Whether you are the lawyer for a corporate entity, shareholder or member in an entity; the shareholder or member of a company, or you happen to sit on the board of directors of a company, it should be easily agreed that corporate documents —-specifically, operating agreements, buy-sell agreements and shareholder agreements—need to be in “good form”. Good form not only means addressing what may happen when shareholders or members leave the company, die or retire; the documents should also recognize what may happen in the event of a divorce.
The reality is that the divorce rate is close to 50% for first time marriages. It is thought the number is even higher for business executives and business owners. A divorce should be treated as a likelihood just like retirement or death. It is therefore not if a divorce strikes but when.
The high probability of divorce deserves more than a mere passing mention in corporate documents and instead should be seriously considered including how a family law court may handle the corporate agreements in the divorce. Clients should be well informed by corporate counsel about the impact of the corporate agreements including how these documents may be viewed by a family court. When I speak to business owners getting divorced, they often seem surprised that their corporate agreements do not provide any safeguards, or enough safeguards, in the context of a divorce. Here are three common misconceptions (urban legends) to be aware of:
- “Book Value is the Value of the Business”. Not necessarily. Just because your corporate document states book value shall be used as the value of the business in the event of a departure of a shareholder or member, does not mean the family court is bound to this valuation. The Family Court will accept a valuation set forth in the corporate agreement if it reasonably reflects true value. Guidance on the factors in establishing value are delineated in Revenue Ruling 59-60. If a valuation is not desired, then put in place a process for determining value through appraisers.
- “A Spousal Consent is a Waiver of Community Property Interest of a Spouse.” Unlikely. Spousal Consent forms are a must for corporate entities but what they mean is that the spouse has agreed to the terms of the corporate agreement. For a spouse to waive community property rights, a transmutation must occur in accordance with Family Code section 852.
- “My Spouse Will Never Hold an Interest in the Business After Divorce.” Likely true, but not guaranteed. Some of this is determined by the language of the corporate agreement in the event of divorce but there are other facts that could result in the spouse holding equally with the other spouse an economic interest in the business. A well drafted corporate agreement with a signed spousal consent is critical to mitigate the risk of co-ownership of the business interest.
There are many things to consider in drafting corporate documents well before there is ever a divorce of one of the entity’s shareholder or members. Once a divorce occurs, is it the divorce lawyers who are left to create the best arguments they can for their clients but are constrained by the terms of the corporate agreements because no one seriously considered divorce as a triggering event.