Succession planning, marital agreements and protecting the family business

Succession planning, and passing on family wealth to the next generation, will be a priority for many involved with family businesses.  The aim will often be that the next generation work their way up the ranks, increasingly take over the day-to-day management, and with it, ownership.  An early transfer of shares to younger family members can act as an incentive to work hard whilst at the ‘bottom rung’ of the ladder.  Equally, from a financial planning perspective, there may be significant tax drivers behind a proposed restructuring of a family business.

As a family law team, we often take calls from our corporate and private client colleagues, and from accountants and financial advisers working with family businesses, about the family law implications of the succession planning, or wealth protection steps, being proposed.  Whilst the commercial and tax benefits may be clear, there are sometimes lingering, and legitimate, concerns about shares ending up in the hands of non-family member spouses following divorce or relationship breakdown, or the business having to raise a significant capital payment to fund a divorce settlement.  In those situations, we often advise that a marital agreement could be put in place to try and ring-fence those shares from future marital breakdown.

What is a marital agreement?

A marital agreement can either be made prior to a marriage (a pre-marital agreement, or ‘prenup’) or during a marriage (a post marital agreement, or ‘post-nup’).  Both seek to achieve the same aim: the regulation of the claims the parties to the marriage would have against each other on a future divorce.  Both have the same standing in family law.  With particular reference to family businesses, marital agreements are often used to ring-fence, or shield, shares from future attack, making clear that any financial claim would be satisfied (instead) from other assets the parties hold. 

Are marital agreements binding on a subsequent divorce?

A Law Commission report in 2014 recommended the introduction of ‘Qualifying Nuptial Agreements’ which, if a couple chose to enter into, would (by and large) be determinative of their future claims on divorce. Despite their recommendations, successive governments have declined to introduce such legislation. Therefore, a marital agreement does not, presently, exclude the jurisdiction of the family courts on divorce to make such financial orders as it deems fair and appropriate in the circumstances of each individual case. 

However, in the absence of legislation being introduced, the family courts have taken up the metaphorical baton.  In a series of judgements, most importantly a case called Radmacher v Granatino in the Supreme Court in 2010, the judiciary have been willing to hold divorcing spouses to Marital Agreements entered into by them provided certain procedural and substantive safeguards are met.  In doing so, they have set a precedent for future divorces.

Procedural Safeguards

The procedural safeguards are as follows:

• In the case of a pre-marital agreement, these should be negotiated and signed in good time before the wedding (usually no later than 28 days before).  An agreement executed on the eve of the wedding is likely to be vulnerable to attack on the grounds of duress;
• Both spouses (or future spouses) should have independent legal advice;
• Both spouses (or future spouses) shall give disclosure of their finances: this is so that advice can be given as to the claims the parties to the agreement are potentially relinquishing by entering into the terms;
• Normal contractual principles also apply so that if misleading or inaccurate disclosure is given, or one party is pressurised into signing the agreement, it is less likely to carry weight on a subsequent divorce.

Substantive Safeguards

Coupled with the procedural safeguards outlined above, a marital agreement won’t be upheld on a future divorce if the court deems it ‘unfair’ to do so.  Fairness is, of course, subjective by nature, but the family courts generally interpret it as meaning that an agreement won’t be upheld if it leaves one of the spouses in a position of need.

In the context of a generational family business, established many years (or decades) prior to the marriage and intended to be passed down the line to future generations, a marital agreement that provides for the family member shareholder to retain their shares on divorce, free of any claim from the other, whilst making provision for the spouses’ housing, and income, needs out of other (non-business) resources is likely to be highly persuasive.

Key Actions

When considering share transfers and succession planning, in addition to tax and commercial considerations, the following should be borne in mind:

• What is the marital status of the family members to whom an interest in the family business is proposed to be passed? Are they single, cohabiting or married?  Are those relationships happy ones?  Aside from the family business, what is the financial position of that particular family unit?
• If shares are being passed to a family member who is already married, should they be asked to put in place an appropriate post-marital agreement to protect those shares in the event the marriage breaks down?
• If shares are being passed to a family member who isn’t yet married, should they be expected (or, even, compelled) to enter into a pre-marital agreement before any future marriage?  Potentially, that expectation could be included in a Shareholders’ Agreement or Family Constitution (if one exists).

Summary

Marital agreements should be a key consideration in any succession planning or restructuring discussions involving family businesses.  Provided the necessary procedural and substantive safeguards are met, a properly negotiated agreement should help protect against expensive and time-consuming family litigation at a later date, with all the negative repercussions such litigation often has for the business at the heart of it all.