Private family business operated by one of the parties to the marriage create problems for the courts when it comes to dividing the assets on divorce.
Such businesses may have created wealth during the marriage and are often the source of an important share of future income.
The first challenge for the courts is how to value a private family business
There are various methods of doing this varying from asset based valuations, to using multiples of projected future income to arrive at a notional capital value. If the courts use such an “earnings basis” valuation then they have to grapple with how to avoid double counting such earnings. It is one thing to create a notional capital value from the profit in a business, but it is another to use the same earnings to fund periodical payments.
The courts also consider how to balance risk. The value in bricks and mortar, land or cash is not the same thing as the value of a business based on an opinion of what that business may earn over the next 3-5 years.
Having dealt with these issues the court then has to go on to decide how funds can be extracted from the family business or whether shares in that business can or should be transferred to the other parties. There is then the tax effect of such transfers to be taken into account.
Had the marriage survived the family would have undoubtedly shared adversity as it had shared prosperity
The leading case on the subject is Wells –v- Wells (2002) EWCA C IV 476. In that case Lord Justice Thorpe said “had the marriage survived the family would have undoubtedly shared adversity as it had shared prosperity”. He did not consider that the separation of the family should terminate the sharing of the outcome of the company’s performance. He said “that is easily achieved in any case in which the wife’s dependency is met by continuing periodical payments. It is less easy to achieve in a clean break case. In that situation, however, sharing is achieved by a fair division of both the copper bottomed assets and the illiquid and risk laden assets”.
The Court of Appeal discussed the possibility of sharing the company between Mr and Mrs Wells, but neither of them wanted that. The court recognised the problems with this “ it is rarely a good idea for parties to remain (or become) co-shareholders in a company post-divorce, given the likelihood of the need for complicated Shareholders Agreements to protect both parties; one from interference and the other from the company being run to their disadvantage”.
Sometimes there is no alternative to such a sharing arrangement
On occasions it is impossible to value the shares, or to estimate the future liquidity of the company.
What happens in most cases however is that one of the parties (usually the Husband) retains the company and argues that by doing so, he is retaining the riskiest asset, and that therefore should receive more than 50% of the overall total to compensate for the wife retaining the “copper bottomed” assets.
That approach has now been thrown into doubt by the recent case of Martin –v- Martin (2018) EWCA CIV2866, which was an appeal from Mr Justice Mostyn who did not follow the principles in the case of Wells. In Martin the Judge simply divided the assets 50/50, leaving the husband with shares in a private company, even though this left him with the bulk of the risky assets. The Judge justified his decision on the basis that the private company had been valued on the basis of what it would sell for now. The estimate of value had taken into account the fact that business assets would be hard to realise, and therefore the value was discounted to reflect that. Having been presented with discounted figures in the valuation, the Judge refused to move away from “equality” by taking into account the difficulties in realising the assets, twice. In doing this he quoted the remark of Thorpe LJ when he said “the only difference between (the asset) and its cash proceeds is the sound of the auctioneers hammer”.
Business assets have different levels of risk
On appeal the Court of Appeal rejected the Judge’s reasoning in taking the valuation of the company’s equivalent in cash. The “auctioneers hammer” quote from Thorpe LJ came from a case where the asset was farmland and therefore an asset with a relatively stable valuation. Such a stable investment was not considered comparable to shares in a private trading company.
The Court of Appeal went onto find that assets do have different levels of risk, and the court had to take that into account when applying the sharing principle.
What the Court of Appeal did not do was give any guidance about how the risky nature of certain assets should be taken into account, other than by awarding the holder more than 50% of the total assets. Perhaps the court deliberately avoided giving clear guidance because every company or family business is different and therefore the risks attached to them are never the same.
What the court did do in Martin was reflect the risky nature of the assets by allowing more time and flexibility to satisfy the reward. The court did not depart from 50/50 division of the assets, even though this left the Husband with a greater share of the risky ones. The husband was given 4 years instead of 1 to find £20,000,000.
Whether the amount of money involved in Martin was so large that this influenced the outcome, or whether the principles set down in the case are going to be applied more universally remains to be seen. Inevitably, it is going to be used as authority for wives to argue that they should not receive less than 50% of the overall assets simply because the husband is keeping more of the riskier business based assets.
Michael Lowry advises individuals on divorce and other family law issues. He is a partner at Stephens Scown, the only South West firm to be given a number one ranking in the two independent legal guides to the profession – Chambers and the Legal 500. If you would like to contact Michael about the content in this article, then please call 01726 74433 or email Family.StAustell@stephens-scown.co.uk.