For family law attorneys representing parties in a divorce, entry of the Final Decree usually signifies the end of the case. While there might be some loose ends to tie up after entry of the decree, such as property exchange and account disbursement, most of these actions (assuming everyone complies with the Decree) do not require the attorneys’ continued involvement.
Closing documents necessary to facilitate a division of property might include deeds, powers of attorney to transfer motor vehicle titles, and qualified domestic relations orders. But what about when your client is dividing a business or a business interest? Why doesn’t just awarding it all to one spouse, or allocating equally, work?
Example:
- Assets. 100% of the community property interest in ABC, Corp. including accounts, equipment, and inventory.
- Liabilities. Any and all liabilities associated with the award of ABC, Corp.
That works, right? Sure. It gets the decree entered, and the case closed. But when your client comes back a year or two later asking why the Internal Revenue Service is ordering she pay taxes and penalties for income her former husband received as a result of shares of a corporation he was awarded in their Decree, suddenly the job isn’t quite done. There are many nightmare scenarios business attorneys must work through as a result of interests improperly divided at the time of divorce.
If you have a divorce case involving division of business interests, the best thing you can do to is to learn about it. Here are issues to consider when determining how to divide business interests:
WHAT TYPE OF ENTITY NEEDS TO BE DIVIDED?
The entity structure will determine how you divide its assets and liabilities and will govern what documents you need to close and effectuate the division. For example, limited liability companies require a division of member interests held by the community estate or the spouse member, while corporations require a division of the number of shares held by the community estate or the spouse shareholder. The Secretary of State’s website contains helpful information regarding company players. If your client or his/ her spouse is part of managing the entity, you should also become familiar with other key players in the business, such as other managing members or board members.
DOES THE ENTITY HAVE ANY GOVERNING DOCUMENTS?
The first governing document to review is the Certification of Formation, which identifies the type of entity and who is in charge. Governing documents for limited liability companies usually take the form of a company agreement. These agreements are important because they sometimes incorporate buy/sell provisions governing how a spouse’s interest in the company can, or cannot, be divided or assigned to the other spouse. Governing documents for a corporation can include shareholder agreements, bylaws, minutes of meetings, and unanimous consents in lieu of organizational meetings. A partnership should have—you guessed it—a partnership agreement. If the entity does not have any governing documents, consult the Texas Business Organizations Code to determine how the entity is governed.
WHAT ROLE, IF ANY, DO THE SPOUSES EACH HAVE IN THE ENTITY?
Here, you’re looking for titles. Are one or both spouses Members, Managers, Officers, or Shareholders? Do either have any voting rights? Are one or both spouses decision-makers, or just interest holders? The role either spouse plays will determine whether additional provisions or documents should be drafted to protect one spouse from the other’s decision-making ability which may affect both of them post-divorce.
ARE OTHER PARTIES INVOLVED IN MANAGEMENT OF THE ENTITY WITH ONE OR BOTH SPOUSES?
Depending on what the governing documents provide, you may need to involve other individuals associated with the business in the member-interests division. Are there multiple members of the LLC? Are there different classes of shareholders? If the division will require the entity itself to act, you will need the other individuals managing the entity on board, and it helps to know from the beginning who those players are.
REVIEW GOVERNING DOCUMENTS
Once you’ve obtained governing documents for the entity, determine what they require and how they affect your client’s divorce. Importantly, determine what is required to change the governing documents themselves, as amendment might be necessary to carry out the award or divide the business. Are there buy/sell provisions related to divorce proceedings? This would govern if either spouse is even able to be awarded an interest in the business, or if it has to be sold back to the company or its members upon its award. Is there a formula to determine value in the governing documents? If there is a dispute about how much the business or the community property interest is worth, a contract specifying a pre-determined and agreed upon formula can save time and money being spent on unnecessary business valuations. Is spousal consent required? If the governing documents specify what happens to the business or business interest upon divorce, did the other spouse agree to it by way of executing the governing documents? If not, the agreement, or at least the relevant provisions, may not be valid.
Once you’ve gathered all the information above, you’ll be prepared to negotiate a settlement or try the issue of division of the business. Once you’ve reached an agreement, or an order has been rendered, closing documents should be executed to finalize the division. Here are some examples for what closing documents you may need to make sure the decree is final.
SCENARIO ONE.
Facts: You represent Wife. Husband owns Awesome Hotdogs, LLC. Husband is the only Member and although he calls himself a Manager, the Certificate of Formation states there are no Managers. Husband named Wife as the Vice-President when he started the business because he thought it would make his business look good to have another officer. Wife has never participated in the business but is listed on Secretary of State and bank documents as Vice-President. You tell Wife she is the Vice-President.
Agreement: Parties reach an agreement that Husband will be awarded the business and Wife will be awarded other non-business-related assets.
What Actions Need to be Taken: In addition to the general award in the Final Decree of Divorce, Wife needs to sign an Assignment of community property rights, interests, and liabilities to Husband. Wife also needs to execute a resignation as an officer of the entity.
Why: Execution of the Assignment will provide more detailed information regarding specific liabilities or assets of the business than a typical Decree. The Assignment can also include tax provisions minimizing Wife’s future liability to the Internal Revenue Service. The resignation is necessary because without it, Wife remains an officer of the business and could still be considered an “agent” with authority to enter into contracts and make decisions.
SCENARIO TWO.
Facts: You represent Husband. Husband and Wife own Action Figure Stars, LLC. Husband and Wife tell you they own everything equally, 50 percent each. However, after your review of their company agreement you discover the Wife actually owns 60 percent and the Husband owns 40 percent. Neither of them realized this. The Company Agreement, obtained from Legal Zoom, is bare bones and has no provisions related to decision-making, tax liability, or roles within the company for each member.
Agreement: The Parties reach an Agreement that Husband and Wife will to continue to operate the business together post-divorce.
What Actions Need to be Taken: In addition to the general award in the Final Decree of Divorce, the Parties should execute an amended Company Agreement setting out the future structure of the business, i.e. who will make what decisions, their agreed ownership interests, and what will happen if they decide to stop running the business together. These specifics of the company agreement can and should be negotiated as part of the Final Decree. If the roles of each spouse cannot be agreed up, it may affect your Client’s agreement to distribution of other non-business assets. It will also be helpful to include in the Divorce Decree a short time line for the new Company Agreement to be drafted and executed, and mediation and/or arbitration provisions should disagreements arise.
Why: As Husband and Wife will continue to operate the business together, it is critical a new Company Agreement be negotiated and drafted, or it is highly likely your Client will be contacting you questioning her decision in agreeing to continue to run the business with her ex-spouse while most likely giving up other assets in the division.
SCENARIO 3.
Facts: You represent Wife. Husband and Wife own Turtle Bait, Corp. Husband owns 49 percent and Wife owns 51 percent. There are both By-Laws and a Shareholder Agreement governing the company. The Shareholder Agreement includes a Buy/Sell provision with a valuation methodology.
Agreement: The Parties reach an agreement that Husband is giving most of his portion of the business to Wife, but he wants to keep the part of the business that sells turtle prints because he thinks there is money to be made in turtle prints.
What Actions Need to be Taken: In addition to the general award in the Final Decree of Divorce, the Parties should execute an Interest Purchase Agreement carving out the turtle print assets. This Agreement should include representations and warranties regarding the operation of the business prior to the divorce and terms regarding Husband receiving a small portion of the assets while also selling all of his shares in the business. Prior to executing the Decree, you should determine the value of the business under the valuation methodology in the Shareholder Agreement and confirm the parties are still in agreement.
Why: A detailed Interest Purchase Agreement will clarify ownership of the business and separation of the few assets Husband wants to keep. Without the Agreement, harmful ambiguities will remain regarding existing and future liabilities which may result in a Court making orders of clarification conflicting with your client’s intentions in the agreement for the Decree. Shellie R. Reyes
