Divorce And The Family Business


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Divorce And The Family Business

  1. 1. Divorce and the Family Business<br />Presentation for <br />By Conrad Adam, Partner<br />Family Law Department<br />Cumberland Ellis LLP<br />1<br />
  2. 2. The Inevitable Introductory Statistics<br /><ul><li>There are some 3,600,000 SME’s (fewer than 250 employees) in the UK 1,400,000 of which are based in London and the South East, a significant number of which are family owned ¹
  3. 3. Family firms produce 30% of GDP and account for 65% of the total 4.5m private sector enterprises in the UK economy²
  4. 4. Between 2007 and 2008 there were 136,226 divorces in the UK³
  5. 5. 38% of first marriages end in divorce. 52% of second marriages end in divorce. An overall average rate of 45%</li></ul>¹Warwick Business School “Finance for small and medium sized enterprises” 2005<br />²Institute for Family Business<br />³National Statistics Office<br />2<br />
  6. 6. Who gets divorced and why?<br /><ul><li>67% of all divorces are granted to the wife on the grounds of the husband’s “unreasonable” behaviour
  7. 7. Behaviour petitions allow for immediate divorce proceedings, often important in a business context</li></ul>3<br />
  8. 8. The inevitable consequence of divorce?<br />4<br />
  9. 9. A : THE LAWThe Court’s approach to family businesses<br />Traditional approach <br /><ul><li>Off limits
  10. 10. The goose that lays the golden eggs
  11. 11. An income stream for the family</li></ul>5<br />
  12. 12. The Court’s current approach<br />All assets including business assets to be taken into account <br /><ul><li>White v White 2001: Farming business: £3.5 million – rejection of “reasonable requirements” and the adoption of the “yardstick of equality”
  13. 13. Special or “stellar” contribution
  14. 14. Cowan v Cowan 2001: £11.5 million – black bin bags – genius. Wife gets c.£4.3 million.
  15. 15. Lambert v Lambert 2002: Husband received £20 million from sale of Adscene Ltd (media advertising). Offers wife 30%. Wife gets 50% on appeal, up from 37% – only in exceptional circumstances – locking Pandora’s box
  16. 16. Neither Cowan nor Lambert dealt with the difficulties of liquidity</li></ul>6<br />
  17. 17. Iliquid business assets<br /><ul><li>N v N (Financial provision Sale of company) (2001)
  18. 18. Wife not a shareholder. Husband had an interest in two service companies valued at £2 million gross and £1.75 million net of CGT</li></ul>Coleridge J<br />“The theory behind White is one thing, actual practicalities involving value, and dividing up, and/or realising certain species of assets make the obtaining of the White objective sometimes either impossible or only achievable at a cost that may not be overall in the family’s best interest. In this regard, of one thing I am convinced. I am sure the House of Lords did not intend to exercise their far-reaching powers to achieve equality on paper if in doing so they, Sampson-like, brought down or crippled the whole of the family’s financial edifice to the ultimate detriment of the children (whose interests, of course, remain the top priority in this and every case). <br />BUT<br />7<br />
  19. 19. N v N (Financial Provision) Continued<br />But he continued ….<br /> “However, I think it must now be taken that those old taboos against selling the goose that lays the golden egg have been laid to rest; some would say not before time. Nowadays, the goose may well have to go to market for sale, but if it is necessary to sell her it is essential that her condition be such that her egg laying abilities are damaged as little as possible in the process”.<br />8<br />
  20. 20. N v N Outcome<br />Where liquidity a problem<br /><ul><li>Lump sum payable to wife of £1 million but in stages. Just over half payable within 27 months or sooner sale of the business
  21. 21. Wife awarded c.39% taking into account other assets</li></ul>9<br />
  22. 22. Where both Husband and Wife are shareholders<br />Parra v Parra 2002 (50/50 shareholding)<br />Total assets c.£2.5 million<br />Thorpe LJ<br />“I am struck by the fundamental simplicity of this case… There were only two obvious solutions: Either the business assets were sold to enable each to make a fresh start or the husband bought out the wife so that she could make a fresh start [husband running the business]. If the parties agreed on the first option equal division of the proceeds of sale was the natural if not the inevitable consequence. If the price for the buy-out could not be agreed the Court was there to fix it.”<br />“If the husband cannot or will not raise the necessary borrowing to pay the lump sum within the period agreed or ordered the business assets (ie the company and the land it occupies …) must be sold and the net proceeds divided.”<br /><ul><li>Wife gets 50% of all assets on husband’s appeal. Down from 54.3%</li></ul>10<br />
  23. 23. Liquidity and the clean break<br />How can a clean break be achieved where business assets are predominantly illiquid? – sometimes it can’t<br /><ul><li>F v F (clean break: balance of fairness) 2003</li></ul>Total assets c.£3.5 million. Husband owns 94% of the shares<br />No forced sale of husband’s business to allow the wife a clean break but generous on-going maintenance instead (parties subsequently agreed after judgement a clean break on payment of a lump sum by instalments).<br />11<br />
  24. 24. Share Price Fluctuation Post Settlement<br />Myerson v Myerson 2009 (Court of Appeal)<br /><ul><li>Husband fund manager
  25. 25. Total assets c.£26 million. Agreed wife will receive £11 million, 43%. Consent Order
  26. 26. Share price in Principle Capital Holdings reduces from £2.99 Feb 2008 (£15m for H) to £0.27p March 2009
  27. 27. Husband applies to reopen the settlement
  28. 28. Outcome - tough</li></ul>12<br />
  29. 29. Inherited or gifted business assets<br /><ul><li>D v D 2010 : High Court : Charles J
  30. 30. 18 year marriage
  31. 31. Main asset farming company inherited and still worked by H
  32. 32. H’s shares entirely inherited or gifted
  33. 33. 30% of the value of the company ring-fenced leaving 70% to be shared
  34. 34. Enabled H to retain the farm rather than sell</li></ul>13<br />
  35. 35. Inherited or gifted business assets<br /><ul><li>N v N 2010 : High Court : Charles J
  36. 36. 29 year marriage
  37. 37. H inherited shares in a property owning company incorporated by his father, including a property which was the matrimonial home for a large part of the marriage
  38. 38. W accepts there should be a departure from equality and seeks a lump sum equal to 42% of all assets
  39. 39. 50% of H’s shareholding ring-fenced
  40. 40. 75:25 division of his shareholding
  41. 41. W receives in total £5.3 million equivalent to 32% of the total assets</li></ul>No complete ring-fencing in either case but taken into account in terms of overall distribution and settlement outcome.<br />14<br />
  42. 42. Possible settlement structure<br />15<br />
  43. 43. How do you protect the family business?<br /><ul><li>Prenuptial Agreements</li></ul>Radmacher v Granatino2010 Supreme Court<br /><ul><li>8:1 in favour of stronger economic party
  44. 44. “The court should give effect to a nuptial agreement that is freely entered into by each party with a full appreciation of its implications unless in the circumstances prevailing it would not be fair to hold the parties to their agreement”.
  45. 45. A significant strengthening of pre-nuptial agreements
  46. 46. Post-nuptial Agreements</li></ul>MacLeod v MacLeod 2008 Privy Council<br />Valid and enforceable, although subject to the court’s right to vary.<br />16<br />
  47. 47. How do you protect the family business continued<br /><ul><li>Timing: Ideally arrangements to be put in place before marriage is even contemplated. Arrangements made in contemplation of divorce or during divorce proceedings will not withstand the powers of the family courts
  48. 48. Shareholders Agreement – prohibition against transfers of shares to spouses
  49. 49. Articles of Association – prohibition against share transfers to spouses
  50. 50. Pre-emption rights for other shareholders on a disposal/transfer
  51. 51. No standard pre-emption rights protection under the Companies Act 2006 (there is on allotment, but not on transfer) s.561
  52. 52. In practice many companies seek to disapply default provisions in any event</li></ul>17<br />
  53. 53. Shareholdings<br />Can you lift the corporate veil?<br />Mubarak v Mubarak 2001<br />Husband an international jeweller<br />Husband had conceded in the proceedings that two Jersey trusts, including two companies owning valuable jewellery could be treated as his own. Wife seeks to enforce lump sum order for c.£4.9 million against business assets. <br />Bodey J<br /><ul><li>An order [against company owned assets] can properly be made where one spouse (usually the husband) is the owner and controller of the company [AND]</li></ul>18<br />
  54. 54. Shareholdings<br />BodeyJ continued<br /><ul><li>There are no adverse third parties whose position or interest would be likely to be prejudiced by such an order being made
  55. 55. Third parties would include those who have real minority interests in the company as well as bona fide creditors and directors
  56. 56. Lifting the corporate veil is most likely to be acceptable where the asset concerned is, perhaps, the former matrimonial home or similar assets owned by the company other than for day-to-day trading purposes
  57. 57. Outcome : wife fails to enforce directly against business assets – but in 2008 wife successfully attacks the Jersey trust</li></ul>19<br />
  58. 58. Shareholdings<br />Hashemv Shayif and Another 2008<br />Property owing company<br /><ul><li>Shareholdings 30% to H, 20%, 15%, 15%, 20% to 4 children
  59. 59. W unable to pierce the corporate veil
  60. 60. Other shareholders although submissive were not merely ciphers for the husband and the wife could not demonstrate any impropriety that required the incorporation to be ignored</li></ul>20<br />
  61. 61. Hashem v Sayif continued <br /><ul><li>Company incorporated 1988. Marriage 1998
  62. 62. Other shareholders H’s 4 sons from his first three marriages. Divorce proceedings 2004
  63. 63. As at incorporation other shareholders aged 18 years to 6 months old. Company had significant property holdings. Including the property occupied by the wife
  64. 64. A Company incorporated in Jersey
  65. 65. Divorce proceedings consolidated with Chancery proceedings</li></ul>21<br />
  66. 66. Issues in Hasham for the Court’s determination<br /><ul><li>Was the company the husband’s alter ego and other shareholders simply nominees therefore allowing the corporate veil to be pierced?
  67. 67. Whether children’s shareholdings subject to resulting trusts in favour of the husband, the children not having funded the purchase of any shares in the company?
  68. 68. Even if the children’s shareholdings in the company were real and genuine as opposed to nominal did the company hold certain properties upon constructive trusts for the benefit of the husband alone?
  69. 69. Alternatively should certain of the properties be regarded as having been settled on the husband (or on the husband and wife) in such a way as to allow the Court’s variation by resettling the properties on the wife free of any trusts?
  70. 70. Outcome: None of these arguments succeeded at trial</li></ul>22<br />
  71. 71. Woolfson v Strathclyde Regional Council 1978<br /><ul><li>Lord Keith of Kinkel: House of Lords</li></ul>“It is appropriate to pierce the corporate veil only where special circumstances exist indicating that it is a near façade concealing the true facts.”<br />23<br />
  72. 72. Ante nuptial and post nuptial settlements<br />What are they?<br />In essence settlements made for the benefit of the parties either before marriage in contemplation of it, or during marriage.<br /><ul><li>Matrimonial Causes Act 1974 gives the Court direct powers over the trustees and the ability to order them to dispose of shares or other property within a settlement, and can order distribution of the settlement funds as between spouses and determine the split</li></ul>24<br />
  73. 73. Trusts<br />Comments in J v J 2003 (disclosure: off shore corporations) <br />Coleridge J<br />Sophisticated offshore structures are very familiar nowadays to the judiciary who have to try them. They neither impress, intimidate, nor fool anyone. <br />Charman v Charman2007<br /> Husband insurance broker. “the King of the London insurance market”.<br /><ul><li>Total assets £131 million. Wife awarded £40 million on top of her own £8 million.
  74. 74. Part of a growing trend for the English Courts to largely ignore (particularly self-settled) trusts and treat them as assets (strictly speaking “resources”) of one or other of the parties
  75. 75. Trust worth £68 million taken into account. The Dragon Holdings Trust. Settled during the marriage but some 20 years or so before the divorce
  76. 76. Departure from equality due to husband’s special contribution.
  77. 77. Husband employs 5 barristers and wife employs 4!</li></ul>25<br />
  78. 78. B : THE PRACTICEBusiness Valuation<br /><ul><li>Single joint experts
  79. 79. Shadow experts
  80. 80. Use of the company’s or other accountants to assist with valuation at the disclosure stage</li></ul>26<br />
  81. 81. Elements of a single joint expert’s report<br /><ul><li>Valuation
  82. 82. Liquidity
  83. 83. Tax</li></ul>27<br />
  84. 84. Valuation basis<br /><ul><li>Willing purchaser
  85. 85. Discount for minority shareholding?
  86. 86. Trading vs. property investment companies
  87. 87. Marketability of shares, particularly minority interest in a private company - discount</li></ul>28<br />
  88. 88. Valuation Continued<br />Partnerships<br /><ul><li>Similar approach in terms of valuation but where there are partners other than the parties consideration of the Partnership Agreement, or in absence of that general partnership law in terms of effect on value
  89. 89. Goodwill?</li></ul>Sole traders<br /><ul><li>Number of employees/contracts? – could it be sold as a going concern?
  90. 90. Otherwise just the “value” of the earning capacity of the party who runs it</li></ul>29<br />
  91. 91. Continued running of the businessduring divorce<br />Client or opponent as<br /><ul><li>Director
  92. 92. Employee
  93. 93. Shareholder
  94. 94. Reference to Articles of Association, any Shareholders Agreements, Contracts of Employment </li></ul>30<br />
  95. 95. Running of the business continued<br /><ul><li>Preserving the status quo
  96. 96. Poon v Poon 1994
  97. 97. Parties were directors and shareholders of a family company. Other shareholders siblings of wife. Wife, as majority shareholder, seeks to remove husband as director
  98. 98. Where all shareholders related by blood or marriage, the family courts have jurisdiction in relation to all issues
  99. 99. Interplay with Chancery Division</li></ul>31<br />
  100. 100. Running of the business continued<br />Dividends : Shareholder protection<br /><ul><li>Application under s.459 Companies Act 1985 (now s.994 CA 2006) by minority shareholder (spouse or otherwise) in relation to the declaration, or not, of dividends. Companies Court
  101. 101. “Just an equitable winding up” application by minority shareholder? Appointment of liquidator and winding up and disposal – extremely drastic</li></ul>32<br />
  102. 102. Using the business to help fund the settlement<br />33<br />
  103. 103. Getting the money out of the company<br />Liquidity<br /><ul><li>Surplus cash?
  104. 104. Investments not used for trade?
  105. 105. Investment property?</li></ul>Borrowing<br /><ul><li>Profit sufficient to cover interest on new borrowing? Ratios
  106. 106. Is security available?</li></ul>34<br />
  107. 107. Getting money out of the company continued<br />Forms of security<br /><ul><li>Property
  108. 108. Stock?
  109. 109. Plant and machinery?
  110. 110. Trade debtors?</li></ul>35<br />
  111. 111. Extraction of funds continued<br /><ul><li>Dividends
  112. 112. Salary and/or bonus
  113. 113. Share buy-back
  114. 114. Issuing of loan notes (new company needed)</li></ul>Tax treatment of each is different as are the conditions/legal hurdles to be met. Satisfaction of HMRC for buy-back of shares and loan notes <br />36<br />
  115. 115. Loan note example<br /><ul><li>Husband and wife equal shareholders in existing company
  116. 116. Wife to obtain lump sum and discontinue in the business
  117. 117. Husband to continue in business</li></ul>37<br />
  118. 118. Loan note example continued<br />Formation of new company<br />New company issues shares in itself to husband in return for husband’s shares in existing company<br />Husband owns 100% shares in new company<br />New company buys wife shares in old company for cash or loan notes<br />Wife has made disposal subject to CGT tax rates<br />Old company is now a subsidiary of new company<br /><ul><li>CGT to be deferred until encashment and establishes a structure for the payment by instalments. Loan notes being capable of being secured against company assets
  119. 119. But there can be major drawbacks the consequences need to be looked at by a commercial lawyer as well as a family lawyer
  120. 120. Specialist tax advice !!!</li></ul>38<br />
  121. 121. Alternatives to one party transferring their shareholding<br /><ul><li>Can parts of the business be hived off/transferred as between parties?
  122. 122. Continued involvement of both parties generally recognised by all as problematic</li></ul>39<br />
  123. 123. Six brief real case studies<br />International retail business. Household name. Husband majority shareholder and CEO. To maintain control husband disposed of shares on the open market (Plc). Wife had wanted shares but this way husband kept control to the extent he was able to block any special resolutions and continue to run the business. As a result of the settlement wife was catapulted into the Sunday Times rich list.<br />Manufacturing business. Husband 100% shareholder. Non disclosure issues. Selection of forensic accountant. Court application. Application for production appointment.<br />Distribution company. 50% of shares held by husband. 50% of shares held by offshore trust of which husband beneficiary. Valuation on disclosure. Tax issues relating to bringing the entire structure back on shore.<br />Property investment company. Husband majority shareholder. Husband’s shareholdings held on trust for the children. Husband’s ability to raise borrowings against trust property and pay himself very significant dividends.<br />40<br />
  124. 124. Six brief real case studies - continued<br />Property investment and letting business. Lettings via limited company. H 50% with business partner. Properties owned by separate partnership. Husband equal partner with same business partner. Valuation issues.<br />Nationwide entertainment business. Husband entrepreneur and wife business manager. Group of 20 or so limited companies and a quasi property partnership business between husband and wife. Husband retains certain IP rights and use of business know how in order to establish new operations. Wife retains the existing business with a new investor in order to buy husband out. Certain IP and elements of the brand having been sold previously.<br />It is essential to involve corporate lawyers when negotiating possible settlements involving business, because a family court on its own may not appreciate fully the business issues or company law issues. Cumberland Ellis is a full service firm with corporate and employment departments rather than a boutique family law practice where issues might be missed.<br />41<br />
  125. 125. Some closing thoughtsBusiness growth despite divorce<br /><ul><li>Confectionary industry ?</li></ul>42<br />
  126. 126. And finally …Treatment of husband’s company car<br />43<br />
  127. 127. Thank you<br />For further information contact <br />Conrad Adam<br />Partner Family Law Department<br />www.cumberlandellis.com<br />www.divorce-london.co.uk<br />www.living-together-london.co.uk<br />4 May 2011<br />44<br />