Published on February 25, 2013
Posted in: Blog
Although the concepts described below are based on Part I of Ontario’s Family Law Act, broadly speaking, the family law legislation in effect in most provinces in Canada share certain common concepts in dealing with the division of property on marital breakdown.
Under Ontario’s Family Law Act:
- the date of a marriage gives rise to an economic partnership between the spouses;
- the spouses are equally entitled to the net wealth that’s accumulated by them during their marriage, regardless of which spouse may legally own specific assets;
- on the breakdown of a marriage, the value of the property that each of the spouses accumulated during the marriage (whether owned jointly or separately) must be calculated as of the date of their separation in accordance a prescribed methodology; and
- the spouse with the lesser “net family property” is entitled to one-half of the difference between his or her net family property and the net family property of the other spouse.
It bears emphasising that, under Ontario’s Family Law Act, the equalization of net family property is characterized as an “entitlement” of the spouse with the lesser net family property because, while that equalization is often effected by a money payment, it may also be (and often can only be) affected by a transfer of a property interest. Where one of the spouses is the owner of a privately-owned business, the consequences of the above-noted entitlement of the non-owner spouse can be extremely disruptive to the business and may significantly prolong the amount of time required to complete the equalization process. The potential for disruption to the business derives from the fact that, quite apart from the impact that the breakdown of the marriage will usually have on the emotional well-being of the owner spouse (which may in turn affect his or her performance as a manager of the business), upon marital breakdown, the non-owner spouse, who previously may have taken no interest in the day-to-day management of the business, will usually insist on having some involvement in, or at the very least some oversight over, the business in order to protect his or her (presumptive) half-share of the owner spouse’s interest in the business. If the owner spouse owns the business in “partnership” with others (either as a partner in an actual partnership or together with other shareholders of the corporation that operates the business), soon after the marital breakdown, the owner spouse may also be pressured by his or her “partners” who may have legitimate reasons for being concerned that the marital breakdown of the owner spouse may have a significant impact on the value of their own interests in the business. The sources of discord described above may also be far from temporary. Unlike shares in public companies that trade daily on stock exchanges at prices that, by definition, represent the fair market value of a fractional interest in those public companies, an ownership interest in a privately-owned business can only be established by a professional business valuation. Therefore, where part of a spouse’s net family property consists of an ownership interest in a private business, in order to complete the equalization process, a valuation of the business will first have to be completed. Doing so takes time and usually involves significant expense. Even if the spouses are able to agree on the value of the owner spouse’s interest in the business fairly readily, the owner spouse may not have, and may not be capable of borrowing, sufficient funds to make the appropriate equalization payment to the non- owner spouse, in wich case, either selling the business as a going concern or transferring a share of the owner spouse’s interest in the business may be the only practical courses of action available to complete the equalization process. A forced sale of the business makes the sale price subject to the vicissitudes of the economic cycle and/or of the cyclical nature of the industry to which the business belongs. If, on the other hand, part of the business is transferred to the non-owner spouse, such a transfer only serves to make more permanent the potential for future disruption to the business since all of the personal incompatibilities between the soon-to-be-ex spouses that led to their marital breakdown in the first place and, if applicable, all of the tensions between the owner spouse and his or her business “partners” (who will understandably feel as if they’ve suddenly had a new partner forced upon them) will remain in place indefinitely.
Triggering Rights in Shareholder and Partnership Agreements
The most common and effective way for the business partners of an owner spouse to protect their interests in a business is to insist that a partnership or shareholder agreement (as the case may be) be entered into that contains provisions that deal with the consequences of the breakdown of the marriage of a partner. Ideally, such provisions will compel each of the partners of the business to obtain a release from their spouses of any interest that their spouses may have in the business pursuant to any provincial or federal law that applies to the division of property on a marital breakdown (supported by a certificate of independent legal advice). If, however, obtaining such an outright release from each of the partners’ spouses is not a practical option, then the partnership or shareholder agreement will provide that if the spouse of a partner commences a proceeding to determine his or her entitlement with respect to the equalization of net family property, that act will trigger an option in favour of the other partners to acquire the ownership interest of the partner whose marriage has broken down unless that partner can provide reasonable evidence that any equalization- of-net-family-property claim made by his or her spouse can be satisfied without affecting the partner’s ownership interest in the business. If the partnership or shareholder agreement deals with the consequences of a partner’s marriage breakdown in the latter fashion, it’s not uncommon for the agreement to also specify the terms of any sale that may be triggered by a partner’s marriage breakdown, including permitting the purchasing partners to satisfy the purchase price by periodic payments over time (e.g., within two or three years after closing) in recognition of the fact that the timing of the sale was triggered by an event that was not of their choosing and they may not have sufficient funds to complete the transaction by paying the purchase price in full on closing.
The inclusion of provisions in a partnership or shareholder agreement that deal with the consequences of the breakdown of a business partner’s marriage is obviously a collateral form of protection for the other partners of the business. The enforceability of any provisions in a partnership or shareholder agreement that trigger an option to purchase along the lines described above may be subject to a legal challenge by the non-owner spouse if there are reasons for him or her to suspect possible collusion on the part of the owner spouse and his or her partners, in order to deprive the non-owner spouse of the full value of his or her equalization-of-net-family-property claim based on terms of sale that the non-owner spouse believes deliberately understate the value of the owner spouse’s interest in the business.
Part II of this blog article will discuss the most common and effective way for an owner spouse to minimise the impact of a marital breakdown on his or her ownership interest in a private business – namely, by entering into a marriage contract that addresses the division of net family property following a marital breakdown differently than the methodology that’s prescribed under Part I of Ontario’s Family Law Act.