WEALTH TRANSFER
Prenuptial agreements may
save the business

It was a perfect day in May in 1991 when John’s granddaughter, Stephanie, married her college sweetheart in the family garden. Stephanie was grateful to her grandparents who had spared no expense to make sure the day was one to cherish and remember.

Stephanie was again grateful last January, since the weather and the groom’s ardor had cooled. When her husband filed for divorce, he asked for his share of their community property, which in his mind included her stock in the family business.

A prenuptial agreement, which the couple had signed at the suggestion of a cautious granddad, saved more than the day for Stephanie. It preserved her stock holdings, which both her grandfather and parents had been gifting to her over a period of years, and—equally important to the family—protected the financial privacy of their business as well.

With current tax laws encouraging parents and grandparents to give away stock in the family business to the next generation, premarital agreements are a necessary business safeguard. Stakeholders in the family business often are concerned about protecting family assets from the claims of a divorcing spouse, a deceased spouse’s children (from a previous marriage), or parents remarrying in their 60s, 70s and 80s.

Gifts retain their sole and separate nature and are not community property. However, if the donee works in the family business and through his or her efforts the value of the business increases, then the increase may be a community asset (over the original value at the time of the gift). For instance, if a father gives shares of the family business valued at $1000 to each of his three children who are active in the business, and nine years later the share values have grown to $5000 each, the $4000 increase could be considered a community asset.

If a spouse believes that stock in the family business (considered to be the donee’s property) was given in place of salary increases (which would be considered a community asset), and that spouse didn’t sign a disclaimer that the salary arrangement was acceptable, that spouse may try to claim an interest in the stock of the family business accumulated during the marriage. This scenario could be a catalyst for issuing a subpoena to review the business’ book and records.

A messy divorce can open up the financial records of a family business revealing sensitive details of employment contracts and other information that the family would prefer remain private. Even if the divorcing spouse is unsuccessful in their claims, the suit can tie up the business and disrupt operations.

Interested stakeholders like Stephanie’s grandfather, however, have several options available to encourage the creation and continuation of prenuptial agreements. For example, parents can tie transfers of family business stock to the signing (and maintenance) of a valid prenuptial agreement, or business interests can be gifted to a trust, instead of outright. Some businesses simply require prenuptial agreements for every stockholder marrying, which frees the future bride or groom from the decision of whether to ask for an agreement.

If a shareholder were to die without an agreement, the non-shareholder spouse could be entitled to a share of the business depending on state law. Divorce could trigger similar claims, depending on where the money came from originally to acquire the business interest.

Because voting rights in the business govern how it is operated, all stakeholders have an interest in who holds those rights. A buy-sell agreement can provide that shares transferred to an in-law by court order (divorce decree) or negotiated settlement, must be repurchased immediately by the business. Some families make their business interests less attractive (and less valuable) when transferred to in-laws as a result of divorce. For example, an automatic exchange of voting shares for non-voting stock, may concede the issue of shared wealth without sharing voting rights.

What Works
Characteristics of a prenuptial agreement that will hold up in court:

• Full disclosure by both parties of the nature and extent of assets. If you don’t want to reveal all your holdings, you can say your assets exceed a certain value without naming everything.
• No evidence of fraud, duress or coercion.
• Each spouse has his or her own counsel.
• Give the process plenty of time (at least 30 days before the ceremony) so everyone has ample time to think through the details.
• Don’t make the assets seem more important than the prospective spouse.
• Keep it simple and relevant. Don’t worry about who gets custody of the family cat.

Prenuptial agreements are not a modern invention since arranged marriages—and the negotiations that accompany them—go back further than Romeo and Juliet. Crafting a prenuptial agreement may be a good litmus test of the relationship, since trying to create a workable document can reveal how the couple will handle other issues.

It takes effort on the part of all members to keep title in the hands of intended beneficiaries while, nevertheless, dealing fairly with in-laws in terms of finances. Most families would prefer a divorcing in-law’s interest to look more like that of a general creditor than a business partner.