How can I give back in a way that works in the context of my family business?
There are a number of ways that your family business can contribute to worthy causes. Donations to existing charities is one way of approaching this. Alternatively, if you prefer a greater deal of control over the way in which the relevant funds will be applied or if you have a specific cause that you wish to support in a way that is not already catered for by existing charities, then you could consider setting up a charitable foundation. While foundations need to be established on an independent basis to your business they can use the business name (or part of it) and can receive donations from the business, its managers, employees and customers. Some of the positive impacts that can arise by establishing a charitable foundation include: (i) a focused and ring-fenced method of meeting your sense of social responsibility; (ii) where managers and employees have been active members of the foundation, higher managerial and employee engagement and improved relations between owners, managers and employees; and (iii) more positive public relations.
How can I both benefit a charitable cause and give the younger members of my family the opportunity to increase their managerial experience?
As we have noted above setting up a charitable foundation can be a positive development for many family businesses. An additional benefit to those noted above is the fact that regardless whether a family member is a member of your family business, setting up a charitable foundation is a great way of giving the younger members of your family a chance to develop a range of skills (such as financial skills, management skills, working within a regulated environment, working with the public) that will be directly beneficial to any future career that they go on to follow.
Do assets held by the family company also belong to a spouse for divorce purposes?
A limited company has a separate legal personality. The shareholders do not own any interest in company property.
The 2013 case of Prest v Petrodel Resources established that assets held by a company cannot be regarded as belonging to a party to a marriage simply because (s)he is the sole shareholder; the party’s interest is in the shareholding.
However, it may be appropriate to consider whether the company assets are truly the assets of the company or whether the company might be regarded as holding property on trust for one of the parties to the marriage in the particular circumstances of the case. In those circumstances not only can the property be treated as property to which the party is entitled, but orders can be made directly in respect of the property. It is not uncommon for a matrimonial home to be a company asset.
What are the factors a court will take into consideration when distributing assets of the marriage, including the family business, to achieve fairness between spouses?
- The income, earning capacity, property and other financial resources which each of the parties to the marriage has or is likely to have in the foreseeable future, including in the case of earning capacity any increase in that capacity which it would in the opinion of the court be reasonable to expect a party to the marriage to take steps to acquire;
- the financial needs, obligations and responsibilities which each of the parties to the marriage has or is likely to have in the foreseeable future;
- the standard of living enjoyed by the family before the breakdown of the marriage;
- the age of each party to the marriage and the duration of the marriage;
- any physical or mental disability of either of the parties to the marriage;
- the contributions which each of the parties has made or is likely in the foreseeable future to make to the welfare of the family, including any contribution by looking after the home or caring for the family;
- the conduct of each of the parties, if that conduct is such that it would in the opinion of the court be inequitable to disregard it;
- in the case of proceedings for divorce or nullity of marriage, the value to each of the parties to the marriage of any benefit which, by reason of the dissolution or annulment of the marriage, that party will lose the chance of acquiring.
What is the legal status of Pre-Nuptial Agreements?
Pre-Nuptial Agreements are not automatically legally binding. The parties to a Pre-Nuptial Agreement cannot override the Court’s discretion to decide how to redistribute their assets and income on an application for financial remedy. When considering an application for financial remedy, the Court must, however, give appropriate weight to a Pre-Nuptial Agreement as a relevant circumstance of the case when considering the factors set out at Section 25 of the Matrimonial Causes Act 1973.
The Court will uphold a Pre-Nuptial Agreement that is freely entered into by both parties with a full appreciation of its implications unless in the circumstances prevailing it would not be fair to uphold the Agreement.
What are the key points of the current law?
When considering the role of a Pre-Nuptial Agreement in a financial claim on divorce, the starting point is the relevant legislation, which is the Matrimonial Causes Act 1973. Section 25 of that Act obliges a Judge to consider all the relevant circumstances of the case when deciding how to divide the parties’ finances on a divorce.
No agreement between the parties can override the legislation or prevent the Judge from deciding on the appropriate division of assets on a divorce. This means a Pre-Nuptial Agreement cannot stop a spouse from applying to the Court for financial provision from the other spouse. Any “waiver” of the right to apply to the Court for financial provision in an agreement will not be effective.
The significance of a Pre-Nuptial Agreement is a relevant circumstance of the case, to be weighed by the Judge. A Pre-Nuptial Agreement will have a substantial impact on the Judge’s decision in many cases. The Supreme Court has made clear the Court should give effect to a Nuptial Agreement that is freely entered into by each party with a full appreciation of its implications unless in the circumstances prevailing it would not be fair to hold the parties to their agreement.
Must the Agreement be freely entered into?
Yes, both parties must enter into the Agreement of their own free will, without any pressure from each other or anyone else. The Agreement is unlikely to be upheld if the Court finds evidence of mistake, duress, undue influence, misrepresentation or unconscionable conduct, such as exploiting a dominant position to secure an unfair advantage.
Both parties should be on an equal footing and freely able to negotiate the terms of the Pre-Nuptial Agreement with one another.
What are the vitiating factors?
Both parties should negotiate the terms of the Pre-Nuptial Agreement as far in advance of the wedding date as possible. Both will need sufficient time to consider the terms and receive legal advice about the effect of those terms so that there is no last-minute pressure on either party as the wedding day approaches.
The Court will take into account individual circumstances such as a party’s emotional state at the time of making the Agreement and factors such as age and maturity and previous experiences of long-term relationships. Such circumstances may inform what pressures a party felt under to sign the Agreement. If a Court considers the parties entering into a Pre-Nuptial Agreement are mature, with a wealth of life experience and knowledgeable in relation to financial matters, this will enhance the weight to be attributed to the Agreement. Conversely, if the parties are young, immature and do not have a wealth of life experience, that may count against the Pre-Nuptial Agreement being given decisive weight.
The Court may also consider whether the marriage would have gone ahead in the absence of a Pre-Nuptial Agreement. If a party would have refused to proceed with the wedding, that may reinforce its weight.
Do the parties need to have a full appreciation of the implications of the Agreement?
Yes, both parties should be in possession of all the information material to their decision to sign the Pre-Nuptial Agreement before signing it, so that they fully understand the implications of the Agreement.
Both parties should both receive specialist family law advice.
Both parties should each provide financial disclosure to be included in the Pre-Nuptial Agreement, setting out their assets, income and potential assets such as inheritances and any interests under discretionary trusts. Once the parties have a full picture of each other’s financial situation, they have a context in which to negotiate the terms of the Pre-Nuptial Agreement.
The Pre-Nuptial Agreement should be intended to determine the financial consequences of any future breakdown of the marriage. Whilst Pre-Nuptial Agreements are not currently legally binding, both parties should expect to be held to its terms.
Does the Agreement have to be fair to hold the parties to its terms?
The Supreme Court has provided the following guidance for assessing fairness:
- It is not fair for a Pre-Nuptial Agreement to prejudice the reasonable requirements of any children of the family. If, therefore, the parties have any children in the future, it would be advisable to reconsider the terms of the Pre-Nuptial Agreement to ensure the child[ren] receive[s] adequate financial provision under the terms of the Agreement.
- The autonomy of adults should be respected: it is “paternalistic” and “patronising” to override the terms of an Agreement simply on the basis that the Court “knows best”.
- There is nothing inherently unfair about a Pre-Nuptial Agreement that seeks to ring-fence what is often referred to as “non-matrimonial property”. Non-matrimonial property comprises property owned by one party before the marriage or assets a party receives from a third party during the marriage, through lifetime gift or inheritance. The Supreme Court judgment sanctions the use of a Pre-Nuptial Agreement to shield family wealth and assets acquired before the marriage.
- The longer a marriage lasts following a Pre-Nuptial Agreement being signed, the greater chance it may not be fair to hold the parties to its terms because of unforeseen changes in circumstances. This is more relevant to young parties starting married life with few assets and less relevant where significant assets have already been accrued before the marriage.
- If the effect of the Pre-Nuptial Agreement would be to leave one party with less than his or her needs, while the other party is comfortably provided for, this is likely to be unfair. Needs are based on the amount a party needs to spend to maintain a standard of living not too dissimilar from that enjoyed during the marriage.
- If one party has a valid argument for an element of compensation (for loss of earning power following a joint decision that one spouse should give up a career to care for the family) then a Pre-Nuptial Agreement which ignores this compensation is likely to be unfair.
- If needs and compensation are adequately covered in the provision offered in the Pre-Nuptial Agreement, then further sharing of the assets may be prohibited. This limits a spouse’s ability to claim an interest in a non-matrimonial property, such as inheritances, gifts and property owned by the other spouse before the marriage.
What is the effect of the Supreme Court test on Pre-Nups?
As the law currently stands, Pre-Nuptial Agreements are almost as good as binding, provided they are fundamentally fair.
However, as emphasised above, even if a Pre-Nuptial Agreement is given decisive weight, the Court still has the power to make financial awards on divorce. A Pre-Nuptial Agreement will be only one of the factors considered when the Court is exercising its discretion to deal with the parties’ finances. You should, however, expect to be held to its terms.
What are the Law Commission’s Recommendations?
The Law Commission has published a report entitled ‘Matrimonial Property, Needs and Agreements’. In this report, the Law Commission recommends legislative reform to make Nuptial Agreements that are in a prescribed form, and adhere to certain safeguards, legally binding. A Nuptial Agreement that meets the criteria is called a “qualifying Nuptial Agreement”.
Qualifying Nuptial Agreements would prevent the Court from making financial Orders on divorce that are inconsistent with the terms of the Nuptial Agreement, unless an Order needed to be made to meet one of the parties’ financial needs, or for the benefit of a child of the family. Nuptial Agreements that do not adhere to the criteria would continue to be treated as a “relevant factor” of the case by a Judge deciding what financial Orders to make on divorce.
A qualifying Nuptial Agreement must meet the following criteria:
- It must be contractually valid (the validity requirement). There must be no factors present that cast doubt on the free will of the parties to the Agreement or on the level of information a party had when entering the contract. Any evidence of mistake, misrepresentation, duress or undue influence may cause the Agreement to fail.
- It must be validly executed as a deed and contain a “relevant statement” signed by both parties confirming that they understand the Agreement is a qualifying Nuptial Agreement that will remove the Court’s discretion to make financial Orders on divorce except to meet financial needs (the formation requirement).
- It must not have been made within the 28 days before the wedding (the timing requirement).
- Both parties to the Agreement must have received disclosure of material information about the other party’s financial situation when entering into the agreement (the disclosure requirement).
- Both parties must have received legal advice at the time they entered into the Agreement (the advice requirement).
- It must not prejudice any children. If the Agreement makes insufficient financial provision for children, it will be set aside by the Court.
- Both parties’ needs must be met. As explained above, need is measured with reference to a standard of living during the marriage. Provision for needs is not limited to an income stream; it includes capital provision and the long-term provision of a home. The possibility of ongoing financial provision for a party caring for children is important. An Agreement that results in a party receiving nothing or very little would not be upheld by the Court.
Accordingly, it is important to bear in mind the proposals and sensible to ensure a Pre-Nuptial Agreement complies with the suggested requirements for a qualifying Nuptial Agreement as far as possible.
Complying with these requirements will mean that the Pre-Nuptial Agreement has the best chance of being legally binding in the future and will provide both parties with as much clarity and certainty as possible regarding the division of their finances if the marriage should break down in the future.
Do I need to make a Will? Surely everything will go to my wife?
If you own assets jointly as joint tenants then these will pass by survivorship to your wife, however, if you do not leave a Will, any assets in your sole name or which you own as tenants in common will pass under the intestacy rules. If you leave a wife and children, the intestacy rules provide that the first £250,000 of your estate will pass to your surviving spouse and along with half of the balance of your estate. The other half of the balance is divided between surviving children when they are 18. Any assets which pass to your children may be subject to inheritance tax, depending on their value and you may consider that 18 is too young an age for your children to inherit.
By not leaving a Will, and relying on the intestacy rules, you are omitting to undertake valuable inheritance tax planning which is available to you. Interests in private trading businesses qualify for inheritance tax business property relief (“BPR”). We advise business owners to leave their business interests to a discretionary trust to crystalizes BPR and ensures that you utilise the relief on first death. We also advise that you should leave your other assets to your spouse either outright or in a life interest trust which means the inheritance tax spousal exemption will apply and therefore there will be no inheritance tax payable on the first death. The spouse can then make gifts to the next generation using the seven-year rule for IHT. The surviving spouse can also buy the business assets from the BPR trust using assets which do not qualify for the relief. If the spouse then holds the business assets for 2 years they will qualify for BPR again and this gives the family a second bite of the BPR cherry when the spouse dies, which is very tax efficient.
What if I lose mental capacity?
It is a sad fact of life that we are all living longer and that some of us will lose mental capacity. If you are the director of a family company your directorship will come to an end if you lose mental capacity. However, you will still retain your shares but who will exercise the voting control over this valuable asset? It is possible to leave a Lasting Power of Attorney which will give an Attorney power to exercise powers over your assets if you lose mental capacity. However, if you have a valuable asset such as shares in a family company, you may not wish to have the same person who is dealing with your day to day financial affairs, exercising the voting control on a substantial shareholding. It is possible to have different attorneys to exercise power over different assets or alternatively you can have a separate business LPA to deal with your business affairs. The important thing is that you seek appropriate advice and consider what would happen if you lose mental capacity, in the same way as you consider what would happen to your assets if you should die.
Should I make a Lifetime Trust?
The advantage of a Lifetime Trust over an outright gift if that the trustees retain control over the assets, therefore depending on when the trust is made, if one of your children divorces or pre-deceases you, assets will not go outside your immediate family’s control. The advantage of creating a trust is, normally, trusts incur an upfront tax charge of 20% when they are created but if your shares qualify for inheritance tax business property relief then you can put as many shares in trust as you like without paying the upfront tax charge. The downside of creating a trust is that you can lose out on entrepreneur’s relief and therefore if you are planning to sell your company, you need to put the trust in place at least a year before any potential sale. The key in this is taking the appropriate tax advice and this is something we are always happy to help you with.
Do I need an Employment Contract for the Family Members who work in the business?
Sometimes there is an assumption if you are employing a family member that you don’t need a service contract. However disputes, even in the best of families, can arise and it is imperative that a person’s terms of employment are formally recorded and therefore we would recommend employment contracts or director’s service contracts in every case.
There is another issue which can arise, if you are creating lifetime gifts of your family company’s shares, as HMRC can argue that the voting control on the shares in the trust is being used to secure your remuneration and therefore you have not made an outright gift because you are still retaining a benefit from the shares. If HMRC raise this argument the seven-year clock which you are hoping to set running by creating the trust does not, in fact, start running. Therefore if family members are creating trusts and are thinking of being trustees, we always advise that they ensure that a Director’s Service Contract is in place to secure their remuneration before the trust is created.
What is a Family Constitution and do I need one?
A family constitution, or charter, or protocol, is a formal document which sets out the rights, values, responsibilities and rules applying to stakeholders in the family business and provides plans to deal with matters which may arise in the course of the family business’s life. A constitution serves as a short aspirational blueprint of the long-term goals of the business, its core principles, its vision and strategies for the future. The document will state what will happen if an unexpected event occurs in the family, such as a family member falling ill, a divorce or a substantial creditor claim against the business. Although family constitutions are generally not legally binding, they are said to be emotionally-binding and families who discuss what will happen if the family is hit by an unexpected event will be better equipped to deal with that event. A family constitution can also provide for an informal and internal dispute resolution process to help reduce costs and avoid publicity if a dispute arises in the family.
It is important that when the time comes to draft the constitution the family has a clear idea of the goals of the business and the roles of the family members within that business and that it is regularly reviewed to check for compliance and whether amendments are needed, for example, when the next generation enters the business.
What issues ordinarily arise when considering a family business in a divorce context?
The following issues generally arise in respect of a private company:
- Is there a market for the shares or any of the assets of the companies?
- If the shares or assets of the company were going to be sold, what would be the strategy that should be adopted in respect of such sales?
- How should the business, and in particular the holding company, be valued, and if part of the valuation should be on an earnings basis what is the correct approach to determining the maintainable profits and what is the range of appropriate P/E ratios?
- How could money be raised within the business and paid out to the shareholders or directors? This would almost inevitably require an assessment of the distributable profits, and an assessment of the tax consequences
- What would be the likely effects on the business and its valuation if moneys were raised and paid out?