Wisconsin
Lawyer
Vol. 81, No. 6, June
2008
Business Owners in Divorce: A Basic Overview
Unique issues arise when a business
owner is a party in a divorce action, including valuing the business and
determining income available
for support or maintenance. Here is a basic overview of the issues for
attorneys
representing either the business owner or the nonmanaging spouse.
by Christopher S. Krimmer
divorce is difficult and emotional
for most individuals going through
the process. A person who owns a business has the additional anxiety of
not knowing
what will happen to his or her business in the divorce. An attorney must
know how to
competently and effectively deal with division of this very important
asset,
whether representing the business owner or his or her spouse. This
article provides a
basic overview of the issues unique to a divorce when a party is a
business owner.
The most significant issue for both spouses' attorneys is to
determine the
value of the business. A business that is publicly traded is easy to
value. The
attorneys can merely pick up the business section of the newspaper and
locate the
appropriate stock tables. The same is not true when the spouse owns an
interest in
a closely-held business. The attorneys will need to rely on experts to
give an
opinion on the fair market value of the business.
Confidentiality of Business Records
The first step is for the attorney who represents the nonmanaging
spouse to
request certain business documents using discovery tools. The attorney
will want
to request any articles of incorporation, records of distributions,
applications
and payment records for business loans, descriptions of real estate
holdings,
balance sheets, profit and loss statements, buy-sell agreements,
shareholders'
agreements, and the corporate tax returns for at least the past five
years.
These business records will contain
sensitive information about the health and direction of the business.
The attorney who represents the managing spouse will want to
make sure that the information remains unavailable to the public and
potential and actual
business competitors. Although discovery documents are not available for
public inspection,
nothing prevents a party from disclosing the information to the public
or a
competitor.1 To protect the privacy of the
business records, the parties may want to enter into a
confidentiality agreement in the form of a stipulated order.
Christopher S. Krimmer, U.W. 1997 cum laude, practices family
law with Balisle &
Roberson S.C., Madison. He is an adjunct professor of law at Marquette
University Law School.
This order can include provisions that identify all the documents
being released
and state who may receive the information (usually parties, attorneys,
and experts only), how
the documents will be stored by the attorneys and experts, and whether
the documents will be
returned to the business after the divorce. For example, the
stipulation could state that
neither party will retain a copy of the documents, and that each party
will view them only in
the office of his or her attorney or expert.
It is always a good idea to stamp each page of the documents
"Confidential" and to
Bates stamp each page so that the documents stay in chronological order
and can be easily
identified at trial. If the divorce action goes to contested trial, the
confidentiality agreement
cannot extend to evidence submitted in court. There is a strong
presumption that most documents
that have been introduced into evidence are open for inspection. This
includes business
documents cited as a basis for the valuation of the business and relied
on by the
experts.2
The Legal Standard: Fair Market Value
One of the most difficult concepts a business owner must grasp in a
divorce is that his
or her business may have more than one value. The business can have one
value for a refinance,
a different value for a business sale to a competitor, yet another value
under the terms of
a buy-sell agreement, and finally, a different value in the context of a
divorce.
The divorce court will divide property on the basis of the fair
market value of the
assets. The Wisconsin Court of Appeals has adopted the IRS definition of
fair market value to mean the price that property will bring when
it is offered for sale by a person who
desires but is not obligated to sell and is bought by a person who is
willing but not obligated
to buy.3
The attorney will need to consult with a reputable expert to
determine the fair
market value of the business. Certified public accountants commonly
perform this function,
although for complex or large businesses, the attorney may wish to
consult with a certified
business appraiser. Four professional associations provide education and
accreditation for experts
who conduct business valuations: the American Society of Appraisers, the
National Association
of Certified Valuation Analysts, the Institute of Business Appraisers,
and the American
Institute of Certified Public
Accountants.4
Discounts
A variety of discounts may be applied in determining the fair market
value of the
business. A client may be inclined to take the gross value of the
business and determine the
marital interest by looking at his or her share of the entire business.
For example, if a business
is valued at $1 million and the owning spouse has a 20 percent interest
in the business,
the parties might assume that their interest is worth $200,000. This is
incorrect. Since the
owning spouse does not have a majority interest sufficient to control
the direction of the
business, his or her interest should be discounted for "lack of
control" or a
minority interest discount.
The percentage of a minority interest discount can range from 15
percent to 30
percent, depending on the circumstances of the individual business,
after considering factors such
as the corporation's bylaws, the extent of risk for mismanagement, the
relationship among
the blocks of stock owned by different shareholders, and the degree of
control, if any, the
managing spouse has over the direction of the company.
An additional discount for lack of
marketability also may be appropriate. A lack of
marketability discount takes into account that there is no readily
available market for the
sale of the shares in the business. In contrast to the potentially large
market of purchasers
of publicly traded stocks, only a limited number of buyers generally are
interested in
purchasing a family-owned or closely-held business. This discount also
can range from 15 percent to
30 percent.
Retained Earnings and Corporate Distributions
One of the most often litigated issues in divorce when a party owns a
business is the
income available for support. The attorney who represents the
nonmanaging spouse might
argue that retained earnings or corporate distributions constitute
income. This analysis would
seem to be supported by the definition of
income under the Department of Workforce
Development (DWD) child support enforcement
standards.5 However, a more thorough
analysis is required.
Retained earnings from a company should be considered income
only if two conditions
are met: 1) The payor must have the individual ability to exercise
control over or access
the undistributed earnings; and 2) the court must determine that there
is no valid business
reason to retain the earnings in the
company.6 If the payor is a
minority-interest owner or the
retained earnings are necessary for the operation of the business, then
the funds should not
be considered income.
There is a danger of double
counting in a divorce. If the expert uses an
income-based approach in valuing the business interest, it is likely
that the retained earnings will
be incorporated into that value. If the other spouse were to receive
one-half of the
business interest in the property division and also receive a support
award based on the same
retained earnings, double-counting has
occurred.7 In such a situation, an attorney
should argue that
to the extent support is based on the retained earnings, for purposes of
the property
division the value of the business interest should be decreased.
Corporate distributions also must be analyzed. Distributions
received by a
shareholder for the sole purpose of paying the tax on a pass-through
corporation, such as an
S-corporation, are not necessarily income available for
support.8 The attorneys should determine
what amount of the distribution was allocated to pay pass-through taxes.
At first glance, the managing spouse may appear to have far more
income than what
is actually available to him or her. It is important for both attorneys
to understand how
to fairly calculate actual income available for support.
Conclusion
The parties to a divorce action usually find the process to be
confusing and
emotionally exhausting. This anxiety is compounded when one of the
parties owns a closely-held
business. An attorney can best serve his or her client by informing the
client of the unique steps
and issues presented in his or her case and then properly addressing the
legal and financial
complexities involved in the valuation and division of the parties'
business interest.
Endnotes
Wisconsin
Lawyer