Is a Buy-Sell Agreement Controlling in a Divorce?

In divorces, a business is often an asset of the marriage. One spouse typically is the “operating spouse” and he or she is in partnership with another person or persons.  Assuming the spouse’s interest in the business has a marital (community) component, that interest must be assigned a value as an asset of the marriage.   When there are other people involved in the business, often a buy-sell agreement, stock purchase agreement or similar arrangement controls that relationship.   When a divorce takes place should the price or formula set forth in the buy-sell agreement be used to determine the value of the operating spouse’s interest for purposes of the divorce?

In California, In re Marriage of Nichols, 27 Cal.App.4th 661, (Cal. App. 3 Dist., 1994), at 672-673, sets forth an important three-part valuation test, which is consistent with the standard used by the IRS (IRS Revenue Ruling 59-60).   In Nichols, the wife argued that the court erred in using a stock purchase agreement to value her husband’s shareholder interest in his business because the agreement merely measures a shareholder’s contractual withdrawal rights and it was undisputed that the husband was not withdrawing from his firm.   The court disagreed and held that, even though it was not valuing the husband’s contractual withdrawal rights, the trial court could use the stock purchase agreement—which is an arm’s length buy-out agreement—to determine the community interest in the business. The court explained as follows, setting out a three-part test for whether to use a buy-sell agreement to value the business:

“In assessing whether to use a formula set forth in a buy-sell agreement, the trial court should consider (1) the proximity of the date of the agreement to the date of separation to ensure that the agreement was not entered into in contemplation of marital dissolution; (2) the existence of an independent motive for entering into the buy-sell agreement, such as a desire to protect all partners against the effect of a partnership dissolution; and (3) whether the value resulting from the agreement’s purchase price formula is similar to the value produced by other approaches.  Here, the trial court found that the firm had an independent motive for entering into the buy-sell agreement and that there was no evidence the stock purchase agreement—which husband signed approximately eight years before the parties separated—was designed to deprive shareholders’ spouses of any rights. As to the third factor, even if the firm’s accounts receivable and work in progress were included in valuing husband’s shareholder interest, after applying appropriate marketability and minority discounts, husband’s interest was worth only $12,500 to $25,000. This amount is not substantially greater than the valuation based upon the stock purchase agreement.  Therefore, these factors further support the trial court’s use of the stock purchase agreement to value husband’s shareholder interest in the firm.” (Emphasis added.)

There is no doubt that each buy-sell agreement, or other similar agreement, must be carefully reviewed and considered to place a value on a business in light of the Nichols case, subsequent case law and IRS Revenue Ruling 59-60.  Individuals involved in a divorce where a business is an asset always need to let their lawyers know if such an agreement exists and how it might be used for or against their position in the case.  Similarly, if a married business owner is going to enter this kind of an agreement, it is important to discuss with corporate and possibly family law counsel about its potential impact in the event of a divorce.