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Sunday, July 14, 2024

Whose Business is it Anyway?

••• SPONSORED SECTION •••

A CASE STUDY IN DIVORCE AND THE FAMILY BUSINESS
By Paige Inman, Al Clyburn, and Richard Crow


Meet the entirely fictional Rookie Family. Led by parents and business founders Cheryl and Wayne Rookie, Rookie Construction is a North Carolina family business that is important to the family’s sense of identity, financial security, and workplace environment. 

The Rookie children, Joel and Tiffany, grew up in the family business. They were given stock in the company when they graduated from high school. Neither gift included a shareholder agreement.

In 2010, Joel married Natalie without a premarital agreement. Joel and Natalie have
two children. During the marriage, Joel worked at Rookie’s Construction as a project manager. In 2015, Natalie filed for divorce and asserted a claim to distribute the
couple’s marital property.

WHAT WILL HAPPEN TO OUR COMPANY?
Ward and Smith family law attorneys Al Clyburn and Paige Inman are certified by the
North Carolina State Bar as specialists in the area of Family Law. They explain that the property distribution claim filed by Natalie may expose the family business to unnecessary risk
and expense.  

Clyburn states, “There is a risk that the Court will find that Joel’s ownership interest in
the business experienced active appreciation during the marriage and that Joel should
be required to pay Natalie for her share of that increase in value. In an action to
distribute marital assets and debts, the court is required to identify, value, and distribute
all marital assets. There is a presumption that the net fair market value of the assets will be divided equally.” 

Inman further explains, Marital property includes the ‘active’ appreciation of a separate asset. Therefore, any increase in value that can be attributed to Joel’s active efforts will be subject to distribution by the Court. This could require a significant distributive award from Joel to Natalie if there are insufficient other marital assets to offset Natalie’s share of the active appreciation which occurred during the marriage.

Additionally, Clyburn says, the cost of litigating valuation can be significant. This case will require an expert to value Joel’s interest on the date of marriage and on the date of separation. The expert may also be required to develop an opinion as to whether the increase in value is the result of active as opposed to passive appreciation. Expert fees and the cost to litigate the issue can add up quickly.

WOULD A PREMARITAL AGREEMENT HAVE HELPED?
Inman and Clyburn say that having a premarital agreement can help to avoid these risks and safeguard a business for all owners. Premarital agreements can be limited in scope to address specific items of property, i.e.:

– An agreement that Joel’s interest in the business cannot be distributed to his spouse Natalie; or

– An agreement that defines both active and passive appreciation of the business as Joel’s separate property to ensure that Natalie will not share in the value of the appreciation.

Inman states, “Premarital agreements do not have to be the scary, argument-causing document that causes disputes between potential spouses. Instead, they can be limited in nature to address specific items of property and provide peace of mind that a well-established family business is not subjected to certain risks as a result of marriage.”

WHY DO I NEED A SHAREHOLDER AGREEMENT?
When Joel and Tiffany received their stock upon high school graduation, neither signed a shareholder agreement. That mistake may cost the Rookie family in years to come. 

Ward and Smith business attorney Richard Crow explains, “Including a clause within a shareholder agreement that requires a premarital agreement could be an effective tactic for alleviating a spouse’s concerns over signing a premarital agreement. It can also add protection for the family members who are acquiring ownership interests as it ensures that the business will not be tied up in divorce-related litigation as well.”

Crow states, “In general, it is a good idea to work out the details and protective provisions within a shareholder agreement before gifting the stock, as doing so makes things easier in a variety of ways.” Agreeing to the provisions on the front end is more cost-effective and creates less internal friction than attempting to negotiate and implement a shareholder agreement after shares are transferred.

Limiting the transfer of stock is an additional advantageous provision in shareholder agreements. Crow says, “Most of my clients love their in-laws and their spouses, but they don’t want to be in business with them. We cover that by including a clause allowing a shareholder or the corporation to buy stock from a shareholder upon certain specified events, such as an involuntary transfer resulting from an equitable distribution.”

ROOKIE MISTAKES
The Ward and Smith team agrees that the issues confronting our fictional Rookie family could have been alleviated with smart planning. When representing a family business, it is imperative for the family’s business attorney to work with a family law attorney to minimize risk in the event of an unexpected divorce.

Crow explains, “If the owners of a family business want to avoid these issues, they must consider protecting the business for the long haul. That means connecting with counsel who will identify current needs, like shareholder agreements in connection with gifts to children, as well as future concerns like prenuptial agreements and buy-back provisions.” Inman agrees.“At Ward and Smith, we
help closely-held businesses
important effort.”

 

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