Business people and sports fans alike will surely recall the major league divorce battle of the McCourts over the ownership of the Los Angeles Dodgers or the contested dispute over the mental capacity of Donald Sterling to administer a family trust owning the Los Angeles Clippers. Unplanned events can change the ownership or control of your business.
Divorce is unfortunately a foreseeable event in the United States (approximately 40 to 50 percent of married couples divorce). Mental illness and mental incapacity are also commonplace, especially for aging business owners entering the latter stages of their life. As we all know, death is a certainty.
You or your partner may in fact not know of his/her personal or health issues until it is too late. These events can devastate your business, resulting in, among other things, you becoming partners with persons whom you never expected to be in business with or losing control of your own business. To avoid these scenarios as best as you and your business can, a prudent business person should consider the following:
Review Your Business Documents
Partnership, shareholder and operating agreements should include provisions that address all of the above events and protect the interests of all owners if the stock interest/ownership interest is transferred to another person. Such concerns can be addressed by executing a buy-sell agreement with your partner or by inserting analogous buy/sell type clauses in the operative document governing the applicable entity. Examples of provisions could include a prohibition against the transfer of shares without the approval of the other owners and the right, but not necessarily the obligation, of the owners to purchase the ownership interest from either the ex-spouse, owner in question, or any other impermissible transferee. Additionally, the buy-sell agreement or other business documents could provide that the divorcing spouse, even if he or she acquires stock, converts his or her stock upon transfer automatically to stock with a non-voting interest with the transfer being the triggering event.
You may also consider that a shareholder’s creditor may force an involuntary transfer of the shareholder’s stock if they levy on his or her assets. The business documents should provide a formula to calculate how your interest in the business is valued for the purpose of purchase by your other partner in the event some right is triggered that gives them the right to purchase. Another provision could designate and determine the type of persons that are permitted to own an interest in the business.
You may wish to have non-compete agreements with your partner for if/when they leave the company, including, but not limited to, if their stock is transferred by death or a divorce proceeding. This can also be inserted into the operative agreement. Failure to do so could expose a business to immediate competition from a partner even despite the right to repurchase the stock from the ex-spouse.
Business owners should anticipate these events and review their current business, personal and estate documents to determine what would occur to the business if you died, were divorced, or unable to act.
Business owners can address a potential divorcee spouse with a prenuptial agreement before the marriage or a postnuptial agreement if they do not have a prenuptial agreement or it does not adequately protect the partner’s business interests. Business co-owners should have ownership agreements that require each owner to provide the company with a prenuptial/postnuptial agreement along with a waiver of the owner’s spouse of any future interest in the ownership or control of the business.
If entering into a prenuptial agreement or postnuptial agreement is not possible, then you could hire a business appraiser and do an appraisal of your business interest at the time of the marriage which can potentially be used as evidence at a later date of the value of the business at the time of marriage.
Address Competency/Death of Partner
An owner’s capacity to make decisions as to the business can become at issue where the mental capacity of the person is challenged. Illustrative is Donald Sterling, where a court granted his wife the sole authority to sell the Los Angeles Clippers because he was deemed to lack mental capacity. Your governing documents should contain provisions providing for who makes decisions for any owner who becomes disabled or dies prematurely.
Set Up a Trust as Business Owner
Depending on the circumstances, another legal structure that could protect the business is the creation of a trust which owns your interest in the business. A trust is a separate legal entity from the partner (settlor). Being a separate entity, while the partner may have rights to earnings or other benefits of the trust, the partner may not have any ownership interest in the business given the trust owns it, which depending on the circumstances, can protect the business from concerns such as stock transfer.
It is important to note that these options or potential provisions for your business, and others, are usually subject to being viewed by future partner/investor, and it is important to discuss the pros and cons of this course of action with an attorney experienced in these areas.