Divorce is an often overlooked scenario that can shake a company to its core unless protections are built into the corporate structure early on. CEOs and owners should address the possibility of divorce among owners long before the scenario enters the picture. When owners are happily married or single, they can have objective conversations about how shares would be handled during a split.
Given that the incidence of divorce is about half the incidence of marriage, it is likely that some executives will part ways with their spouses—even if they are the perfect couple when the company is formed. Despite this likelihood, almost no corporate structures have default clauses for divorce. Indeed, common practice leaves that area as a personal issue to be dealt with through prenuptial agreements, which can cause an intense tug of war. The consequences of inaction can be dire, and unfortunately are common enough to make headlines on a regular basis.
Consider the case of a privately held company with about $40 million in revenues that was thrown into turmoil in the wake of an unexpected divorce. A minority partner in the organization battled with his spouse, who won a percentage of the shares at stake and became a minority shareholder with an axe to grind. The ex’s status as a voting shareholder gave her full access to information and allowed her to grind the business to a halt. Her behavior had the desired effect, as she forced a buyout of her shares that far exceeded their market value.
Without protective measures in place, owners have little recourse to avoid the worst case scenario. When a structure is created well before problems arise, however, companies can emerge from precarious situations in much better shape. Business owners should:
- Take the personal side out of the equation. This means approaching the subject as an objective conversation, when divorce is not imminent and the stakes for other shareholders are low (or not even on the table). If a divorce does seem to be on the horizon, CEOs should take immediate steps; once spouses and attorneys are involved, it will be too late to make adjustments.
- Include a “poison pill” in the charter documents that is triggered by the attempted transfer of any shares to a parting spouse. The “pill” serves two purposes; first, it can cause the shares to lose their voting rights, and second, it can trigger a long term buyout of the shares that eases the burden on the company. In most cases, this dissuades former spouses from even pursuing the shares as part of a divorce settlement.
It can be surprising how frequently these provisions are not put in place, even for companies operating at the highest level of commerce. Rupert Murdoch’s divorce, for example, highlighted not just how shares come into play, but the complexities of valuing ownership in a divorce based on the growth of the company and the spouse’s role. As noted in the New York Times, “The calculation of what percentage of the business Mrs. Murdoch could be owed starts on the day they were married and ends with the value of the company on the day they filed for divorce… The calculation changes if the business was started while the couple was married…A spouse of a business owner who stayed home and raised the children is generally awarded somewhere between 30 to 35 percent of the business.”
In another high profile case in the late 1990s, GE Capital CEO Gary Wendt had to deal with more serious implications to a business that he had almost singlehandedly shaped into a booming success. As he and his wife battled over a settlement and the value of her contribution to the company’s growth, the Wall Street Journal reported his concern that “because of his ’insider’ status at GE, disclosure of any plans he might have to sell GE stock in the future could prompt further trading by others.”
Indeed, as the total award came in at more than $20 million, the legal team for Mrs. Wendt put great emphasis on the inclusion of stock options, according to the New York Times. “The case is also important because it deals with how assets like stock options should be valued in a divorce settlement—an issue with a growing number of couples as executive pay has soared, fueled by the more common use of stock options and deferred compensation. ‘One point we were trying to make is that these valuable future assets are marital property, subject to division,’ said Arnold Rutkin, a lawyer for Mrs. Wendt…we definitely made the point. Some of the boys in the board rooms will be really unhappy when they read this.’”
The reference to the board room is the key for executives: whether leading a global powerhouse like GE Capital or a mid-market manufacturing enterprise, keeping drama off the management agenda is critical.
Whether facing tragedies like an owner’s death, disability, divorce, or drug dependency, executives that give forethought to such difficult circumstances can provide important clarity that helps companies avoid unnecessary turmoil. Life’s curveballs are unavoidable, but with the right legal structure and ownership clauses in place, they do not have to put a company back on its heels.
Frederic Marx is the head of the Business Law Group at Hemenway & Barnes LLP and has concentrated his practice in a number of areas including those involving family groups in strategic and tax planning for their business and multigenerational long-term objectives. He is also managing director and chairman of the audit committee of Hemenway Trust Company, a New Hampshire based private fiduciary firm.