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Valuing shareholdings in divorce proceedings: the potential impact on a business

According to the Institute for Family Business, over five million family businesses in the UK generate more than a third of UK GDP.

In 2018, the family business sector paid £196 billion in tax (over a quarter of the Government's total revenue) and employed 14 million people in the UK (50% of private sector employment). Many of these family businesses are limited companies, where the person who established or acquired the business or their families or descendants possess 25% of the right to vote as mandated by their share capital.

Divorce can affect a business, not just spouses and children

At Shoosmiths we regularly see the impact a divorce can have on a family business when the shares in it become an asset to be fought over in the proceedings. It is not only the husband or wife who are at risk of an unfavourable court order being made against them - other shareholders may well suffer the ramifications of the couple’s divorce too.

In the event of financial proceedings, the court would be tasked with carrying out two key roles:

  1. Ascertaining the true value of the shares by ordering an independent expert to undertake a valuation

  2. Utilising its discretion to decide how the shares are to be divided between the husband and wife

This could, for example, involve the court ordering the sale or transfer of company shares. For the other shareholders of the business, this could result in the shares being sold or transferred to a third party with whom they have no desire to conduct business. Even on a less severe scale, most shareholders would not cherish the prospect of the company’s shares being valued and their cash value taken into account within the business owner’s divorce negotiations.

How far can the court go?

The infamous divorce case of Hart v Hart (Hart v Hart [2017] EWCA Civ 1306 (31 August 2017) (bailii.org)) is testament to not just how far the court can go to enforce its own rulings, but to the devastating impact divorce can have on a business and the individuals involved. Mrs Hart was awarded approximately £3.5m out of the marital assets. A substantial element of Mrs Hart’s award was the shareholding in a company operated by Mr Hart, the value of which was determined by the judge after hearing expert valuation evidence. Due to Mr Hart’s reluctance and ultimate refusal to transfer the shares and provide information and documents regarding the business to his wife, Mr Hart (aged 80) was committed to prison for contempt of court.

What shareholders can do to safeguard their interests

Often it is only in the midst of litigation that shareholders realise that they could or should have done more to protect their business interests. There are some strategies which can be put into place to protect a company from the consequences of a marital breakdown:

The company’s articles of association can be drafted to include pre-emption provisions. These can give shareholder's a right of first refusal over the issue of new shares in the capital of a company (or, if provided for under a shareholders agreement or the company's articles of association, the right of first refusal over the transfer of existing shares).

  1. Provided certain safeguards are met these provisions are unlikely to be challenged by the courts.

  2. Even where there is a company shareholder agreement, the court can make orders that impact upon the company, including orders for the sale or transfer of shares. However, the drafting of the shareholder agreement can be vital in mitigating the potential risks faced by the shareholding spouse and/or the other shareholders and may ultimately constrain the court. For instance, the agreement may:

  • dictate that these shares will be transferred to the founder holder in the event of divorce
  • restrict the ability to withdraw income or capital from the business (which could be the consequence of an order made in divorce proceedings) which would otherwise have a detrimental impact on cashflow, liquidity and the share value
  • stipulate that 100% of shareholders must agree dividend payments, share prices, or a sale of the business. Importantly it may also fix a binding mechanism for valuing the shares which would constrain any court appointed expert tasked with providing a valuation.

An increasingly effective option for shareholders who are contemplating marriage, is to enter into a pre-nuptial agreement, the aim of which would be to provide certainty for the couple and protect the business in the event of divorce. A similar mechanism can be used to safeguard the position of the business if shareholders were married before taking advice, or should new shareholders join the business who are already married. They should consider entering into a post-nuptial agreement which is a similar procedure and has the same effect.

As the Supreme Court confirmed in the case of Radmacher v Granatino ‘the court should give effect to a nuptial agreement that is freely entered into by each party with a full appreciation of its implications unless in the circumstances prevailing it would not be fair to hold the parties to their agreement’.

Disclaimer

This information is for educational purposes only and does not constitute legal advice. It is recommended that specific professional advice is sought before acting on any of the information given.

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