Andrew Drake is a partner at Penningtons Solicitors LLP. www.penningtons.co.uk
Divorce can throw everything out of kilter, especially if one partner insists on taking a chunk of the family business as part of a settlement. Andrew Drake outlines the issues, examines the implications and urges caution when considering a settlement
The press has highlighted the substantial settlements that UK courts are prepared to award to spouses on a divorce. In those cases where the assets owned by the couple are reasonably 'liquid' or easily divisible, it may be a straightforward process to effect the settlement.
What happens, however, where the assets are not so easily divisible or where their division has implications? Where the bulk of an individual's wealth is tied up in the equity of a business, the prospect of having to transfer to the other spouse, let us say 40%, of that equity under a divorce settlement can be daunting enough. However, such a transfer can be even more difficult if other members of the family also own equity in the business.
Let us assume for the moment that there is only one breadwinner in the marriage, called Adam, who is a director and a shareholder in the family business. He is in the process of divorcing Eve, who is neither a shareholder nor director, nor employed in the business. The bulk of Adam's wealth is tied up in the shares he owns. Let us also assume that Eve is seeking a divorce settlement and is requesting the transfer of, say, 40% of Adam's shareholding to Eve and that Adam and other members of his family have an exit plan to achieve a trade sale in three years' time.
What are the implications of a transfer of Adam's shares for Adam and other members of his family who are either shareholders or directors? Adam's influence as a shareholder will be diminished and Eve will acquire certain rights (including rights of veto) as a shareholder. The point is well illustrated if we assume that Adam owns 65% of the equity. Not only will the transfer of 40% of that holding mean that Adam loses majority control of the business but Eve will acquire 26% of the business, a percentage which, under English Company Law, entitles her to block a Special Resolution (required for important matters such as any change in the Company's Constitution).
Can these concerns be overcome by persuading Eve to accept non-voting shares? Before any transfer of Adam's shares to Eve can even be contemplated, a check will need to be made as to whether the transfer is, in fact, permitted under the company's constitution or by a shareholders' agreement or family charter. There may well be pre-emption provisions in one of these documents that give other members of Adam's family a first call on any shares that he wants to transfer. Pre-emption rights can be waived but Adam's family may well not be prepared to do this.
If Eve does become entitled under a divorce settlement to a material proportion of Adam's shareholding, this may well lead to her demanding a seat on the board. This has implications, not only for Adam but for the other family board members. A board that is finely balanced between the different family members may suddenly become unbalanced as a result if Eve is appointed.
Even if there are no pre-emption provisions relating to the transfer of shares to Eve, thought may need to be given to restricting the onward sale by Eve of any shares that she does acquire under the settlement, particularly given the plan to sell in thee years' time. The family will wish to guard against Eve transferring any of her shares to a new spouse.
Finally, when the family find a buyer for the whole business, they will want to ensure that Eve goes along with the sale. Thought will need to be given as to whether Eve is asked to agree to the other shareholders having "drag-along rights" – that is, a right to compel Eve to transfer her shares on the same terms on which the other shareholders are selling under the trade sale.
It is imperative that in any divorce settlement, the impact on the business and the family shareholders is fully thought through.