Published: New Hampshire Trial Lawyers Quarterly
July 26, 2024
Since as long as you remember, in some capacity, you have worked for your family's business. You gained valuable experience. Years later, you now have an ownership interest in the business. One day, upon the passing of your parents, the business will be yours. Eventually, you hope to pass down the family business to your child. With these circumstances in mind, you want to preserve the value of the business. Safeguarding a business requires proactive thinking of what could happen before, during, and after a divorce.
Absent a prenuptial agreement, your interest in your family's business, even your interest before you got married, is considered an asset in your divorce. See In re Sarvela, 154 N.H. 426 (2006) (finding that even if an individual owns a business before getting married, the business interests are not excluded from the martial estate).
New Hampshire courts use a two-step analysis in making an award of property in a divorce. First, the Family Court determines as a matter of law whether the property to be divided is marital property. Second, the Family Court determines what division of that property would be equitable. A court's determination of what is equitable can be further influenced if the married couple owns and operates the business together or if the spouse worked for the business. It is also important to note that parties are generally entitled to an equitable division of the marital estate and the Family Court presumes that an equal division is equitable in a long-term marriage.
Have some say in the division of the business. Do not leave the destiny of your family's business in the hands of the court. You should consider putting plans in place to retain control of your business.
How to protect the business before marriage: consider entering into a pre-nuptial agreement to protect your family business.
An individual with an established family business can protect those assets from his or her spouse in the event of a divorce by adding a provision addressing the business in a pre-nuptial agreement. The provisions in the prenuptial agreement could protect and conserve a closely held or family business from intrusion, disputes, or dissolution upon death or divorce.
A prenuptial agreement is a contract entered into by prospective spouses in contemplation of marriage that varies or supplements the legal rights and obligations that would otherwise be imposed by law. In re Estate of Wilber, 165 N.H. 246 (2013). Pursuant to RSA 460:2-a, "[a] man and woman in contemplation of marriage may enter into a written interspousal contract and the courts of this state shall give the same effect to such contracts entered in other jurisdictions as would the courts of that other jurisdiction."
If you do not want your future spouse to receive a percentage of your family business in the event of a divorce, then you should include a clear provision in the pre-nuptial agreement regarding the business.
In a prenuptial agreement you can designate as separate property things like shares in a closely held business that you retain and do not become part of the marital estate in the event of a divorce.
SAMPLE LANGUAGE: In the event of divorce, [husband/wife] shall not be entitled to any interests in XYZ business, including any and all income, dividends, increase or decrease in value (including any increases as a result of the pay down of a liability associated with any asset), accumulations, additions, accretions, acquisitions, purchases, contribution or distributions. [Husband/wife] shall be awarded all of the above business interests.
You also may want to include a provision, such as "The parties agree that the court shall not consider XYZ's business value or assets when dividing the remaining marital property."
At the time of drafting, both parties must provide a full disclosure of all assets, including the business assets and its value. A pre-nuptial agreement is presumed to valid unless "(1) the agreement was obtained through fraud, duress or mistake, or through misrepresentation or nondisclosure of a material fact; (2) the agreement is unconscionable; or (3) the facts and circumstances have so changed since the agreement was executed as to make the agreement unenforceable." Matter of Nizhnikov, 168 N.H. 525, 528, (2016); see also In re Estate of Hollett, 150 N.H. 39, 42 (2003).
A pre-nuptial agreement allows you and your spouse to agree to the division of the business interest; thus, removing it from the Family Court's determination. If both parties agree to how the business assets should be distributed in the event of a divorce, such that one of the parties will keep the business and the other party would be entitled to buyout, then the parties should consider setting forth a value of the business in the pre-nuptial agreement and agree to a formula for the buyout of the business. Establishing the business value as of the date of the marriage is helpful because while an increase in value gained during the marriage may be subject to division, the pre-marital value of the business as separate property could be protected. You may also treat any appreciation of the business as separate pre-marital property. There are several variations on how the business interest may be treated in a pre-nuptial agreement in the event of divorce. These are matters are all subject to negotiation.
It is important to note that pre-nuptial agreements are only one avenue for ensuring that your family business is carried out as you and your family sees fit. Families should also consider adding stock restrictions to their shareholder and/or other business agreements.
How to protect the business after marriage: consider entering into a post-nuptial agreement to protect your family business.
If you and your spouse are already married and you want to ensure your business interest is protected, then you should enter in to a postnuptial agreement. The New Hampshire Supreme Court held that agreements made between spouses after marriage are valid and enforceable in New Hampshire. In re Estate of Wilber, 165 N.H. 246, 252 (2013). The Court in Wilber found that such agreements, in essence, are subject to the same requirements as agreements entered into by parties prior to marriage. Id. The Court explained that the principles governing prenuptial agreements should be looked to for guidance but declined to decide whether postnuptial agreements in New Hampshire will be subject to a higher level of scrutiny. Id. Postnuptial agreements are scrutinized by the Court more closely than ordinary contracts. In re Estate of Hollett, 150 N.H. 39, 42, 834 A.2d 348 (2003). That said, a pre- or post-nuptial contract "carries with it a presumption of validity." In the Matter of Yannalfo and Yannalfo, 147 N.H. 597, 599, (2002); see MacFarlane v. Rich (MacFarlane), 132 N.H. 608, 614 (1989).
The provisions mentioned above, can also be included in a postnuptial agreement.
What happens if a new business, which stemmed from my family business, was formed by me and my spouse?
Good news—you will likely not be forced to work with your spouse after the divorce, unless there is an extenuating circumstance. Generally, the Family Court will not want both parties still involved in the business after a divorce and one party would continue to own and operate the business. That means that the spouse most capable of operating the business will retain ownership of the company and will have his or her employment terminated. As the business stemmed from your family's business, it is highly likely that you will continue to operate the business.
Absent a prenuptial or postnuptial agreement, discussed previously, the departing spouse will either be paid cash for his or her share in the business or receive a note payable over years, generally not over more than a 10-year period. The note may be secured by the assets of the business or a lien may be placed against the equity interests in the business until the note has been paid in full.
Notably, in certain circumstances, even though New Hampshire courts have allowed deferred installment payments, the payments must be made over a "reasonable" period of time. Buyout provisions over 10 years have been found to be unreasonable. Typically parties execute a promissory note and mortgage and the promissory note shall include the Applicable Federal Rate as of a designated time period, such as the date of the divorce.
Preferably, decisions regarding the future ownership and operation of the business will be determined by the terms of the contract when the business was established. Such a contract, commonly known as a shareholder, partnership or member agreement (the "business contract") depending on whether the company was formed as a corporation, partnership or limited liability company, sets forth the relationship among the equity holders, including their respective rights and responsibilities.
The business contract will help protect what is, in many cases, the family's most valuable assets, and ensure the continued success of the business in the event of divorce. A family court judge will likely enforce the terms of the shareholder agreement, including terms addressing ownership and operation of the business, thereby ensuring some predictability in an otherwise potentially volatile situation.
The business contract should include a variety of protective provisions. For example, the parties can stipulate that divorce will trigger mandatory buy-out of one of the spouses from the business. It is key to include a clear mechanism for valuing the departing spouse's interest in the company, and for the couple to consider possible financing options to fund the buyout.
There are several ways to determine the value of the departing spouse's interest in the business, including setting a pre-agreed formula, fixing a set price, or requiring the determination to be made by an independent third party such as an appraisal firm. The parties should consider whether and on what terms the departing spouse's interest may be offered for sale to a third party.
Although unlikely in the case of an established family business, in a worst-case scenario, the Family Court could order that the business be sold and equitably divide the proceeds between the parties.
If the business is going to be sold, then current and future tax liability should be considered. If the business is not being sold, then outstanding tax liability would need to be discussed as an expert will not include that analysis in the determination of the fair market value. Outstanding tax liability does not affect the value of the company as it is not able to be factored in to the analysis under the Matter of Wolters decision.
The New Hampshire Supreme Court held in the Wolters case that "when valuing marital assets for the purpose of distribution, a trial court may consider potential tax consequences to the parties only if a taxable event, such as a sale or other transfer of property, is required by the property distribution, or is certain to occur shortly thereafter." Matter of Wolters, 168 N.H. 150, 156 (2015) (internal citations omitted). In contrast, where there is merely a likelihood or a possibility that a taxable event will occur, a court may not reduce the value of an asset by uncertain tax consequences. Id.
This is important because a business valuation expert is not required to consider the future tax liability of a company when determining its value. Therefore, the Parties should discuss how to divide the future liability if the business is not being sold. This analysis should be discussed with your family business accountant or tax preparer.
Protective provisions in contracts benefit owners of family businesses under an array of situations, not just divorce.
The provisions discussed in this article can benefit the owners-operators of any closely held family business. The success of the family business depends on the affiliation of the owner-operators. Buy-out provisions can be triggered not only by divorce, but also be deadlock among the owners, untreated substance abused or mental health issues, a variety of bad behavior, including conviction of a felony, or the death of an owner.
A multitude of other protective provisions can be utilized. For example, restrictions can be placed on the sale of equity interests in the company and the ability of non-blood relations to own interests in the company. An independent advisor can be appointed to mediate family disputes. The agreement can mandate objective and professional decision-making to avoid future problems that may arise.
Advanced succession planning provisions can help mitigate family discord that often arises when a family business passes from one generation to the next. Trusts and other estate planning instruments can also be used to ensure a seamless succession and deal efficiently with any possible estate tax related issues that may arise.
Counsel with experience and a deep understanding of the dynamics of family businesses and the applicable law should be retained to draft such a contract. Each owner should also consider whether to engage his or her own attorney to represent his or her own best interests.
Under all of these circumstances, tax implications should also be considered. Was your spouse or another family member being compensated in excess of the value they provided to the business? Did your business take a compensation deduction for this family member? These questions need to be considered at the time of the divorce.
Navigating these discussions can be challenging, but the time spent now will avoid potential issues later. There tools mentioned in this article are only some of those available to help business owners mitigate the risk of having business decisions made for them by the Family Court in a divorce or in a proceeding brought by disputing family members.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.