Guy Broadfield, Senior Associate, Burges Salmon

Hello and welcome to season two of Death and Taxes, a weekly podcast by the Private Client team at Burges Salmon. My name is Guy Broadfield and I'm a tax and trust lawyer in the Private Client team. In this special episode of Death and Taxes I'm pleased to say we've partnered with the Institute for Family Business to discuss succession planning for family businesses. In part one of this two-part mini-series, I'm joined by Richard Handel, a director in the firm's Family team, to discuss the impact divorce can have on family businesses. Richard advises high net worth and ultra-high net worth individuals on divorce, with a particular focus on complex financial settlements and asset protection, including pre and post-nup agreements.


Before we start, and by way of background, the Institute for Family Business, known as the IFB, is a dedicated and independent membership organisation whose aim is to champion and support family businesses. It is the largest family business organisation in the UK and has a wide range of family businesses as members across the country. Family businesses often have to deal with unique issues because they don't just have a business to run there is also a family to manage, often with complex succession, planning complicated shareholdings and sometimes difficult family dynamics. The IFB provides family businesses with a community to share and exchange views and its members meet regularly and have the option to talk to each other as required. The IFB also gives its members access to a wide range of resources, such as webinars and roundtable events, in a safe and non-solicitous environment. In addition the IFB also works hard to champion family businesses amongst UK policymakers to ensure what matters most to family businesses is written into government policy, enabling family businesses to thrive now and confidently plan for the future.


So, our focus with the IFB at the moment is on succession in the context of family businesses. Now, Richard, when we talk about advising families, both in a business context and a non-business context, they'll often have plans about how to transfer wealth from one generation to another and that's an important consideration for those families as part of their planning, and of course in the family business context that's still important but then there's also the question about how you manage those plans on a business level and what the commercial impact of those plans might be.


But for the purposes of today's talk it would be helpful just to talk with you about how divorce in particular can impact succession plans for family businesses, and so in the first instance it would be helpful to talk with you about what happens in a divorce where one party owns shares in a family business, what the process looks like and what the consequences can be, and then perhaps later on we can come on to talk about how you might look to avoid, or minimise, disruption to the business.

Richard Handel, Director, Burges Salmon

Well when a couple are divorcing they'll want to sort out their finances and those with family businesses often want to know what that will mean in terms of the impact on those businesses. The first thing to note is that the value of a business will be taken into account when dividing up assets, but how it's treated may be different to other more liquid assets such as a family home or investments. Obviously family businesses are much more illiquid and therefore they can't simply be divided. A business will also often be an income producing asset and the court will need to look both at the capital value of the business as well as the income from the business. Each family business is unique and there's certainly no one one-size-fits-all solution, and there are a number of issues that the court will have to grapple with. So for example, who are the shareholders of the business? It might be the husband and wife, it could be a number of siblings, it could be an inter-generational, so parents and children, and the different makeup of shareholders will impact on what the court thinks is the most appropriate way to deal with the business, and it means that some shareholders in the business may not be parties to divorce but will of course be very concerned about what impact it might have for them going forward.


I suppose looking at the family members in in question, both those who are getting divorced and those perhaps who are not, but this is all what you've explained there is all on the basis that in terms of the individual who's getting divorced that their shares are quote "in the pot" when it comes to dividing up the assets between the spouses, and we can come on to talk about the use of prenups to perhaps ring fence certain assets or not, but I assume that one of the main concerns of the wider family members is that if you have a family shareholder who's going through a divorce ultimately the family will want those shares to remain in the family the worst outcome would be a situation where there is a divorce of a family member and the outcome of that is that their shares, or at least part of their shares, have to be transferred to the departing ex-wife which could cause difficulty at shareholder level in terms of there's less continuity of family ownership, or at least their ownership's been diluted.


So that has to be sort of the worst outcome, and if you're trying as a family to make sure that doesn't happen almost after the event after the at least as part of divorce, then the only other option in that case is to find a way to buy out that depart, the spouse isn't it, in effect, you either have to give them shares or find money to the value of those shares to give them broadly.


Yes, that's exactly right, as you've identified it's a real issue where the family wants to keep the shares within the family and there can be a real question and a challenge about well how can they do that, how can they buy out the other party's interest. And so as I mentioned it's possible or maybe possible to offset that interest by giving one party a great share of the assets outside of the family business. That will of course depend on the value of their interest in the company and what other assets there are, and it may not always be possible but also then if that's not possible they would need to look at what perhaps liquidity there is in the business to be able to use to buy back the shares, and look at you know other options.


But it is a real challenge and certainly isn't straightforward and as I say each individual business is unique and it will depend on a particular business and what their structure is and the value and the different scenarios.


And in some context you see that there's been some careful consideration into this type of event when it comes to the articles of association of the company, and occasionally you do see provisions whereby it's agreed as between the members of the company that in the event of the divorce of a shareholder that the company will buy back their shares at that point in accordance with a predetermined formula. In some cases it's a rather nominal cost, in other cases perhaps a more sophisticated valuation mechanism. I mean Richard do you see those often, do they work in terms of at least giving the other shareholders some comfort as to being able to keep the shares within the family? I mean I suppose it might work from a corporate perspective, does it work from a family law perspective, in terms of the negotiation?


So we do see these types of clauses from time to time and, as you say, from a corporate perspective it can be effective and particularly if you're buying back shares at a nominal value. From the family court's point of view, the family court always tries to strive for what it would say is a fair outcome, so if one party was selling back their shares to their company but got nothing in return then the court wouldn't necessarily simply ignore the value of the true value of those shares, so the company would be able to buy back their shareholding and which would hopefully minimize the impact on the company, the divorcing couple in the overall sort of context of their divorce may need to look at the true value and how they would then deal with making sure there was a fair outcome in terms of the divide dividing up the assets.


Of course it's all well having a fair valuation mechanism but ultimately the company still needs the funds to be able to buy those shares from the divorcing shareholders, so that doesn't necessarily get rid of the questions or issues regarding liquidity in the company.


So the overall conclusion on that is that it can be a very destabilizing event, both for the individuals, but also for the for the family business and can lead to arguments between obviously the divorcing spouses, but also concerns raised by other family members who might be impacted by that process. And so Richard, there are steps that families can take to try and limit the impact of divorce on family members, and again that applies to families who own business interests and those who don't, so when it comes to trying to protect the business what are the options available, I assume we're looking at pre and post-nups in the first instance?


Yes we often recommend to clients who are trying to protect family business interests to have either a pre-nup before they marry, or perhaps their children who might take over the business at some point in the future or have some involvement before they marry, or a post-nuptial agreement, so after marriage, to try and deal with this issue. In this jurisdiction although marital agreements are not strictly binding if they're done in the right way then they are likely to be upheld by the court, and doing them in the right way means both parties are providing financial disclosure, both parties are having independent legal advice and the agreement being fair, so an agreement can be bespoke and deal with lots of issues from maintenance to claims about housing provision or trying to protect inherited assets, but from the family business point of view it's possible to potentially ring fence the family business and essentially say that that will be kept out of any division in the event of a divorce.


If there are circumstances where shares are being transferred to a spouse then you could also include in that agreement, as we mentioned previously, and which could be tied into the articles of association transferring shares back to the business for a nil or nominal value, and then if you incorporated that in a nuptial agreement, essentially saying that they would have no share in the business then that would be a more effective way to try and keep those business interests out of the divorce and protect the business going forward.



And that protects the business by meaning there's continuity of shareholding, the family's shareholding isn't diluted, and it also leaves the directors of the company to focus, giving them time to focus on proper commercial matters rather than worrying about the divorce, or otherwise, of a shareholder.


We often find in family businesses where there are a number of perhaps siblings involved or the number of children who are going to get involved in the business as a sort of family governance point of view it becomes a, if you like, a rule of the family that any child getting married will enter into a prenuptial agreement which will effectively, as best they can, ring fence the family business and that just becomes a sort of standard practice which makes it much more palatable to those getting married.


Okay so I think it's clear that the importance of pre and post-nups in this context is undeniable, I think when we're talking about the impacts of divorce, Richard, a lot of what we've focused on so far has been in circumstances where shares are held by individual family members. Now when it comes to family businesses often, for tax reasons and other reasons, shares in the business are held in some cases by the trustees of a family trust, so not by the individuals but by trustees for the for the benefit of the family members, how does that change the position if one of the family members who is a beneficiary of the trust goes through a divorce? Do the same considerations apply, or is it slightly more nuanced than assets being fenced or not?


Well there are a number of different ways that the family court deals with trusts and divorcing spouses who are beneficiaries to a trust. One of the issues the court will have to grapple with is whether the trust is what's called a nuptial settlement and it's pretty grey area as to what is and what isn't a nuptial settlement, but if the trust is making continuing provision for the parties to the divorce then it may be regarded as being nuptial. If a trust is regarded as nuptial then the court has very wide powers in relation to that trust, so including adding or taking away beneficiaries, or making distributions out of the trust, so if you have a trust in a divorce case then there's likely to be arguments about whether it is or isn't nuptial because if the court does make that finding of nuptiality it will give one party much greater power to try and either negotiate a deal or there was a risk that the court will be able to do things with the trust assets that weren't anticipated when it was put into trust.


Nuptiality is as I say is very difficult sort of concept and there are arguments on both sides as to whether a trust is nuptial or not. There are also arguments that just certain transactions of trust can be nuptialized, making those transactions could be dealt with by the court or assets taken out of trust, for example if the trust makes provision of a home, then the court may say that that aspect is nuptial and therefore can be dealt with outside of the trust, or removed from the trust. And also trusts, even if they're not nuptial at their time of creation, can be nuptialized later, so it's very much fact specific as to how the court would deal with it and will depend on the particular circumstances of the case but certainly having a trust is not necessarily going to give protection.


However as we've talked about before, having a pre-nup or a post-nup, you can include in that document that the trust should effectively be ring fenced and no claims against the trust should be made, including claims that it's a nuptial settlement in the event of a divorce, so you can try and ring fence those assets through that type of agreement, and avoid having to deal with any of the issues or potential natural settlements.


Well thanks for that Richard, it's certainly clearly a difficult area that's often finally balanced.


 I mean from my perspective it seems like if a trust is nuptial then there is scope for the veil of the trust to be pierced, such that you know the trust assets can form part of the divorce settlement, and it's interesting to hear that in some cases you might have a trust that's part nuptial and part not.


What are the consequences if you have a trust where it's determined that the trust is not nuptial, does that mean that those assets are still protected, or can there be any other claims that are brought against the trustees in a divorce context?


If the trust isn't nuptial then there's more protection within the trust itself, but nevertheless the family court could make an order for example against one party with the expectation that the trust will effectively come to that party's rescue, so in other words they might make an order for say a lump sum payment of, let's just say, five million pounds against one party to the divorce with the expectation that the trust will make a distribution in order to allow them to meet that lump sum payment, or in full or in part, and the court might do that if there's historically been distributions from the trust and it has taken the view that the trust is likely to make further distributions if the particular individual asked for one, and whether the trust would do that will obviously depend on the other beneficiaries to the trust and how they have how they might be impacted and the value of the assets in the trust and it's particular circumstances of the trust, but there's no guarantee the effect with the trust assets will be sort of ring fenced, simply because it's not nuptial.


But again, having a prenuptial agreement or a postnuptial agreement means that you can include in that document the provision that you want the parties to have and so you can try and protect the assets within the trust and the assets more generally.


It just comes back to this point about pre and post-nups because I think particularly within the context of trust in the family business, often there's an understanding that having the trust mechanism there is sufficient protection in and of itself, but I think what you're saying is it is more nuanced. And whilst there are certain aspects from the trust in terms of separation of control of assets and how you might benefit beneficiaries, from an asset protection point of view those structures need to tie in with pre and post-nups to get full protection, or more certainty for them, as much certainty as there can be, for the family and the family business going forward.


Yes the short point is that don't just rely on a trust to try and get that asset protection in the event of a divorce. If you want the protection you need to have a pre or post-nup and if you don't you're leaving yourself exposed.


Thinking about it holistically and making sure when you're thinking about all those succession issues that you're including what's the worst that might happen and if that's a divorce how then you actually deal with that and you can try and protect the business in advance.


Thanks again for listening to Death and Taxes, a private client podcast from Burges Salmon. You can find out more about Burges Salmon and our team at www.burges-salmon.com, or on our LinkedIn page.


If you'd like to find out more about the IFB or its membership, please see the IFB website www.ifb.org.uk.


In the second part of this family business mini-series, we will discuss how disputes between family members, and possibly trustees, can impact succession plans, so don't forget to subscribe to listen to all episodes from season one and two.