Selecting a business or marriage partner is complicated. While some factors apply to both selection processes, many obviously do not. Few elect to engage in business with a spouse. Fewer still would engage in business with the spouse of a business partner. Closely-held business owners use buy-sell agreements to restrict transfers of ownership and to ensure a smooth transition of operations in the event of certain events, such as death, disability, or divorce.
Divorce presents a variety of issues that can impact business ownership. If the ownership interest was acquired independently before marriage or during marriage by gift or inheritance, for example, and without contribution of any marital funds, services or assets, it may constitute a non-marital asset, which is subject to division or transfer upon divorce. However, even if initially acquired before or outside of the marriage, the interest may be “transmuted” through subsequent contribution of marital funds, services or assets to the business, requiring a division or transfer upon divorce.
Illinois courts generally attempt to avoid dividing a business in divorce situations, especially where animosity between spouses would jeopardize ongoing operations. In such cases, courts attempt to equitably (as distinguished from equally) distribute marital assets by awarding the business interest to the spouse that is actively engaged in the business and offsetting that interest by allocating other marital assets, or by requiring cash payments, to the non-active spouse. This provides a “clean break” for the parties.
Such a distribution, however, may not be possible where other marital assets are insufficient or where there is no cash or any financing opportunities that would allow for payments to the non-active spouse. In such cases, the interest may be divided, possibly prolonging tension between the spouses, as well as other business owners, to the detriment of continuing operations of the business. A similar situation can arise in the event of death if a surviving spouse elects to renounce a will (and thereby take a share of marital assets being one-half, if there are no children, and one-third if there are children) that leaves the business to someone else, but this may be avoided through the use of living trusts which are not subject to renunciation.
A buy-sell agreement enables owners to restrict transfers and may impose purchase obligations on the company or other owners. Purchase obligations work well in the event of a death, providing a cash-out for the surviving spouse, but not in divorce, since the active spouse generally continues employment in the business and prefers to maintain an ownership interest. In addition, if a portion of a business interest is allocated to a non-active spouse, a court may decide that transfer restrictions in a buy-sell agreement are unenforceable as to such spouse or the company’s transfer agent because neither was a party to the buy-sell agreement and neither agreed to the restrictions contained therein.
To maximize protection of business interests and to avoid potential disruption that could arise as a result of a divorce, a business owner must identify the source of interests as non-marital and avoid any post-acquisition contributions of any marital funds, services or assets. The interest should be contributed to a living trust and should be subject to a buy-sell agreement. Consideration should be given to asking the non-active spouse to be a party to the buy-sell agreement and subject to the transfer restrictions contained therein. A waiver of rights to the interest may be included in the buy-sell agreement, with an acknowledgment that marital rights will be funded through other identified assets in the event of a divorce. Such actions admittedly may be difficult or unpleasant to implement, and may not be acceptable to all owners or spouses.
These are sensitive issues that could damage a family and/or destroy a business. Counsel should be consulted at an early date to facilitate discussions and focus the parties’ objectives.