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The risks of mixing business and pleasure

COVID-19 and the subsequent lockdown hasn’t been easy on anyone. Families and couples have been stuck in close quarters for long periods, leading to strained moments. For those of us lucky to continue working during this period, this has been a welcome distraction – but what if you also work with your significant other?

According to the Institute for Family Business, there are more than 4.8 million family businesses in the UK, and COVID-19 has forced them to face big financial decisions to ensure long-term survival. Business advisors have been offering practical advice on how best to survive the pandemic, but what happens in the event of a personal relationship breakdown? What happens when that business partner is also your life partner?

It’s not the most romantic topic to discuss when going into business with your significant other, but it is important to make practical plans to protect your business in the event of a relationship breakdown. This article explores typical problems that can arise and how to tackle them.

The problem

When a relationship ends, the most common issue is the definition of “matrimonial property” on divorce. Matrimonial property consists of all the property which either party to the marriage acquires between the date of the marriage and the date of separation.

A business interest held prior to marriage is not matrimonial property. If an asset is not matrimonial property, it need not be taken into account when looking at the division of assets. Assets which are gifted or inherited, either before or during the marriage, are also excluded from the definition of matrimonial property. However, it is possible for a non-matrimonial business to be converted into matrimonial property meaning the value of that business is taken into account when looking at the division of assets on divorce.

How does a non-matrimonial business become matrimonial?

Businesses owned prior to a marriage can be converted into matrimonial property in a number of ways:
Restructuring – It may be advisable for a sole trader or partnership business to be incorporated. During a marriage, incorporation will convert this business into a matrimonial asset. A share redistribution, or the creation of subclasses of shares, or a company restructure involving the set-up of subsidiaries, could have the same effect. Would a different business decision have been made if you had been aware of this?
Share transfers – You might decide to transfer shares to your spouse, due to favourable tax treatment of the dividends. This creates matrimonial property. It also entitles your spouse to dividends as long as they remain a shareholder, even after separation. You might even lose control of your company by gifting shares. If your spouse refuses to attend company meetings, do you have the necessary quorum to hold meetings without them? Will the transfer of the shares back to you result in any capital gains tax liability? Can your spouse sell their shares on?

Entrepreneurs – If you are thinking of setting up a business during your marriage, that business will be matrimonial property. You should consider how your new business is going to be funded and whether you are using pre-marital or gifted money since this will convert non-matrimonial property into matrimonial property. There could also be issues in raising capital to meet your spouse’s claim while allowing you to continue to run the business.

Involvement of a spouse – You might want to involve your spouse in your business. Do you employ your spouse and put them on the payroll? Does your spouse’s employment come to an end on separation? By terminating their employment, have they been unfairly dismissed? It could leave open an argument that your spouse has helped grow the business, even if that business is entirely non-matrimonial, and should have the right to a share of it in some way.

If you make your spouse a partner in the business, this converts your business to matrimonial property, but there are other consequences. Your spouse could dissolve the partnership without notice. There may be difficulties with how each partner’s capital accounts have been managed and which could have a devastating effect on day-to-day management of the business if a disgruntled spouse decides to withdraw all their capital.

If your spouse has a controlling stake in a business, this may become an issue on separation as a disgruntled spouse could effectively prevent daily decisions being made. Similarly, a disgruntled spouse may refuse to transfer the shares back to you and continue to be an unwelcome interference in a small family business.

The solution

It is important to take family law advice early, before the stage of drafting a partnership or shareholders’ agreement and before restructuring. It is easier to prevent issues from arising than to resolve disputes: spouses are more agreeable when their interests are aligned.

More often than not the solution is to enter into a post-nuptial (or pre-nuptial) agreement. This type of agreement is useful to keep your business, with all the restructuring or changes you make, separate from matrimonial property.

Where your spouse will become a shareholder or partner in your business, consider a shareholders’ agreement or partnership agreement. By putting one of these in place you could:

  • Include a right of pre-emption so your spouse cannot sell their shares to a third party;#
  • Ensure an automatic transfer back in the event of divorce or separation;
  • Regulate the level of capital and income each partner is entitled to;
  • Include provision that the partnership can continue to trade in the event of the resignation by one of the partners?

We recognise that these decisions aren’t exactly the most romantic, but they make business sense. With COVID-19 putting additional pressure on both business and relationships, it’s important to take these actions before anything goes sour.

This article originally appeared in Scottish Legal News on Thursday 10 September.