Family law: What happens to business assets in a divorce?
Engaging forensic accountants and solicitors early on in the divorce process is key to a fair settlement of matrimonial assets, writes Neil Hodge.
Divorce can be a messy enough process without the extra complication of valuing and dividing up a business, but a recent court ruling has highlighted just how important it is to get professional accounting and legal advice at the outset.
In October, England’s Supreme Court allowed two women, who claimed they had been misled over their husbands’ wealth during their divorce settlements, to take their cases to the English High Court to seek a more equitable share of the assets.
Alison Sharland accepted £10m in her divorce from her husband Charles, a software entrepreneur who co-founded AppSense, believing that this sum represented half of his wealth. However, it later transpired that he had lied about his company’s value, saying it was worth £47m while the financial press estimated it to be worth more than 13 times that (about £630m). He also did not reveal that he had plans to float the company on the stock market, whereby she was also set to profit as she was entitled to 30% of the proceeds of her husband’s shares.
Varsha Gohil, meanwhile, accepted £270,000 and a car as her divorce settlement in 2002. However, in 2010, when her former husband was convicted of money laundering and jailed for 10 years, evidence emerged that he had failed to disclose his true wealth, which was estimated to be £35m, during divorce proceedings.
Although there is no guarantee that either of the women will succeed in their legal battles, the cases illustrate the perils of not getting a proper estimate of a couple’s assets during the divorce process.
Scottish divorce law is enshrined in the Family Law (Scotland) Act 1985 and relies on a 50/50 split of the 'matrimonial assets' that have been built up during the marriage, which can include the house, furniture, car, pension pot and the business, either family-run or independently owned/part-owned by one of the divorcing couple.
Unlike in England, where courts have wider discretion in the awarding of assets, the concept of a 'stellar contribution' – whereby one of the divorcing parties is deemed responsible for the business's success, as advertising tycoon Sir Martin Sorrell proved in his divorce in 2005 when he was awarded 60% of the assets - is not recognised in Scotland.
Divorce in Scotland works on the premise of a 'clean break' and applies to where the divorcing parties are resident, as opposed to where the business is based (so the business could be based in England, or overseas, but the couple would be subject to Scottish law if normally resident in Scotland).
A business owner can retain total control of a company after a divorce so long as the spouse’s assets amount to the same value. Generally, Scottish courts would be reluctant to award shares of the business to a spouse who had no day-to-day involvement in the running of the company if selling off part of the business meant its future could be put at risk, its value affected, or the workforce reduced to cover the costs.
Shaun George, head of family law at solicitors Brodies, says it is more problematic when the business is owned and managed by a husband and wife team. "Each person may have had specific roles - for example, the husband may have been the person developing the product or service, but the wife may have been in charge of marketing it and selling it. Either one of them leaving the company could devalue the ongoing business as one of the major selling points for clients may have been the particular skills or experience held by that person."
"Consequently, who should own the company as part of the divorce settlement? This can take time to sort out, particularly if the divorce is acrimonious."
Calculating the value of matrimonial assets
The key point about divorce in Scotland is that the value of the matrimonial assets must be taken from the time of the separation, rather than when the divorce is finalised (again, in England, courts have much wider discretion in how assets are divided). In most cases, this poses little difference in valuations. But there have been exceptions.
For example, the financial crisis saw company valuations slide dramatically in some cases - particularly if they were listed on an exchange - and property prices also took a nosedive. Aberdeen’s key sector - the oil and gas industry – has been subject to volatility swings over the past few years, meaning that property prices and business valuations (particularly for those linked to North Sea oil and gas) have varied considerably, and this has increased the need for divorcing parties to engage forensic accountants.
"Normally, reaching an agreement on the division of assets is a straightforward process, though some cases can be lengthy."
Says Greig Rowand, forensic accounting partner at chartered accountants Henderson Loggie. "But the financial crisis showed the peculiar cons of Scottish law. For example, a business owner looking to get divorced in 2007 might have had business assets valued at £10m at that time, which the spouse could expect half of. However, by 2008 when the financial crisis kicked in and property prices fell through the floor, the company could have seen its sales slump and its value drop to £7m, yet the spouse has already been awarded £5m on an old valuation."
Conversely, a business could be worth £1m on the date of separation, but worth £10m at the date the divorce is completed, and courts would similarly be reluctant to change the amounts awarded, particularly if there is no indication of fraud, adds Greig Rowand.
Another important issue that business owners need to be aware of is that 'matrimonial assets' do not include those that may have been acquired, developed or bought beforehand, says Brian Tait, family law partner at solicitors Drummond Miller.
For example, if Mr X had owned his business, property, plant and machinery prior to the marriage, these would not be deemed to be part of the matrimonial pot and would not be included in any divorce settlement.
However, if Mr X had set up a different company during the course of his marriage, this would be deemed to be a matrimonial asset and would need to be included within the divorce settlement. Similarly, if Mr X had turned the business he had set up prior to the marriage from a limited company to a holding company or a partnership - and thereby changed the nature of the business asset - he could expect the new entity to be treated as a matrimonial asset. Likewise, if Mr X had made his spouse a partner or company director, she would be entitled to a share of the business assets in any divorce settlement.
Experts say there are several considerations when valuing a company. Much depends on the kind of business it is. Projected turnover, profit and the balance sheet are more helpful for a marketing-type business or a hotel, for example, while the asset base - such as property, plant, machinery and stock - is useful to determine the value of a manufacturing company or farm, for example. Debts, loans, tax liabilities, and cash also need to be accounted for, as does 'goodwill'.
Complications for start-ups
Complications may also arise if the company is a start-up business that is not projected to break even for a few years, or if the business is going through a downturn and is losing money.
Rhona Adams, partner and head of the family law team at solicitors Morton Fraser, says that "if a business is failing (or is just not quite at the point of succeeding) at the time the parties separate, then it will have a 'nil' value in the matrimonial balance sheet. In other words, the party with the business interest would get to retain it but would not be credited with having kept an asset with any value by virtue of that".
She adds: "It doesn’t matter for the purposes of this exercise if the business might take off in the future and start to make serious money for one of the parties – the exercise in which the court is engaged is dividing up the assets fairly as they stand at the date of the parties’ separation."
Given the delicate or even fractious nature of a divorce, Shaun George's firm offers a 'collaborative approach' for couples where forensic accountants are engaged at the outset on behalf of both parties to provide full disclosure and an accurate valuation of the matrimonial assets so that a suitable agreement can be reached about how the assets can be split and the business can be preserved.
Forensic accountants and lawyers say that in some scenarios they have to develop some creative solutions. For example, divorcing couples who own farms may not be able to divide the land, and doing so may affect growing crops or keeping livestock. It also may not be possible to sell any of the land to a neighbouring farmer because the holding is not located next to that farm’s existing plots.
As a result, forensic accountants and solicitors have explored possibilities such as providing a spouse with an annual income over a period of years that would equal half the business’s assets at the day of separation; enabling the couple to be joint owners/managers of the farm but to live separately; and building separate properties on the farm land so the couple can make as clean a break as possible.
"Involving forensic accountants and solicitors together at an early stage to properly assess all the matrimonial assets can prevent a lot of stress for both parties," says Shaun George. "It is important that both parties provide full disclosure as it is very difficult to convince the court that the settlement is unfair after the divorce is granted," he adds.
Neil Hodge is a freelance business journalist. This article first appeared in the January 2016 edition of CA magazine.