Break glass in case of divorce: Shareholders’ agreement to the rescue

Article content

This is Part 3 in our series on shareholders’ agreements. In Part 1, we covered how these agreements, while so vital, are often treated like a hot potato. In Part 2, we covered how a well-written agreement can reduce tax.

Starting a family business together can be a great way for spouses to unite in a common goal. But fast-forward several years and the business might be flourishing while the marriage is not.

“Now, not only are you dealing with a divorce, but also a business problem,” says Milan Topolovec, president and CEO of Ottawa-based Inner Orbis and TK Financial Group and an estate planning advisor.

While some clients are able to soldier on and manage their operations, for others the result is an epic battle, Topolovec says. If there’s no documentation, the future and viability of the business can be threatened.

It’s why family offices strongly recommend common-law and married couples sign shareholders’ agreements. These documents stipulate each shareholder’s role and obligations, spelling out who retains the business in the event of a divorce, the types of shares each party holds, voting powers and how the shares would be distributed.

The agreements also need to be signed, a common oversight that often renders the most perfectly crafted agreement null and void.

A shareholder agreement is not a cure-all, Topolovec says – you could still end up in a legal battle. “But your biggest asset is your business. It’s the goose that lays the golden egg.”

Talk together about issues

Family offices should bring all family members and their advisors to the table regularly to discuss potential issues that could affect the business, then address them in a shareholder agreement, Topolovec says. He also recommends that legal counsel be present.

“Bring in all of the players at the table – often,” he says. “You learn so much being physically present with an individual.”

Doug Byblow, an independent family office executive in Calgary, agrees. “For the family office executive or trusted advisor tasked with managing risk and establishing structures and processes in such circumstances, perhaps the most critical point is to take a holistic approach to the planning process – ensuring that the corporate, taxation, estate planning and matrimonial advisors work collaboratively and are all solving for the same problems,” he says.

The shareholder agreement should then be customized to the family’s needs, which are articulated at these meetings.

“It’s going to depend on what the parties want,” says Kevin Caspersz, senior associate lawyer at Shulman & Partners LLP in Toronto.

Timing is everything, he says.

For example, if a couple started a business after they married, a shareholder agreement would be valuable but not as critical as in other partnership scenarios, says Caspersz. That’s because family law dictates that all assets acquired during the marriage have to be divided equally, and that also applies to the business itself. This in turn might lead to equalization payments from a spouse who wishes to retain the business, provided that spouse has the funds to pay out the other party.

Shareholder agreements often include a shotgun clause, also known as a buy-sell agreement, which forces the other partner to sell his or her stake in the family business or to buy out the spouse.

If one spouse started the business prior to the marriage, and the other spouse joined at a later time, a valuation of the business should be determined prior to the marriage, says Caspersz. A business valuator can determine that figure compared with the accumulated value of the business from the time the spouse joined the firm. This will help guide the equalization payments upon marriage breakdown.

Common-law rules are different

Where a shareholder agreement is of utmost importance is when a common-law couple enters into business together.

“That’s probably where it’s going to get messy,” says Caspersz. Common-law unions are not governed by family law, meaning common-law partners are not entitled to the same division of property that married couples are.

As a result, each party will be entitled only to the assets brought to the union. And if one party is listed as the sole shareholder, that person will have the right to retain the business, regardless of what the other spouse has contributed.

In such scenarios, says Caspersz, “it’s going to force the other party to make an unjust enrichment claim.” Such a claim essentially means that if a partner leaves the relationship without dividing up shared property, then it’s unfair and could result in a monetary or proprietary award for the other spouse.

To prevent a costly legal showdown, Caspersz recommends prioritizing a shareholder agreement.

Communication, tax considerations key

The shareholder agreement needs to tackle who will make decisions for the business, Byblow says, and whether there are good governance processes in place to allow for effective business decision making and communication.

“Will a personal conflict lead to business stalemate?” Byblow says. “Who gets to make which decisions?”

Another issue is taxation. “There is a great deal of complexity concerning tax implications associated with transition of shares of family-owned businesses,” he says.

These rules are highly technical and have recently been amended, and more changes are on the way. For this reason, reviewing the shareholder agreement regularly can help troubleshoot any tax issues that arise. (For more on shareholder agreements and taxes, click here.)

All in all, a shareholder agreement must address complicated issues that apply to that family’s unique situation. And it requires skilled legal expertise to prevent disputes from occurring should a marriage — and business partnership — go south.

At the end of the day, Caspersz says, “that shareholder agreement is always going to be important in establishing ownership or interests in the business.”

More from Canadian Family Offices:

• Nine hotspots where wealthier Canadians are scouting for property
• How Canada’s new luxury tax works
• How major donors are helping improve neglected elder care
• Does least-happy child deserve extra helping of parental resources?

Please visit here to see information about our standards of journalistic excellence.