Shareholders Agreement (USA) with other shareholders prevents a spouse from becoming a shareholder. While the courts have upheld ordinary USAs, they have sometimes declared that a spouse holds some of their shares in trust for the other spouse. This is generally accompanied by court-ordered rules setting out the obligations of the shareholding spouse and granting the non-shareholding spouse the right to sue the company if their shares are intentionally devalued. Sometimes the court does not uphold unusual or overly-aggressive clauses in USAs.
- Sometimes the business or some of its shares are sold, or the company is liquidated. This is very rare and usually not in anyone’s best interests. Selling a business is not like selling a house as there often is not a large market of potential buyers. Maximizing value typically depends on finding the right buyer, which sometimes means a competitor or entity looking to enter the industry. Selling the business at the time of the divorce may also not be the best time to sell it. You might end up receiving much less if ideal buyers are not looking to buy at that moment. If you only own part of the business, there might also be a minority discount, which means a lower sale price because potential buyers may not be as interested if they do not have control, or if they must share and interact with other shareholders. Many smaller businesses would fall apart without a key shareholder’s involvement, if it is not possible to simply replace them with a manager. It’s rare that courts will order the sale of a business, unless neither spouse wants to keep the business or the conflict between spouses means continued operation is unsustainable. If the business is more valuable as an income stream than the sale proceeds, selling it might be killing the goose that lays the golden egg. There are people whose job it is to sell businesses, similar to realtors. Some of them might even have a Chartered Business Valuator on staff, so that you can receive some information about the potential sale price (although hiring your own Chartered Business Valuator would still be more reliable, if you can afford one). They can list businesses anonymously and can require potential purchasers to sign non-disclosure agreements. These agreements make it unlikely for competitors to take advantage of a sale, and for employees and other stakeholders to find out about the sale and jump ship.
- There could be a buy-out over time. Although if the period is too long and they are not receiving any other advantage, the non-shareholding spouse might be further ahead to become a shareholder and share the profits.
- Sometimes creative solutions can come out of tax reorganizations.
- If a business has multiple locations and both spouses are sophisticated and involved with the business, they could divide the branches.
- If the spouses anticipate the children taking over the business, sometimes we will start planning the transition. For example, implementing an estate freeze with the advice of a tax professional.
While the courts are limited in what they can order, negotiating a resolution often results in a much more advantageous resolution to both spouses. And there are many more creative solutions beyond the options described above.
Can a spouse go after a corporation’s assets?
Usually, the property we are dividing is the shares, not individual assets. The corporation owns the assets, not the spouses directly.
Sometimes the corporation’s shareholders will voluntarily agree to withdraw an asset from the company to buy out a spouse, especially if the spouses are the only shareholders. Doing so is often more advantageous to everyone than both spouses continuing to be shareholders or selling/liquidating the business.
What happens if a history of questionable corporate conduct means the spouses should not both be shareholders? And a lack of other options means that pulling an asset or funds out of the company is the only way for a spouse to be paid out? Our Court of Appeal had this issue come before them in the case of Aubin v Petrone. In that case, even though there were legitimate third-party shareholders and a Unanimous Shareholders Agreement, the Court granted the estranged spouse a mortgage over the business’s office building. It later ordered that if the business did not make significant payments as scheduled, the mortgage could be enforced, putting the office at risk of foreclosure. There were extreme circumstances in that case though. The result was not ideal for anyone, as the spouses and company are still fighting in court. The first trial decision was released in 2018, and there have been several court decisions since, including one within a month of writing this article.
Again, whenever assets are to be removed from a company, consult a tax professional. Some accountants have additional training in tax, and some circumstances even warrant involving a tax lawyer.
Part 2 of this article addresses how to insulate a business from a divorce’s potential negative impacts, both proactively and if the divorce is already underway. It also addresses what steps to take if you are divorcing and you or your spouse owns a business, and how a self-employed spouse’s income is calculated for child and support purposes.
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Disclaimer
The information in this article was correct at time of publishing. The law may have changed since then. The views expressed in this article are those of the author and do not necessarily reflect the views of LawNow or the Centre for Public Legal Education Alberta.
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About Ken Proudman
