••• SPONSORED SECTION •••
by Melody King and Bill Durr
One’s ownership in a closely held business (often a family business) may be affected by a separation or divorce. In many situations, the business will be joined as a party in an equitable distribution lawsuit (the term used in North Carolina for a lawsuit involving the division of marital property after a married couple separates). Once the business is a party to the lawsuit, it might need its own attorney – separate from the attorney for the spouse with the ownership interest.
There are three essential steps in any equitable distribution lawsuit: classification,
valuation and distribution.
Classification
Initially, the Court/attorneys must determine what property might be subject to distribution. Property is a very broad
term and includes LLC membership interests and shares in
any corporation.
“Marital property” means all real and personal property acquired by either spouse or both spouses during the marriage and before the date of separation. Marital property includes, but is not limited to, ownership interests in businesses. Marital property is distributed between spouses in an action for equitable distribution.
If, during the marriage, a spouse acquires an interest in a closely held business (including a family business) and that acquisition does not come about by gift or inheritance, the interest will be classif ied as marital property, and the interest will have to be valued. It does not matter that your spouse is not a legal owner of the business.
“Separate property” means all real and personal property acquired by a spouse before the marriage or acquired by gift or inheritance during the marriage. Separate property is generally not distributed in an equitable distribution action, with exceptions as outlined in this article.
Business interests are often acquired before the marriage or acquired during the marriage by gift or inheritance, most often from a parent. One might conclude that this business will be classified as separate property, and the spouse will not be entitled to any share of the business’s value. Well, not so fast…
How might a non-owning spouse acquire a marital interest in a business that is by def inition the separate property of the recipient/owning spouse? The most common answer is through the contribution of “funds, talent, or labor” of the marriage. One or both spouses may contribute marital funds to the business or work in the business during that marriage. To the extent the value of the business increases due to marital contributions or efforts, the increase in the business’s value due to these contributions or efforts likely will be considered marital property.
Another way to analyze whether some component of a family business may be a marital asset is to consider an active/passive analysis. If the value increased passively (for example, through market factors or the labor of third parties), then the business will likely remain separate. If the value increased actively (for example, through the management or labor of one or both spouses), then there will likely be a marital component to the business.
Valuation
Quantifying the increase of a business due to marital contributions is a diff icult task. The valuation process often requires one or both parties to retain a business valuation expert. Presentation of credible evidence as to the value of the business is critical, and failure to present credible evidence could lead to an unfavorable value or the court’s refusal to value and distribute the property.
Distribution
The final step of the process is to distribute the property.
So how will the business be distributed? If the ownership interest is a marital asset, then a Court could distribute the ownership interest to one spouse, both spouses, or, conceivably, to the spouse who previously had little or no involvement in the business.
The analysis becomes far more complex if the owning spouse acquired his/her ownership interest in the family business through gifts made to him/her by her parents, but he/she worked in the business and was the driving force behind the family business’s growth throughout the marriage. Let’s complicate it even further: the non-owning spouse also worked in the family business and is very familiar with the business operations. Could
the Court distribute to the non-owning spouse an ownership interest in the business?
It is possible.
Steps to Protect the Family Business
First and foremost, do not comingle/contribute marital property into a business that is otherwise your separate property. It is also advisable to distance your spouse from a business that is otherwise your separate property. However, the most protective strategies to limit the exposure of a business in an equitable distribution action is through written agreements.
A premarital agreement is one option. A business owner may insist that any family member who has an ownership interest in the business, or who might acquire a future interest, enter into a premarital agreement. This is far more common than one
might expect.
If you or a family member is already married, then a post-marital agreement is an option. For example, prior to gifting an ownership interest to a child or grandchild, one might require the married
recipient of the gift to execute a post-marital agreement with the recipient’s spouse.
A third option, which can be combined with either of the first two options, might be the modif ication of the business’s governing documents so as to specify who may hold an ownership interest in the business, as well as certain buy-out provisions in the event of separation or divorce. However, if one utilizes only this third option, it does not eliminate consideration of the value of the spouse’s ownership interest in the business as a part of the equitable distribution process.
It is important to understand that unless additional steps are taken, a thriving family business may experience unintended and disastrous consequences.
Read additional articles in our new series “The Power of Preparedness” throughout September at wardandsmith.com ■ WS
This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the
advice of an attorney.