Who gets the family business in a divorce? Will I continue to co-own it with my spouse? Will I have to buy out his or her interest? How will my business be valued? Will I need to hire an expert? In this episode, host Jaime Davis and her law partner Nicole Taylor discuss the answers to these questions and more concerning what happens to the family business in a divorce.
Note: Our Podcast, “A Year and a Day: Divorce Without Destruction”, was created to be heard, but we provide text transcripts to make this information accessible to everyone. All transcripts on our website are created using a combination of speech recognition software and human transcribers and could contain errors.
Jaime Davis: Welcome to the first episode of Season 2 of A Year In A Day. I’m your host, Jaime Davis. As you may recall, we ended Season 1 with a discussion about the issue of domestic violence with my colleague, Jonathan Melton. We will be starting Season 2 off with several new episodes in the next couple of months. In this episode I will be discussing what happens to the family business in a divorce with my law partner, Nicole Taylor. Nicole has practiced almost exclusively in the area of family law for over 20 years, and has extensive experience representing clients involved in complex equitable distribution cases where family businesses are at issue. Nicole has also been certified by the North Carolina Dispute Resolution Commission as a family financial mediator. Welcome Nicole.
Nicole Taylor: Hi Jaime. It’s good to be here. Thanks for having me.
Jaime Davis: So in, in North Carolina generally speaking, marital property is any property acquired by either spouse from the day they got married until the day they separate from one another. There are a couple of exceptions for inheritances and gifts from third parties, but for the most part property acquired during the marriage will likely be considered marital property and subject to division during a divorce. Given the large percentage of U.S. businesses that are private and family-owned companies, and the fact that about half of American marriages end in divorce, I thought it would be helpful to our listeners to discuss what happens to that family business if they find themselves going through a divorce. So with that said Nicole, how is the business distributed in a divorce?
Nicole Taylor: So Jaime, broadly speaking there are three ways the business still end up being distributed. The first and the most common is that one of the spouses keeps the business, or has it distributed to him or her. And that is almost nine times out of ten if not more than that what happens. It’s not unusual for the value of that business to far exceed most, if not all, the other assets that are marital. And when that’s the case typically one spouse receives the business and maybe a few of the smaller assets, and the other spouse receives the remaining marital property. And if there’s a difference in the value of what each one of them received, then the business owner, assuming that’s the larger value, is gonna end up paying what’s called a distributive award to the other spouse to kind of equalize or make equitable the overall distribution of the marital property and the marital debt.
Jaime Davis: Right, because we’re talking about equitable distribution here, and so in most cases each spouse should receive about 50 percent of the property, and I can imagine where a business is involved and that business, you know, makes up the large bulk of the estate. It’s gotta be really hard to figure how to, how to even that out.
Nicole Taylor: It can be challenging and we’ll talk in a little while in more detail about how does the Court decide what value to place on the business, um, and how to structure that overall division of the property. But it can be very challenging and it can be, be a very complex process when you’re dealing with a family business, particularly if there are other owners, um, who have an interest in that business as well, not just one or both of the spouses.
Jaime Davis: Absolutely. So if one spouse doesn’t keep the business what else can happen with the business?
Nicole Taylor: Well, in some situations, not very often, but it does occasionally happen, both spouses will continue to own an interest in the business. So for example, maybe they both already owned an interest while they were married. So maybe one of them owned 25 percent and the other one owned 25 percent in a closely held company with other family members or other partners. Sometimes it works out that, that that is the only way to logistically divide up the marital estate, because there might be cash flow problems, though they just continue to each own their 25 percent interest in that business, and that may be how the Court decides to divide it up. The Court may distribute all of those interests, just to one party, again, like we talked about as the most common situation. But it can to continue to allow them to jointly own that business. You don’t often see it though, because judges really want, in my experience, they want the divorce and the related equitable distribution process to be final between the parties to the extent it can. So not for the parties to continue to be business owners and partners going forward, because typically even in a civil and, you know, quote friendly divorce, that can be trouble down the road and, and a recipe for disaster if things start to go south.
Jaime Davis: Right. I mean generally in these cases we are trying to disentangle these folks’ finances and I imagine that continuing to co-own a business with your ex spouse probably brings about its own set of problems. Can you think of a few that may arise?
Nicole Taylor: Sure. So if you continue to be business partners with your spouse, in essence, it can have the same problems that other business arrangements can have, and with any other business partner. You know, you can run into problems where the two of you disagree about how the profits should be distributed, or when the profits should be distributed. You can run into problems about how much, when or both of you should be paid in salary, maybe one of, one of the parties works full time in the business and historically the other one didn’t. Well, you know, if there’s going to be conflict possibly about whether salaries get changed or paid differently, or are structured differently, you know, you can run into problems about capital calls. Maybe the business needs an infusion of cash, because there’s an economic downturn and so the cashflow is a problem, and there’s a capital call made. There can be, you know, some conflict there. Maybe one of the parties has the ability to, to infuse some cash into the business and the other one doesn’t. If the business needs to take out some loans to either expand or, again, an economic downturn, to cover expenses while the cashflow isn’t as great as it used to be, and maybe one party is okay with that plan, and the other one isn’t. So there can be the same types of conflict that you might have with any business partner, but it’s exacerbated often by the fact that it’s your exspouse that you’re dealing with.
Jaime Davis: Right, because you’ve already got these underlying trust issues. I mean let’s face it, folks get separated and divorced for a reason and so if you are already distrustful of your spouse, and then you are in a position of having to co-own and run a business with him or her that could be challenging.
Nicole Taylor: Very challenging. Now you can, you know, sometimes I, I’ve had cases where parties wanted and agreed to settle on a scenario where they did both continue to own shares in the business, or where one of the parties who was the owner transferred some of the shares to their spouse as part of the settlement. That’s, again, rife with potential conflicts, but one way that you can try to reduce the amount of conflict that you might have down the road is to bring in a business lawyer, a corporate lawyer to help draft shareholder agreements or, you know, operating agreements if it’s an LLC or other partnership, that addresses these sorts of scenarios. So, you know, what, what kind of distributions and when are they gonna be made and under what conditions? Or, you know, how are salaries gonna be set? What kind of voting control and those sorts of things are each party gonna have? When are major decisions gonna require the approval of both parties? So just like you would see in any other business where there’s more than one owner, you’d gone, you’re gonna want to have those kinds of agreements in place in a settlement where both of the spouses are continuing to own an interest, or one is transferring part of their interest to the other one in that settlement.
Jaime Davis: Right. It, it seems to be very analogise to what we do when we are drafting separation agreements or consent orders, or even court orders that we wanna spell out very clearly what the rules are for each party so that they know how they’re going to be able to interact with one another moving forward.
Nicole Taylor: Correct. Exactly.
Jaime Davis: So we talked about two of the three ways that the business can be addressed and equitable distribution. What is the third way?
Nicole Taylor: Well, the third way is to sell the business or the interest in the business, and then agree on how those proceeds are gonna be divided. That is something that you rarely see happen of all three of the options and scenarios, that’s really the least common. And in fact, I’ve, I’ve not seen a Court do it and I don’t really anticipate the Court having authority to do it, except under certain circumstances, and I believe the Court would have to make some extensive justifications for why it was ordering the business or the business interest to be sold, and the proceeds divided in order for that to be upheld on appeal. But parties can agree, of course, to market the business, sell the business and how those proceeds would be divided, but just like agreeing to joint ownership or some form of shared ownership on a going forward basis, agreeing to sell the business and divide the proceeds brings it own set of potential conflict too. So again, I would strongly recommend anyone who’s considering that to bring in a business lawyer, get input on what kind of language to include, what kind of terms for a sale should be included, who gets decision making authority, what are the parameters of that, how is any sort of conflict going to be resolved? Is there gonna be some sort of a tie breaker, kind of a private judge in arbitration if the parties can’t agree or get into an argument down the road about the logistics of the sale or how to implement it, or ultimately what terms to accept? That sort of thing. So it’s not, it’s not something that can’t happen, but I would caution against it without bringing in some experts to help craft some really specific language on how to handle that transaction.
Jaime Davis: So jump in and disagree with me if you do, but it seems that the, the easiest way, if there is an easy way, to address the family business in a divorce situation is to distribute the business to one of the spouses. And the reason I say that is really then the only thing that you have to agree on is, is what that business is worth, whereas with these other two options there are all of these other sub issues, if you will, that you need to agree upon before you can make it work. Like you were saying, you would need these extra agreements about, you know, what would the distributions be? How much would everyone get paid? And all of those sorts of thing. Would you agree?
Nicole Taylor: I would agree. That being said, figuring out the value of the business and how to structure any sort of distributive of award payment that might be necessary to equalize the division of the assets, if one party is gonna keep that business, in and of itself is typically not a, a simple straightforward process either. All three of these options have their, their own complexities and their own challenges, but of the three, that’s the cleanest. Having one person, one spouse take the business and buyout the other one’s interest in simple terms to put it, is the cleanest way to handle how to divide up.
Jaime Davis: So let’s assume that happens. Let’s assume that one spouse will get the business in the divorce. How is the business interest valued?
Nicole Taylor: Well, the easiest way to do it, and, and I’m not advocating it as the best or smartest way to do it, but the easiest way to do it is if the parties can simply agree between themselves on what the business value and the marital interest in that business, the value of that is, and then agree on, you know, what the other property is worth and then who’s gonna get the business and how much is gonna be paid if there’s any distributive award necessary to, to make the division equitable. But agreeing on the value of the business is really challenging in most cases, and it’s very rare that, you know, you have both parties agreeing right from the get go on yes, let’s just use book value or, you know, pull a number out of the air. I think that sounds fair. That doesn’t typically happen and I wouldn’t advocate for it to happen in most situations.
Jaime Davis: Sure. In your experience how often have you seen that happen?
Nicole Taylor: Sometimes, not very often, but sometimes it does happen in situations where both spouses have a very in depth understanding and knowledge of the business. You know, it, it’s, and so they both feel comfortable that they, they have a good handle on what it’s probably worth. Or in a situation where maybe there’s been a recent offer. You know, maybe the company thought about selling and took it to market and there was an offer or maybe they recently had it independently appraised for other reasons, you know, maybe they just do it every other year for purposes of what their operating agreement says they need to do. So in those situations where, where the parties already have a good handle on the value, or a reliable source that is a good value indicator, in those situations it can happen. You know, even then if somebody came to me and said my spouse and I have agreed to this value, just draft up a separation agreement, and I would want to understand how they arrived at that value and of course let them know they might want to consider having an expert look at how they arrived at it, or look at the appraisal that they relied upon, those sorts of things.
Jaime Davis: Right. Like where did that number come from?
Nicole Taylor: Correct. Right. Right. Maybe because it matters, when I said earlier, a minute ago that maybe the company recently had it appraised, or for example it might be a closely held corporation that has an ESOP plan. And so those are required to have annual independent appraisals done of the stock. What is the company’s stock worth? Well, in those situations there’s probably who, whichever company valuation analyst did the valuation, it’s probably reliable, but you don’t know for, for certain. So you’d want to understand what their qualifications were, you’d want to under, you know, you’d want to get a full copy of the appraisal. You want, want to consider maybe having your own consultant business valuation, consultant slash expert, review it and give you some input on whether it looks to be in line with what he or she would expect to see a valuation person do in a situation where they’re evaluating ESOP. So those are some considerations when you’re kind of trying to arrive at a decision about agreeing on a value without having to have two competing experts at war with each other about –
Jaime Davis: Right.
Nicole Taylor: – what are the value of the business is.
Jaime Davis: So let’s assume that our separating couple cannot agree on the value of the business. What happens next?
Nicole Taylor: Well, so there are a couple of options here. Again, you’re going to need in, in opinion, you know, in order to come to a reliable number of what the business is likely worth, you’re gonna need to bring in an expert business appraiser. Somebody who’s got the training, skill and qualification to review the documents and do the due diligence of, you know, management interviews, those sorts of things, to give you feedback about what that value number is. Now the parties can each get their own expert or they can, you know, on occasion agree to use a joint expert. So they would retain that person jointly to prepare the appraisal to be used for purposes of trying to negotiate their settlement.
Jaime Davis: So in a case where a couple hires an expert jointly, the appraisal comes back and let’s say the husband disagrees with the number, is there any recourse in a case like that?
Nicole Taylor: So usually when – it depends. It depends on how the joint engagement was structured. So for example, if there’s litigation pending and the two parties agreed in some sort of formal stipulation to have a joint appraiser and this appraiser would be the number that would be used by the Court, whatever it was once it came back, would be used by the Court for purposes of valuing the business, then it’s gonna be a lot harder to challenge that number or have, you know, any real recourse absent being able to share some huge, you know, mathematical error or some sort of clear bias, you know, some, something to that affect.
Jaime Davis: If something is obviously wrong.
Nicole Taylor: Something obviously wrong. Something that anyone’s gonna be like that is completely out of bounds, you know, not okay. We, we can’t rely upon this. But if you just have an informal agreement to retain an expert jointly, then there should be nothing that prevents each party from getting a second opinion or bringing in their own independent expert to refute it if the number comes back and, and they think it’s not in line with the true value.
Jaime Davis: And so, let’s say that our hypothetical couple, they’ve each gone out, they’ve each hired their own appraiser to value the business, what does that valuation process look like?
Nicole Taylor: Well, there’s a, that’s a long answer, because it is, it can be a long process. But in general it is, it includes some due diligence on the part of the appraiser working with the lawyers and the parties, depending on whether it’s a joint appraisal or working with just one party and one lawyer. There’s gonna have to be some discovery, whether formal through litigation and that’s by discovery I mean where there is production and information in the form of documents, interviews, if it’s informal or depositions, if it is formal discovery through litigation. That process is gonna have to, to be undertaken by the expert so that the person who’s valuing the company can get all the information they need, you know, it’s like tax returns, financial statements, that kind of basic information, and then of course, more extensive information beyond that, but I could spend an hour listing everything that the expert might want to receive.
Jaime Davis: Sure.
Nicole Taylor: So there’s the whole what I have, well, what I call discovery process. And then when the expert has the information, they’ll look at three basics, basically three different approaches. So they’re gonna have just the asset-based approach, and that’s basically a balance sheet approach, you know, what are the assets less the company debts, right? And then depending on whether the interest being valued is a 100 percent interest or something lesser, they’ll have to take into account whether any discounts need to be applied and that sort of thing. But the asset-based approach is basically a balance sheet. You have the income approach and that essentially in a nutshell is kind of like what are the future expectations for an investor if they were gonna come invest in this company? I need to look at the income and they can, and, and project out what an investor would expect to receive as either an income stream, and they look, and they can capitalize the earnings. They can do a discounted cashflow method. There are several different ways that they can go about it, but general broad term, that’s an income approach. And then there’s a market-based approached and that is where they look at similar companies in the same sort of geographical region to try to find comparable sales to do a market comparison, to arrive at a value there. So sort of like in real estate where you look at market comps for, for homes in the area to try to, to see what the value of, of the marital home is. Well they do the same thing for market sales on stocks of companies that are similar in nature and in the same geographic region as the particular company being valued.
Jaime Davis: And I would think that the market approach might be more difficult depending upon the size and type of the business that we’re talking about, and, you know, are there even any comps out there?
Nicole Taylor: A lot of times there are no comps or the comps that are out there, there’s not enough information to be able to make any necessary adjustments that might need to be made, because a lot of times they’re looking at publicly traded companies that have revenues that are, you know, 100 times more than the small closely held business that, that they’re valuing. They are, you know, required to go through the exercise of using all three approaches under their business valuation standards that apply, but most of the time they, they rely primarily, if not solely, on what the income approach indicates the value of the company is, but they do walk through the exercise of can we even use the market approach, and if so, here are some, you know, here are some market comps and, but I, I’m not gonna give any weight to that, because we don’t find them reliable enough.
Jaime Davis: Right. They’re not really comparable.
Nicole Taylor: Right.
Jaime Davis: So you mentioned that the income approach is the approach that is most relied upon. Does that typically have any impact on, let’s say a person’s alimony obligation? Because it seems like we’re talking about the same stream of income for the business owner.
Nicole Taylor: So it can, in North Carolina the alimony statutes specifically says that one of the things that the Court can and should consider, is the extent to which a party’s income stream comes from an asset that has already been valued and distributed in equitable distribution. So it really, the answer is maybe. It’s not yes. It’s not no. It depends on the facts of each case and to a large extent who your judge is. You know, some judges might be more inclined to take that into account than others, but they are, they do have the discretion to consider that as a factor.
Jaime Davis: And at least folks are cognizant of the issue that it is a possibility that hey, this could be a double dip of something that we’ve already counted.
Nicole Taylor: Right. I mean it should, it, everybody in a situation where the company is being valued and there’s also an alimony claim, it’s an issue to be flagged and for both sides to be aware of the potential and think about well, what, what would our particular judge be inclined to do here?
Jaime Davis: I will say in my experience, and disagree with me if you do, that typically alimony and ED are heard – oh, when I say ED I mean equitable distribution, are heard at the same time and so the judge is able to consider the same, you know, underlying facts at the same time versus having one issue heard and then having the other issue heard later. Is that your experience?
Nicole Taylor: It, it was historically, but I’ve, it, in recent years there are some judges, in some counties, who, who have started to require equitable distribution to be just tried before and separate from alimony. So I think again, it really, it depends on maybe what county the, the case is pending in and who your judge is in that particular county.
Jaime Davis: Where you are and who you’re arguing in front of.
Nicole Taylor: Exactly. Exactly.
Jaime Davis: So we talked about the different ways that we can value the family business. When the expert is valuing the company what date are they using? What is this value as of?
Nicole Taylor: So the, the one value that you’re definitely going to have at issue is the date of separation value. So you’re going to, and, and the date of separation is the date that the parties physically stopped living in the same house. One party moves out and they’re living in separate houses. So the Court is, and when I say the Court, it’s not because I’m suggesting everyone ends up there, but you sort of measure what’s a, a reasonable settlement value on what’s likely to happen in court. So when I say the Court, that’s what I’m referring to. You can still settle your case out of court. But the Court’s required to value the assets, the business, any other assets, as of the date of separation, before it can distribute those assets. And that would include what is the value of the business on the date that we separated. Sometimes if the business was owned, for example, prior to marriage, then you might also need to value it on the date of marriage, because there may be a question of is there a marital and separate component here? And in order to determine that you’d have to look at what the value was on the date of marriage, and what the value of the business was on the date of separation, and to the extent that there was any increase in value during that time period you have to start looking at what caused that increase. So passive, this is a very long answer to your question, but passive income on a separate asset is step, separate property. But if there’s an active increase in value in that separate asset, that active increase can be marital. So someone’s shares in a company that they own prior to marriage, may be a mixed asset, depending on whether there is a change in value.
Jaime Davis: So it sounds like determining, you know, what is active appreciation, what is passive appreciation, would be a very subjective type of analysis, but, you know, surprisingly it can be quantified in some cases.
Nicole Taylor: That’s right. In some cases, it can be quantified, maybe not 100 percent of it, but some portion, some substantial portion can often times be quantified, particularly with respect to passive forces that have contributed to an increase in value. And for example, changes in the economy. You know, experts can look at geographic growth in your area, changes in demand, because of population growth for your particular product. Sometimes they can use regression analysis to show, for example, if you sell me a plant for medical devices for replacements, you know, I’ve had a situation where the appraiser was, was able to tie through regression analysis statistically, the baby boom generation’s need for knee replacements directly to my clients’ increase in revenues from selling knee replacement devices. So cases like that surprisingly, sometimes really can scientifically mathematically be quantified how these passive forces do increase the value. You know, another example is the tax cuts recently to the corporate tax rate. You know, that is a passive, it’s just a government change in the law that neither spouse had any control over that’s going to impact the value of the company, because it’s paying lower taxes. When appraisers go through the appraisal process, they tax affect the company even if it’s not a C Corp, if it’s an S Corp, or a partnership with pass through income, they still use a process that tax, tax affects it. So that’s gonna impact the value as well, that change. Third-party contributions, also a passive force that’s harder to quantify, but, you know, for example, if it’s a 50/50 partnership and maybe husband owns 50 percent of the business with his dad, and they both go to work every week and work the same amount of hours and do the same job and the company grew during the marriage, you know, it’s like, likely that the Court would say well, to the extent there was an increase in value, that may have been active, because of people’s efforts, not just because of market forces, you know, dad was actively involved so that’s a third-party effort. That’s gonna be passive for purposes of determining whether part of that increase is marital or not.
Jaime Davis: Right. So the issue would be whether the appreciation was due to the active efforts of the spouse?
Nicole Taylor: One, one or both of the spouses. So, you know, it may be that one of the spouses owns the shares, but the other one is paid a salary and comes to work every day as an employee, but is doing, you know, actively doing all of these other duties in her role or his role coming to work, so that would be considered often times active efforts. So it doesn’t just have to be the active effort of the, of the spouse who actually owns legal title to the interest. It’s either one of them. If either one of them are doing things that are actively contributing to the value of the company then that is gonna, if there’s substantial evidence –it’s kind of like a proximate cause standard.
Jaime Davis: Sure.
Nicole Taylor: You know, if the judge thinks well I, you know, I think that husband’s efforts and wife’s efforts each proximally cause X amount of the increase in value, as long as it’s a reason decision, not just pulled out of thin air, it’s probably gonna with, withhold appeal, review on appeal. You know, it’s just gotta be a reason decision with enough evidence to, that it makes sense as to why the judge made that determination.
Jaime Davis: So we have covered a lot of ground today. Do you have any tips for people headed for divorce in situations where a business interest is going to be involved?
Nicole Taylor: Yes. You know, with every case is different, and so depending on whether you’re the business owner or the nonbusiness owner, my advice might be more specifically geared towards your set of facts, but in general, regardless of, of which you are, owner, non-owner spouse, the first thing you need to do is to get organized. So there’s particularly if there’s going to be an issue about any separate versus marital component, because you owned or acquired by gifts, some portion of your interest before or during the marriage. So you’re gonna wanna gather, you know, all the basic corporate documents. The original organizational documents, articles of incorporation, any shareholder agreements or operating agreements, any amendments to those agreements, you’re gonna wanna go ahead and get those together. You know, a lot of times, you know, people, those agreements might be 20 years old and you haven’t looked at ’em in years, and so you might think you remember what they say, but you really need to pull ’em back out and read it, because they could have some key provisions you need to know whether there’s anything that might happen in the divorce that’s going to trigger, for example, another shareholder or partner’s right to buy you out, because maybe your spouse names the company as a defendant in the law suit. You know, that might, depending on the wording of your particular shareholder or operating agreement, be something that triggers a buyout provision. So you’re gonna wanna review all those as soon as you can if you’re about to separate or, you know, in the process of separating so that you know, you know, what, what might come up.
Jaime Davis: Have you run into situations where the business is, you know, so old, it’s been around for such a long time that a lot of these documents maybe don’t exist as of the date of marriage?
Nicole Taylor: It, it does happen. Yes. And that’s, it makes it very challenging, and more difficult. But usually there’s at least one or two pieces of paper that can be tracked down somewhere.
Jaime Davis: Sure.
Nicole Taylor: Whether it’s a gift, tax return or some very old one piece of paper, you know, that was, happened to be notarized. I mean usually there’s at least something that gives somebody something to work with. But yes, there are, there are occasions where there, you just can’t find anything.
Jaime Davis: Are there any other types of documents that you should start to get together? I mean what if the business has loans or lines of credit or those sorts of things?
Nicole Taylor: Yes. And, and going back to the comment about looking at the operating agreements and the shareholder agreements, you also need to look at your, at your loans and lines of credit, because there might be something in your loan covenants that could be triggered again, if your business is named as a defendant in a law suit. Which sometimes happens that they just get joined as a party, just out of an abundance of caution or for some other reason. So knowing up front what the implications of, of that would be is much better than trying to figure out and scramble the fact, when you’ve been, you know, your business has been brought into this law suit and now you’ve got to deal with the bank, because it may have triggered, you know, it may violate some loan covenant. The other issue too is, we were talking earlier about how to structure a distributive award payout. You really need if you’re the, if you’re going to be keeping the business, and you’re gonna be using the income stream from the business to pay a distributive award over time, you’ve got to make sure whatever money you’re gonna distribute out to yourself, doesn’t again, violate loan covenants to the bank, because most of the time those, those covenants deal with what percentage of your net profits you can distribute out each year. And so, you, you’ll need to make sure and, you know, and, and any kind of structured settlement that you address that issue, that you don’t overextend yourself and say I’m gonna make all these payments, and then put yourself potentially in violation of your loan covenants. Similarly, if you’re trying the case in front of a judge, you know, the judge needs to know what the business owner’s ability to pay is.
Jaime Davis: Right.
Nicole Taylor: Because, you know, if you’re under a court order to pay something that’s gonna ultimately require you to violate your loan covenants, that’s a problem and the judge, I’m sure, would like to know that on the front end rather than having to deal with it on the back end if, you know, you have to come back in front of the Court, because you can’t meet your obligations.
Jaime Davis: Absolutely. What happens if you are the quote unquote out spouse and you really don’t have any knowledge of how the business finances work?
Nicole Taylor: So it’s something that you, you need to try to get a handle on. If you’re the out spouse it’s often hard to do that before attorneys get involved, because you just might not have access to any of that information. Sometimes you can at least get somewhat familiar with the income stream of the business by looking at your joint, if you file joint tax returns they’ll contain some information. But you’re really gonna need to get copies of the corporate returns for the businesses to figure out the details of that and if there are financial statements get copies of those. You know, sometimes if it’s a more of a collaborative or cooperative civil time divorce, parties can agree through their lawyers to just voluntarily exchange that information. Sometimes it’s, you know, not a cooperative divorce and so you’ll end up if you can’t get that voluntarily, if you can’t get all the information, you feel you need voluntarily, you’re gonna have to, you know, make decision whether you’re gonna pursue a court action so that you can get that information through the Court.
Jaime Davis: And I know one of the objections we hear a lot on the front end from opposing counsel is hey, these are confidential documents. These are some proprietary business secrets, and I think it’s important for folks to know that, you know, there’s a work around there. You can absolutely enter into a confidentiality agreement where you agree that you are not gonna use this information for any purpose other than getting this domestic situation resolved.
Nicole Taylor: You can do that. If there’s not litigation, if, if nobody has filed any sort of a law suit, you can do that in a private confidentiality agreement. You can also do it through a protective order that the Court would enter as a court order if there is a law suit pending. So you can, you don’t have to file a law suit in order to, you know, come up with some language that everybody can sign off on to eliminate that concern. That being said, you know, if it’s, if it’s a nasty Word War III type divorce and the parties don’t have any trust left whatsoever in each other it can be challenging to convince either one to sign any sort of confidentiality agreement, because there’s, you know, they don’t necessarily believe the other one is going to comply with it any way, or they’re concerned it’s gonna be, they’re going to allege that there’s a violation just out of spite.
Jaime Davis: Right.
Nicole Taylor: So it can be challenging, but at the end of the day, you know, a lot, a lot of times there is a valid concern about some, some of the issues, you know, some of the information that the business is gonna end up meeting to turn over in order to the valuation to be completed. You know, there could, there could be a legitimate concern that that not be used in any inappropriate way, sometimes it’s necessary to get those agreements in place.
Jaime Davis: So if you feel that you may be headed for a divorce, is that a good time to start paying your family expenses using the business account?
Nicole Taylor: No. A lot of times business centers take distributions and they may write a check directly to a third party and then the accountant may code as a distribution later.
Jaime Davis: Sure.
Nicole Taylor: So, you know, as a general rule no, but if you do it, you just need to make sure that it’s being done in a way where it’s clearly identified these are shareholder distributions or dividends, or however it’s gonna be coded as clearly as something that came out of the business as income or in some other fashion, to the business owner or for their benefit and, and not trying to, you know, claim it as a business expense when it’s clearly not. When you’re just paying something from a check for the business and you, you know, your accountant codes it as a distribution, that’s typically not problematic, because at the end of the day it’s being accounted for. Where it’s more problematic is when a business owner is using the business credit card for both personal and business purposes, and then just paying the credit card off and coding the entire payment as a business expense. It’s very difficult after the fact to go back to the business credit card and try to fair it out on that card what’s business and what’s personal. Sometimes it’s a De minimis amount so if it’s not something the business valuation expert has to really go through in great detail. But sometimes, you know, people are running $20,000.00 worth of credit card expenses through their business, it can be an issue. And so, you know, just it’s just an added layer of expense to try to go back and figure that out for the expert or the C, you know, the CPA or forensic accountant, whoever you might retain to, to look at that, for them to have to go back through and try to allocate personal to business from those cards.
Jaime Davis: So given the scrutiny that your financial records, especially your business financial records, are going to be under, you know, during a divorce, I would think that it’s really important to make sure that your business books are in order?
Nicole Taylor: That’s right Jaime, it is. A lot of times, you know, especially if it’s a family-owned business, and maybe you’re, you know, you have a spouse who’s always been a 100 percent shareholder and it’s not ever really been questioned before, and, you know, personal expenses may have been run through the business as a regular, you know, event, everything changes once you start going through a divorce. And so making sure that you, you know, your books are reliable is, you know, it might have an added level of expense on the front end, because you might have to pay a CPA for things that you, you know, you didn’t have to pay before, but on the backend of any kind of a court hearing or settlement negotiations, you, the other side or the Court, depending on where you are, are going to be much more likely to find that your statements is credible if you have credible books and records.
Jaime Davis: And I would think it makes your business valuation that more, that much more credible too, right?
Nicole Taylor: Right. Right. I mean, you know, if, if it’s a, if it’s a large business with a significant number of employees, you probably already have outside CPAs doing, you know, reviewed financials at a minimum, and maybe sometimes audited finances.
Jaime Davis: Sure.
Nicole Taylor: Um, so, you know, but if you’re a much smaller business with, with just a few employees, you know, that’s not often the same level of scrutiny that’s done every year for the financial review. But even in that situation, a smaller business, go ahead and get your books in order and, yes, it’ll help with the whole process.
Jaime Davis: What do you think about the business owner making really big changes in the business while a divorce is going on?
Nicole Taylor: It’s typically not a good idea. Sometimes a business opportunity may present itself that you can’t pass up, but if you’re not the controlling owner, and so you’re not really the one making the decision, it’s other people who are primarily controlling the business decisions and decisions to make significant changes in the company, that’s one thing. But if you have a controlling interest and you’re going through a divorce and all of a sudden you start making really big changes with your business, you know, selling off assets or starting to take on huge amounts of loans for reasons that don’t really appear to make good financial sense for a company, a lot of times you’re buying yourself a restraining order. You know, that’s something that you don’t, you don’t want to see. You don’t want a Court tying your business up by ordering that you can’t transact, buy, sell property, take money out of your business bank account, that sort of thing, you don’t want that to happen. And if you start making major changes to how the business is run, particularly income starts going out the door, or huge amounts of debt start to be undertaken for no obviously legitimate business purpose, that can be explained and understood by the Court, it’s gonna create problems, typically.
Jaime Davis: Because your spouse can actually ask that your business be joined as a party to the law suit in some cases, right?
Nicole Taylor: Right. Right. And yes, and that happens and I’ve been on both sides of that. I’ve been the person who asked for a company to be joined and then restrained from taking certain action, and I’ve been the lawyer for the business owner who’s had to defend those. So I’ve been on both sides. You know, and, and it happens and it’s, it’s not infrequent, you know, it’s a concern and so either, you know, if you’re a business owner you need to be aware of that and take that into consideration.
Jaime Davis: Nicole before we wrap up today, do you have any final tips or thoughts for our listeners?
Nicole Taylor: The one final tip I, I wanna make sure that I put out there for anybody listening to this who has a divorce situation they think may be coming up where business is gonna be involved, whether you’re the business owner or what we’ve referred to earlier as the out spouse, go see a lawyer. You know, go see a lawyer as, as soon as you think this is really something that’s, that’s gonna be coming down the pipeline, because you wanna understand, in general, what that means for you, but you also wanna understand what implications it may have with respect to the business, particularly where the business is the main source of the family income. You know, make sure that you understand the implications and kind of the do’s and don’ts for your particular situation as it relates to that business. It’ll help to have your ducks in a row. To have a more in depth understanding based on your particular case.
Jaime Davis: Well, it’s one of those issues you’re gonna have to deal with and it makes sense to just go on and get out in front of it.
Nicole Taylor: Exactly.
Jaime Davis: Well, Nicole thank you so much for joining me today. If any of our listeners would like to contact you, what is the best way for them to reach you?
Jaime Davis: I hope you all enjoyed this episode of A Year In A Day. If you have any suggestions for future episodes, I would love to hear from you. You can email me at email@example.com. If you like what you heard today please leave us a review on iTunes. As a reminder while in my role as a lawyer my job is to give folks legal advice. The purpose of this podcast is not to do that. This podcast is for general informational purposes only, should not be used as legal advice, and is specific to the law in North Carolina. If you have questions before you take any action you should consult with a lawyer who is licensed in your state.