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E16-Divorce and the family business

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Divorce and separation are almost always difficult.  Throw a family business into the mix and the complexity and emotion escalate exponentially.  Whether the business is big or small, a family farm or a tech start-up, operating as a sole trader, partnership or company, dividing a business asset throws up difficult questions.  And of course, if both parties are reliant on the business for their livelihood and career aspirations things become even trickier.

Topics covered in this episode include:

  • Entitlement to a share in the business versus direct effort put into the business
  • Dealing with family businesses handed down through generations
  • Valuing a business for family law purposes
  • Options for dividing a business asset
  • Can a Family Court judge force the sale of a business
  • Can a pre-nup protect a business asset in the event of separation

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Full Episode Transcript

Benjamin Bryant: Welcome to Episode 16 of The Family Matters show, I’m your host, Benjamin Bryant from Bryant McKinnon Lawyers. And today we’re going to deal with a really complicated aspect of family law: divorce and the family business. Joining me is my business partner, family law specialist Heather McKinnon. Hi, Heather. Good to be here with you again.

Heather McKinnon: Hi Ben. Always excited to be back and looking forward to getting into this tricky topic.

Benjamin Bryant: Tricky topic, that could be an understatement Heather. Throwing a business into the mix when you’re separating adds a huge amount of complexity and emotion to an already difficult process. It doesn’t matter whether the business is big or small, a family farm or a tech startup, operating as a sole trader, partnership or Pty Ltd company dividing a business asset throws up questions that are difficult and sometimes painful to answer. So Heather, I’m going to ask some of those tough questions and hopefully you can help our listeners out there to at least start figuring out how to work their way through this process. Are you ready?

Heather McKinnon: Ready?

Benjamin Bryant:  Heather, if a client comes into the office and they’re working in a family business alongside their partner and now seeking a divorce, what would you suggest that the client needs to think about first?

Heather McKinnon: Well, I’m thinking here, but I mean, always a priority for me when I’m helping a client at that initial stage is their psychological and emotional health at separation.

Heather McKinnon: So the first question that has to be really answered is: Do you think you can turn up to the business and face your ex every day, given that you’re now separated? It’s a very, very carefully considered sort of question. And in my experience, for what it’s worth, not many people can do it. I think that it’s really, really hard to face your ex once separation’s occurred. So certainly that’s going to be the immediate decision. Can you both stay turning up every day or does there have to be a decision made that one of you is going to walk out and not turn up to work as you have been during the relationship.

Benjamin Bryant:  And I guess it depends on the personality types of the parties and also the business that they’re running. Because if you have a couple of type C accountants, perhaps they can go to work and sit in their respective offices all day. Or if you have type A chefs in a high pressure situation, that’s not going to end well.

Heather McKinnon: And look, there’s also the human dynamics at play. Often, you’ll have a situation where in the accounting practice that you just mentioned, one of the partners might have started a relationship with someone else at work. So, you know, you get these really complex situations that need to be thought through carefully.

Heather McKinnon: There’s always a way out. That’s the thing to remember, that businesses have to deal with change and flexibility every day. You look what’s happening with Covid. So the end of a personal relationship is just another thing that the business has to be able to manage if it’s to survive in the long term.

Benjamin Bryant: Businesses are treated as property under the Family Law Act, like the family home or superannuation or a bank account. Does that mean that a partner is automatically entitled to a share of the business when the marriage ends, even if they never worked in the business and never contributed to the growth of the business?

Heather McKinnon: Really good question Ben. Obviously, the balance sheet that we look at when we’re assessing what the property of the parties is, includes things like the business. And it doesn’t matter if one party’s been silent and not being involved, it’s still an asset. So, for example, that factual situation you set where someone’s not actually contributed. So, for example, you might have a mum at home with little kids and the husband’s then operating a professional practice. The fact that the mum hasn’t gone into the professional practice doesn’t mean that she wasn’t contributing to the relationship because she’s been at home looking after the kids.

Heather McKinnon: So the business is valued for the purposes of the settlement. It’s placed in the balance sheet with whatever the value is and then the decisions that have to be made are: Is it going to be sold? Is it going to be transferred to one of the parties? Or, for example, are we going to continue to operate the business and keep shares in the business? And that is a solution that works for some people.

Benjamin Bryant: And we’ll explore those options a little bit later on. Does the advice change if it’s a business that’s passed down through the generations or something?

Heather McKinnon: It’s it’s not really about how the business came into effect. Certainly, if you’ve got a farming business, then it’s likely that the person whose family has farmed that for generations will be the one that takes that asset at the end of the day because they’ve got the personal connection to it. But the sort of assessment we make is quite cold and calculating. All we’re looking at is what are the various asset types and what are they valued at. There’s no magic in the Family Law Act that says if you’ve got the farm from your grandfather, it’s going to be yours. That’s a separate assessment to be made by a judge if you can’t sort it out. So what people have to understand is that their business isn’t unusual. It’s just a category of asset, like the house, like superannuation, like motor vehicles. It’s not special in any way.

Benjamin Bryant: So what you’re saying is that the contribution in the business has to be seen with the overall contributions to the relationship with the financial non-financial, direct or indirect.

Heather McKinnon: Correct. So the big money’s you know, when you’ve got someone working flat out in a business, it normally means that the other spouse has taken on a much bigger role in the running of the home and parenting of the kids. So you will often get an entrepreneurial type character turn up saying, it’s my business, I’ve done everything. And of course, when you see hearings in the family court, the judge will then to talk to them about. So while you were doing your 12 hours a day, who was picking the kids up from school? Who was staying home when they were sick? So that’s what you’ve got to sort of get your head around that putting contributions on one asset doesn’t give you any sort of special claim on that particular asset.

Benjamin Bryant: So when putting the business on the balance sheet, as you say, we need to find out what it’s worth, what is the best way to go about valuing a business and what are the things that are valuer will consider?

Heather McKinnon: So normally the people who operate businesses over a period of time have a very good working relationship with the family accountant. So the starting point would normally be: if the parties both have trust in that adviser to get their input on what they think it’s worth. And for many couples, they accept the advice of the accountants that have been working hand in hand with them over the decades or so that the business has been in existence.

Heather McKinnon: But if they can’t reach agreement, then there are specially qualified accountants, forensic accountants, that specialise in the value of businesses. And what we do is, the lawyers for each of the parties will recommend a list of forensic valuers and then the husband and wife or the partners to the relationship have to choose one of those experts. And that expert then gets on with the job of coming up with the magic number. What is this business worth? And the science of valuation is quite complex. It’s not a situation where you look at just the balance sheet like you would on a taxation return. It’s not what’s the value of the assets, less the liabilities. In the valuation of businesses for the family court, we’re looking at how much the business earns over time. So what’s the historical income stream that’s produced? And then the accountants apply a formula to come up with a number. And we talk about that method of valuation being net-maintainable earnings. And that is something that in a large majority of cases will be the formula that the valuers use. So your family accountant can often, if it’s a relatively simple business, come up with that number without spending a lot of money. But in bigger businesses, that process is very complex and it gets very expensive to value. But at the end of the day, that’s what has to happen if you can’t agree.

Benjamin Bryant: And if we use the example of a family farm which has high value, high capital value but delivers perhaps a relatively low income, it can mean that buying the other person out of the business is quite hard. What if the only possible way to raise the money for a property settlement was to sell the farm? Can the courts force someone to do this?

Heather McKinnon: Absolutely they can. So when I started practice nearly 40 years ago, we had a series of cases in the family court on farming cases where the owners who had acquired the property into generation ran arguments that farming cases were special, similar to the land claims that indigenous people might make on land. But the court very early on determined that it’s just business like a shop. There’s no magic in that asset. It’s just capital that the parties have. And so if one party can’t buy the other one out, the asset will be sold.

Benjamin Bryant: Now, let’s look at some other specific situations, what happens if both partners want to buy out the other partner’s share of the business and they can’t reach an agreement? Does the court then decide who gets to keep the business?

Heather McKinnon: So at the end of the day, that is the role of the judge in cases where there’s no obvious solution. So the option for the judge is: one buys the other one out, second alternative is sale. And as we’ve indicated in earlier discussion, the court is very mindful of a person’s ongoing ability to earn income. And if they’ve been earning their income from that business, they will usually give that person the first dib on that. So what we see, as you know Ben, in practice, is if the balance sheet has a business and a house, then the person who hasn’t been working in the business will normally get the house and the person who earns their income from the business will be given the opportunity to acquire the business. So that’s how it works. But usually the orders that the judge makes will give the person a period of time, 60 to 90 days or whatever figure the judge comes up with. And if you can’t raise the finance, they then provide that it gets sold on the open market.

Benjamin Bryant: And what if you have partners that don’t want to buy each other out and there’s no sale? Have you ever seen partners stay in the business together?

Heather McKinnon: Everybody asks. I think there’s been a handful of cases in Australian history when it has worked – that they keep working after the marriage is ended, but it’s very rare.

Heather McKinnon: But there are cases that are practical for that to occur. And usually there are cases where the business involves people other than just the husband and wife. So they might be unit holders in quite a significant business with a lot of other people. So it’s easier for them to continue to own respective shares because the governance of the business means that you’ve got a whole heap of people have to vote on it, just not the husband and wife. So those cases are suitable for ongoing involvement of both parties. So that might be something like a large property development or tourism operation where you’ve got a number of people who’ve invested in it and the husband and wife have just got a particular shareholding in it.

Heather McKinnon: But in terms of working a smaller business, that is just the husband and wife, if you’ve got the intellect to set aside your emotions and to separate your lives out, it can be done. But as I’ve said, there’s a handful of cases where I’ve seen that successfully occur.

Benjamin Bryant: And good luck to them.

Benjamin Bryant: Heather, we’ve heard that farming cases are not special cases. We’ve heard that the contribution in the business is seen with the other contributions. And we’ve heard that the court can absolutely sell a business if it needs to. Are there any preventative measures that a party can take. If, for example, early into the relationship there’s a growing business by one of the partners, is it possible to enter into something like a prenuptial agreement to try and quarantine or protect that business?

Heather McKinnon: Certainly people will try that. And if it’s a business where there’s a lot of commercial lawyers and that involved, I will recommend that that, but as I’ve indicated before in these podcasts, I have a very strong view that most prenup agreements don’t work. And that’s because it’s impossible to track the trajectory of a relationship over decades. So if you’ve got a young entrepreneur in their 30s that’s established a good business, they then enter a prenup that says they’ll keep it, but the marriage ends three decades down the path. In that time, lots of things will have happened that will suggest that a judge might look at whether the bargaining power between the spouses when they entered the prenup was really equal. So I’m not a fan of them. I don’t think that it’s sensible to start a relationship off on that foot. I think parties need to understand that a relationship is everyone contributing to their best endeavours in all the things it takes to manage a relationship and so trying to keep this asset close to your chest and saying, “it’s mine, it’s all mine”, sets the whole thing up for failure, because you’re not sharing, you’re not in a partnership, you’re not acknowledging and respecting the contributions that you both make to the decades that you live together.

Benjamin Bryant: And the difference between a family law situation and a commercial situation, is in a commercial situation when one partner leaves there would be a buyout specifically for the business, in a family law setting if one party was to retain the business, the other party perhaps would get a cash adjustment, Is it possible to get both?

Heather McKinnon:  The planning around the settlement is quite complex. So if you’ve had  a company or a partnership and both parties have actually been legally in the business, then there’ll be loan accounts, long service accounts, holiday leave loadings and really what happens is that the accountant and the parties get together to look at what is the most advantageous way to structure the settlement. Do we just cancel out all those loan accounts that are sitting in the business or is there some reason that under the family law orders, we should provide that the spouse who’s exiting the business gets a cash payout of their entitlements in the company, plus payment for the other assets that they’re leaving behind. So every settlement’s structured separately and the good news about separation, if there is any, is that it gives accountants the best chance to structure with flexibility and creativity to maximise the financial benefits to both spouses as they reconfigure the structures of the business and the other assets. So everything’s possible. But what I would say is that it’s all about keeping that goodwill in the negotiations and listening to the accountants and trying to set aside your emotion from what could be a very sensible financial settlement. If you can let go that one party is winning and the other one’s not.

Benjamin Bryant: What a great overview.

Benjamin Bryant: This is such a complicated topic that I’m sure we could talk about all day, but I’m going to have to end it there. Heather, thank you so much for your insight.

Heather McKinnon: No problem, Ben. And if there are any other questions that people want us to address, they should e-mail or message us. It’s a tough situation and we’re happy to help where we can.

Benjamin Bryant: Great point, Heather, in fact, if you have any questions about any family law matter, you can email us at familymatters@bryantmckinnong.com.au  or message us on Facebook and we’ll include your question in our community question show, which is coming up in a couple of months.

Benjamin Bryant: Next month though, we are going to talk about mediation. If you are having difficulty reaching agreement about property settlement or children’s matters, mediation can be a great way to find solutions and certainly much less expensive and emotionally draining than going to court. So it’s important to understand how mediation works and how you can get the best possible results out of mediation. To help us tease this out. We have another great guest. Philip Theobald has been mediating, arbitrating and settling family law disputes for more than three decades. And before that, he was a practicing family law barrister. So he knows a thing or two about this subject. Join us again next month to find out more.

Benjamin Bryant: Goodbye for now. Stay safe and well.

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