01 Sep 2021
What happens to family businesses on divorce?
On divorce, the “sharing principle” generally applies to all marital assets, meaning that those assets should be shared exactly equally between the divorcing couple. The first step to be undertaken is to quantify all the assets owned by the couple, in their sole or joint names, and held directly or indirectly. The next step is to categorise them as “marital” (for sharing) or “non-marital” (generally to be retained by the owner).
Assets owned prior to the marriage that remain separate and are not used or relied upon financially by the couple during the marriage retain non-marital status. Therefore if you own shares in your family business at the date of the marriage (received, say, by way of gift or inheritance) and you play no role in the family business at all, the entire value of the shares on divorce is almost certainly not a marital asset. If however you are a director or have some other active role in the business, especially managerial or in giving direction, then any increase in the value of the business during the marriage is a marital asset. This assessment will be fact-specific so if you hold, for example, a non-executive directorship then the court will look at the reality of your involvement in the business – such as the frequency of meetings attended and your decision-making powers – to determine if the increase in value of the business is a marital asset. Any business that is set up by either party during the marriage is a marital asset from the outset – unless a prenup or postnup provides otherwise.
Depending on which category the business asset falls into, different valuation exercises will be required. If the asset is non-marital, usually no formal valuation will be required since it is being retained in its entirety. If the asset has always been marital, its entire value will be shared so just a valuation as at the date of the final hearing will be required. If only the increase in the asset’s value during the marriage is marital then of course both a valuation as at the date of the final hearing and a valuation as at the date of the marriage will be required. Where no valuation of the business exists from the time of the marriage, this retrospective valuation exercise is the most challenging aspect of the division of business assets on divorce, and the greatest source of dispute and deliberation in case law on the topic.
In Jones v Jones  EWCA Civ 41, the Court of Appeal had to consider the fair division of assets where the husband had owned his business for ten years prior to the marriage, but, due both to favourable market conditions and the husband’s hard work, the business had grown significantly during the couple’s ten-year marriage. The wife appealed after the court of first instance  EWHC 2654 (Fam) had awarded her £5.4 million out of the couple’s assets totalling £25 million. The first instance judge had attributed 60% of their wealth to the husband’s pre-marital share in the business, and split the remaining 40% equally. Wilson LJ in the Court of Appeal allowed her appeal and held that:
1. The approach of the first instance judge had been arbitrary: the starting point should be that the marital assets are £25 million less the value of the business at the time of the marriage. The business was worth £2 million at the time of the marriage so that provides the starting point of £23 million to be shared equally.
2. The sum of £2 million had to be moderated upwards to take into consideration the concept of “latent potential” in the company at the time of the marriage (valued at £2 million).
3. Further allowance had to be made for passive economic growth in the company between the date of the marriage and the date of divorce. This could best be represented by the increase in the FTSE All Share Oil and Gas Producers Index over the period (116%). Thus the value of the company at the date of the marriage was £9 million, which left a pot of marital assets worth £16 million and the sharing principle thus required the wife’s award to be £8 million.
Jones was the beginning of a semi-mathematical approach to the division of family businesses on divorce. However you can see from the above, one might ask how the judges arrived at £2 million as a value for the latent potential in the company, and how might the passive growth deduction be applied uniformly across all sorts of different businesses?
Moylan LJ in the Court of Appeal then took a different approach in the more recent case of XW v XH  EWCA Civ 2262. Before the couple’s marriage, the husband had co-founded a business that during their seven-year marriage became a household name used by billions of consumers the world over. When the business was sold one year after their separation the husband’s sale proceeds were £490 million.
Moylan LJ found that the first instance judge was entitled to attribute some latent potential value to the company at the time of the marriage and to categorise part of the proceeds of sale of the shares as non-marital property. To do so, a judge can err from simply applying the expert’s valuation increased by indexation because sometimes a broad evidential assessment will reveal that there was significant value not reflected in the formal valuation. The Court of Appeal agreed with the first instance judge that the ultimate success of the company was attributable to “a not inconsiderable extent” to its pre-marriage “foundations” and that they remained a “significant” factor. Moylan concluded it was fair to treat 60% of the wealth derived from the shares as marital property and 40% as non-marital. This has since been described as the “broad-brush” or “alchemy” approach, which has the disadvantage of being even more unpredictable but is perhaps more realistic in accepting that you cannot be wholly scientific in the valuation exercise.
Ultimately where a family business is involved you must prepare yourself for a dispute over the proportions of the value that are non-marital and over the valuations themselves. This is because the accountant’s valuation is one factor amongst many and we cannot predict which factor a judge is going to prioritise over another in the judge’s assessment.
How can we best protect against this problem?
Generally speaking a marital agreement such as a pre-nup or post-nup will agree that the “sharing principle” will not apply to your marital property. Often a marital agreement will specifically identify certain assets which will remain non-marital. If you own shares in a family business on entry into a marriage it is always better to have a pre-nup stating that no matter what the value of the shares on divorce that value is not to be shared.
As is well-known, marital agreements are not a binding contract under English law but, when done properly, they are in effect binding. The Supreme Court ruled in Radmacher v Granatino  3 WLR 1367 that “the Court should give effect to a nuptial agreement that is entered into freely by each party with the full appreciation of its implications unless in the circumstances prevailing it would not be fair to hold the parties to their agreement”. Thus provided the parties fully appreciated what they were signing, and that on divorce the outcome of the agreement’s terms would not leave either party in a “predicament of real need”, the court will not interfere with the agreement. Broadly “real needs” are adequate housing and enough income to live off, not necessarily at the marital standard of living. Try to ensure therefore that after ring-fencing the family business there will be other assets to be shared and sufficient income to meet daily expenses. Provided that is the case, a pre-nup should successfully protect the business asset from division. Where there are very valuable business interests and it works from a tax perspective, you might want to put the business assets in a trust in addition to having a pre-nup, but in any event a pre-nup is essential.
Read Mark and Kate’s article in STEP Journal (behind paywall).