A divorce in the family business can be devastating both emotionally and financially. Jonathan Von Kohorn, of The Von Kohorn Law Firm LLC, provides guidance on strategies that can help create better outcomes for family business owners.
Tibor: Hello and welcome to Family Businesscast, the show that helps business-owning families to maximize their wealth across generations. My name is Tibor Dani and I’ll be the host for your show.One of the biggest internal threats that a family business faces is divorce. So in this episode, we’re going to be taking a look at some best practices for dealing with divorce in your business and in your family. To help dive into this topic, it’s my pleasure to welcome John Von Kohorn to the studio. John is an attorney with a family law practice in Fairfield, CT, and he has extensive experience in divorce and most of his career was spent on this topic in the courtrooms and counseling clients on this topic. John, welcome to the show.
John: Thank you, Tibor.
Tibor: So John, we hear the statistic thrown around in the news a lot that the divorce rate is 50 percent. Is that still accurate? Or has that number changed over time?
John: I don’t know how much of this is really good scientific statistically available information, but from what I’ve heard anecdotally, the divorce rate seems to be at least 50 percent. Unfortunately, it seems to be going even higher than 50 percent.
Tibor: We’ve all heard the stories of how a divorce can financially and emotionally almost ruin a person. When you add in a business or a family business and you add that to the whole dynamic, why is it even worse for the business owner?
John: I think when you have a business owner, or closely held family business, you have less trust built in to a lot of the financials that will be disclosed as part of the divorce process. So when you have a party who has a W-2 from a typical corporation, there’s a lot of confidence in the figures being reported. There’s not much of a need to further investigate the income information stated by the company as it would be reflected on a financial affidavit. That’s in contrast to someone who owns their own business or is part of a business with family connections. There is the possibility, and there is almost this built-in assumption that the number being reported doesn’t necessarily capture all the income that would be considered available for purposes of alimony, child support, and any other financial purpose as part of that divorce proceeding.
Tibor: Okay. So we’re talking really about things being uncovered that maybe would be inappropriate to be uncovered for the family business, or is that the main issue?
John: How people choose to declare business expenses is an issue. How people choose to cover their own lifestyle related expenses is an issue that comes up frequently. Whether or not they are deferring their own income or detaining those earnings within the company is certainly an issue that comes up. Separate from the income issue, there’s also the property. There’s an equity issue as well that comes up that you don’t have when someone’s a typical W-2 employee.
Tibor: Sure. In the case with family businesses, you also have different things that become public information now, right? That maybe not all parties knew about in the business or let’s say were kept from one spouse or something like that.
John: Really there’s a spectrum of the other spouse in terms of what they knew about the business. If they worked in the business, if they were maybe managing the books, oftentimes you can have a spouse who’s not the owner who knows more about the inner workings of the company than the owner. On the other side of that, if they’ve had their own career or if they’ve been a homemaker and not involved in the business and not otherwise financially sophisticated in terms of what’s been happening in the business, the history of it, and the cash flow. On that end of things there could be no knowledge of what’s going on.
Tibor: So when we’re looking at this, basically you’ve got a couple of different issues that come up, right? You’ve got obviously the financial considerations and splitting the assets, splitting the income. Then you’ve got the disclosure requirements where certain things need to be disclosed that maybe weren’t meant to be disclosed or the owner didn’t necessarily want to be disclosed, right?
John: Sure. Well if the request for documents, for information, is being directed to the company or to the company through the other party, there will be concerns about confidentiality of records. There will be concerns about the cost associated with producing that. And there will be valuation issues. Valuation in terms of equitable interests and valuations in terms of really trying to get to the total income including all perquisites that are made available to a party through the business.
Tibor: Okay. So what are some tools that a business owner, or any individual basically but let’s focus just on family businesses, that they could set up to kind of help mitigate some of these issues or set up parameters for dealing with this should the need come up?
John: From the perspective of the business owner, if their goal is to minimize a disruption to the business, to maximize the confidentiality, one of the first things that you’d want to discuss would be a prenuptial agreement. The earlier that’s brought up the better. There’s a whole body of law in terms of best practices of pursuing a prenuptial agreement. But to outline it for you, the things that matter the most is that each party is separately represented, that the agreement be written up in a fair way, and we can talk about what that means, and that it be done with enough time in advance of the marriage that it’s clear to everyone involved that there was no duress and there was nothing unconscionable about the terms and the circumstances that led to the execution of the premarital agreement.
Tibor: Okay. So everybody knows about pre-nups and I guess post-nups as well, done after the marriage, right?
John: This is an area where it certainly varies state by state. New York, for example, is permissive about post-nuptial agreements. But the idea of it just in general contract law is that there’s this idea of consideration. That one party has to be doing something for a reason, for the consideration. They’re getting something, they’re giving something. Quid pro quo if you will. A prenuptial agreement is in consideration of the marriage. After the marriage has taken place, it can’t be in consideration of the marriage. So unless there is statute or case law that authorizes it, you need to be careful about where that contract might be enforced. And even thinking about it just in terms of a simple contract is often a bit of a trap. One of the things that I would mention is that if the focus is really on protecting the business, there’s things you can do–strategies–within that prenuptial agreement that can help the prenuptial agreement be more enforceable.
Just by way of example, you could simply only protect the business as part of the prenuptial agreement. You could specifically say in the prenuptial agreement you’re not trying to prevent payments of alimony, you’re not trying to prevent other property division. That in and of itself will place the focus on the protection of the business and generally cause that part of the agreement, because that’s the only substantive part of the agreement, to be more likely to be upheld if there was a challenge later. Separately from that, I think it makes sense that all the partners in the business, or the owner of the business, discusses with the business attorney what’s going on and what steps they can take to protect the business as well.
Tibor: Okay. So we’ve got the prenuptials as probably being one of the most important tools. What about other forms or other tools could you have? Like divorce provision set up in the operating agreement of the business? Or buy-sell agreements? Could they include divorce provisions?
John: Whether we call them divorce provisions, or as you said the buy-sell provisions, those elements in terms of partnership agreements can be incredibly important. The timing on this is incredibly important. Provisions for buy-sell should be made before the marriage is entered into. These can be made at any times through the partners. It should be done on the early side. Let’s say the marriage has already taken place and someone has filed for divorce, upon that filing in most states there will be the entry of things we call automatic orders. The automatic orders have the force of law, even though no judge has ever addressed the case specifically yet, it’s just because of the filing these orders are in place.
One of those orders is very frequently a ban on dissipation, just giving something away for no consideration. So if you wait too long, it might be too late. And you could even risk contempt against you for having started to adjust these contracts after the filing of a divorce especially if it smells and is apparent that all you were trying to do would be to minimize your exposure to the divorce. So the early planning is absolutely essential and it certainly would be a small amount of prevention that would pay off real big down the road if there was a problem.
Tibor: Okay. So definitely think about divorce in the context of the buy-sell agreement, the operating agreement. Include those provisions in those agreements as well.
John: Any business attorney worth his salt is going to know what to put in there and if you have any concerns, have them spend ten minutes on the phone with any reasonably good divorce attorney and they’ll be able to put together documents that should be very adequate to protect everyone’s interests involved. And this really isn’t being done to hurt the other side. All of this should be followed through on in the spirit of what the plan is. Why wouldn’t two people who are getting married have some sort of plan for their mutual financial security? Why wouldn’t you want that? Why wouldn’t you want partners in a business to understand what the plan is if there’s a problem someday? It’s planning. Everyone should be involved in that process, everyone should be aware of what’s going on.
It should be a transparent activity and if everyone follows through on that, then on the back-end when there are problems and when people aren’t acting with their best behavior that can really pay off. That’s when you need those plans to be in place so everyone knows what’s going to happen. And it can even decrease the stress. If everyone knows there’s already a plan in place, then even though there’s something that’s very traumatic, and it’s hard to think of something more traumatic than a divorce to go through, then isn’t it nice that once you’re in that traumatic situation that there is a plan that’s going to tell you where we’re going from here?
Tibor: All right. So it sounds like starting the planning process early is the best case scenario. We’re all human beings. This is a tough subject. Let’s say we didn’t do the prenup. Now I’m 15 years into the business and now I’m starting to think about these issues. Is there anything I can do at this point?
John: Well in that example, no one’s filed for divorce yet. There’s probably been some discussion of it. There’s probably been some moments where that’s been considered. Now is certainly the time to connect with your business lawyer because again the automatic orders won’t be in place yet and there probably are some things that you can legally pursue that will protect your interests. There are certainly some judges in the area who the very first question they’ll ask when they’re in chambers or they’re having a pre-trial and the lawyers come in. The judge will hear that there’s a family business, a closely held business.
The very first question out of the judge’s mouth is, ‘Is there a buy-sell agreement?’ It really can be an all or nothing situation. Either things were set up appropriately in advance or they weren’t. If you’ve neglected to do that, if someone’s filed on you and you haven’t done it yet, that doesn’t mean that it’s all lost and the company’s going to have to be liquidated or anything like that. That’s not what happens. But what the effect of that will be is that there will likely be a valuation process which will be thorough. It will involve lots of documents, lots of time, and there will be a valuation of your interest in the business and possibly of the business itself.
That valuation process could be done in a couple of ways. It could be done by a neutral business evaluator who represents both sides and is supposed to come up with something that is objectively neutral. That’s possible in some situations. It’s not always possible. The alternative to that is that both sides have their own evaluators. Sure enough, you very likely see two wildly different professional opinions in terms of value. Anywhere from 0 on one end to millions of dollars on the other end. Trying to settle that case can be very difficult. How do you settle the case when both sides are receiving accredited, certified opinions that are wildly different as to value? And then are you going to have to have a judge decide that for you? Are you going through the expense and the stress of having a judge decide that?
Tibor: So what would be your recommendation then? I mean one appraiser? Should there be in the buy-sell agreement, because some professionals would say exactly what you said. You’re going to pay for two appraisals. They’re obviously going to be different. You’re going to end up having to get a third one anyway. So maybe it’s better just to agree on a third-party mutual.
John: I think this is the type of decision that really depends on each case. The factors to think about I would describe as follows: you need to know who you’re working with. Let’s assume for a moment that you’re working with a divorce lawyer who knows the business evaluators in the area, who has a sense of who gives truly good opinions and who’s just a hired gun. You have to have a sense of how much does my client know about the business? How much does the other side know about the business? If I’m representing a party who knows absolutely nothing about the business, who never knew anything. It was always private, it was never discussed and they might not be financially sophisticated.
I would be uncomfortable suggesting off the bat that we go with a mutual appraisal. Why would I want to do that? Wouldn’t I want a thorough review on my end that wasn’t beholden at all to whatever claims were going to be made, whatever representations were going to be made. Wouldn’t I want an exhaustive review on my own end? If you’re in a situation where everyone can express some confidence and has had some prior work experience with a particular appraiser who’s been nominated and everyone’s confident about their skill and reputation, if there seems to be a certain amount of parody and transparency in terms of working knowledge and accessibility of documents about the business, I’d be hard-pressed in that situation to not agree with you and say of course, let’s use a neutral. That makes sense.
One of the nice things about using a neutral is that it’s so much easier to settle the case because instead of getting a high, low and query is something in the middle, the correct outcome if you’re dealing with a high appraisal versus a low appraisal. And remember that low appraisal can frequently be zero. And again this varies from state to state, but certain businesses may have separate value excess of the income that passes through to the owners in one state. Whereas in another state the value of a business is simply the income that it throws off.
Tibor: Okay, John. So let’s switch gears a little bit. So let’s say it’s 20 years down, maybe we have a prenuptial agreement in place, maybe we don’t. Now we’re at the point where we’re thinking that divorce might be imminent. What’s the process here? What’s generally going to happen when we file for divorce?
John: There are three things that you can really do at the outset of divorce. Number one: you want to have in your mind the sense of who your divorce team is. There’s going to be a business person involved maybe inside your company maybe outside of your company. There’s going to be potentially an accountant involved. There’s going to be potentially a business evaluator involved who’s going to be very much on the outside of your company. You’re going to have a divorce lawyer involved. You’re not going to be in a situation where you get to do a $499 divorce. You see these advertisements for them. What those cover very effectively are simple divorces where no one is disagreeing on anything.
If you can come to an agreement with your spouse and the two of you don’t need any help, then by all means hire someone to help you fill out the paperwork. If you can get the paperwork filed and get the divorce done for $499, congratulations. You’ve managed to not waste the resources of whatever state you’re in, all their judicial resources, and you’ve saved yourself lots of money. If you’re unable to agree on all issues and not need any help at all, then you’re going to need to have some sort of team.
Who’s going to be on your e-mail distribution list when things come up that are divorce related. Maybe you have a meeting in person with everyone there just once so they can get acclimated to your case, maybe you don’t. Maybe it’s the telephone, maybe it’s all by e-mail. But there should be a team in place. That team should be able to deliver to you a suggested list of documents to start working on now. Things you can assemble now to speed up the process because the longer this process continues for, the more expensive and the more disruptive it will be both for your own life but also for your business life.
Tibor: Okay. So the first step really then is to assemble the team, get everyone coordinated, get the accountant and the financial adviser possibly, and secure good counsel–a good attorney. How do I know that I’m hiring a good guy, a good attorney? What am I looking for?
John: It’s very difficult. The consumer of divorce services is the least informed consumer in America as far as I’m concerned. You have no idea the quality of people you’re working with. There’s no way to really truly vet that. You could be working with a very good guy who is responsive to your calls, who answers your e-mails, who’s always there when you need him, and who’s giving you horrible advice. And you might not discover that until you get to trial because it turns out that the proposal from the other side was the reasonable one all along and the advice you were getting was just horrible. It could turn out that the person who’s very nice and answers your calls walks into the courtroom and is the worst trial attorney in the world. How many times are you going to see him in court before it matters? Never.
When you go to court it matters. I don’t care if it’s a trial or a temporary hearing before you get to trial. You’re not going to know how he performs until you get there. Have you heard from anyone that you trust who has seen him in the inside of a courtroom before? That’s a good thing to figure out. There are some clients that divorce lawyers get who simply go to divorce court, they’re open in many states. They sit there and look around and they go with someone who seems to have a good rapport with the judge, a good rapport with the other lawyers, and knows how to stand up there and get business done. Now I’m not saying everyone needs to go to divorce court to sort of personally audition their divorce lawyers. But it matters. It matters that they’re able to effectively advocate in court if necessary. There’s very good mediators who’ve never set foot inside a courtroom and that’s fine. But those are mediators as opposed to litigators. If you’re going to have a case that’s potentially litigated because you’re not agreeing on everything, then walk into court with someone that knows how to be an advocate in a trial situation.
Tibor: So clearly perhaps a referral would be . . .
John: Word of mouth referral is the best way of pursuing it. But as part of that referral, have they ever seen them go to court? That’s a question I would ask.
Tibor: So definitely have they stepped foot in the courthouse. Track records? Is there anything we could talk about there or find out about? Or is that not relevant with attorneys?
John: It’s not publicly available information. To the extent that the attorney that you might be working with has had unethical conduct in their past, where they’ve been sanctioned or grieved, that is likely publicly available in just about any jurisdiction at this point. Just with what’s available online through the Bar Association, through the Grievance Committee for that particular jurisdiction. You’d be able to find out if there’s really some bad offenders out there.
In terms of their success rate, it’s difficult to find a divorce lawyer who’s not willing to talk about their own successes. I think all of them generally are good at marketing themselves. If you’re getting a word of mouth referral, I think it’s fair to say at least someone was impressed or gratified with the services they received. As part of that, I would want to know what types of services were rendered. Was it a simple divorce? Or was it a contested case?
Tibor: Okay. All right. So divorce is imminent. First step: get the team in place. Second step: get the documents organized because that’s going to help you save money down the road.
Tibor: Okay. What’s the third thing that we could do to prepare?
John: Well the third thing you can do to prepare is to really understand that at this point anything that you do financially is going to be reviewed. Expect to someday be sitting, whether it’s in a courtroom or at a deposition, to be speaking under oath and answering very broad questions about what you’ve done financially at that point in time. So to the extent that you are going to pursue some sort of strategy to minimize your exposure in the divorce, I think your reality is that at this point in time, you’re talking about an internal strategy as opposed to an external strategy. If at that point you’re thinking of hiring someone in the asset protection industry or pursuing trusts or off-shore accounts, I think it’s fair to say that any divorce attorney worth his salt is going to have that all come out. To the extent that that comes out in the proceeding, there will be an accounting and there will be an off-set for that in the back of your divorce agreement or your divorce decision.
Having said that, an internal strategy, strategies within your business that don’t necessarily involve your divorce lawyer. Those strategies are probably where the most effective outcomes are for individuals. And those are strategies that you’re going to develop that obviously need to be legal and need to be appropriate and your divorce lawyer can certainly provide you some feedback on those, but those are strategies that you’re going to be implementing, pursuing, potentially researching in house I would say.
Tibor: Okay. That’s some great advice. I appreciate that summary there. So clearly there are some things that can be done when the divorce is imminent that could really reduce the overall cost and create a more favorable outcome for the business owner. If people wanted to learn more about this or wanted to get in touch with you about this information, what would be the best way to get a hold of you?
John: My law firm contact information is at http://www.thevklawfirm.com.
Tibor: Thank you so much for stopping by the studio. I’m sure our audience is going to be better prepared to deal with this situation going forward.
John: Please, Tibor. Thank you.
Tibor: Okay, thanks.