When faced with the task of advising a client on the division of a family business or business assets upon a spousal separation, it is imperative to approach the matter with meticulous attention to detail and a comprehensive understanding of the intricacies of the different legal areas. It is customary for such scenario to be contemplated and considered from a family law perspective, however there are also several key business law strategies that should be taken into account, when addressing business ownership complexities in separation proceedings. This practical guide seeks to provide a business law perspective for managing the division and continued operation of family-owned businesses during spousal separation.
Understanding the Nature of the Business Documents
Conduct a thorough review of all business documents provided by the client, which should include all corporate governance documents, shareholder agreements, partnership agreements and other operating agreements. Ensure that you have a complete and accurate understanding of the business structure, ownership interests, and relevant clauses that may impact the division process.
Based on your review, identify and assess the key issues that need to be addressed, such as share transfer restrictions, valuation methods, and dispute resolution mechanisms. This will help you prioritize areas that require further expert analysis. Some of the clauses or provisions that should be carefully scrutinized include:
- Ownership Structure: Identify the ownership structure and voting rights of each spouse, including percentages held by each.
- Control Provisions: Determine who has significant control or if there are mechanisms to break deadlocks.
- Transfer Restrictions: Look for any restrictions on the transfer of interests, including right of first refusal and tag-along/drag-along rights. These may impact the ability to divide or sell shares during separation.
- Buy-Sell Provisions: Identify any buy-sell provisions or exit clauses. These provisions detail the conditions under which buyout can occur and can provide a framework for valuing and transferring business interest or assets between spouses.
- Dispute Resolution: Identify mechanisms for resolving disputes among shareholders or members, which may become relevant during the separation process.
- Profit Distribution and Compensation: Understand how profits and dividends are allocated among the owners of the business, as this will affect income considerations in the separation agreement. Ascertain if any spouse receives a salary and/or dividends, and how these payments may need to be adjusted post-separation.
- Roles and Responsibilities: Determine the roles and responsibilities of each spouse, which may influence decisions on continuing or dissolving the business. Review non-compete, non-solicitation and confidentiality clauses carefully.
- Spousal Involvement: Understand the management structure and decision-making processes, which may influence the future operation of the business. Identify provisions addressing what happens if one spouse exits or stops active participation in the business.
- Valuation Mechanism: Determine methodology of assessing the business valuation. Check if the agreement includes a pre-set valuation process.
- Division of Assets: Conduct detailed valuation and analysis to ensure adequate and appropriate division of the business asset, in accordance with relevant settlement agreement.
- Dissolution Clauses: Identify the conditions and procedures for dissolving the business, which may be necessary if the business cannot be jointly managed post-separation.
Key Considerations for Spousal Buyouts
The buyout process should be carefully planned and well-drafted agreements prepared. The following are some essential factors to consider:
a. Buyout Agreements between Spouses
Once you have a clear understanding of the business documents and key issues, and there is a consensus to move forward with a buy-out option, the parties should draft the relevant agreement and retain relevant financial experts to conduct a detailed valuation and analysis. Their expertise will be invaluable in ensuring a fair and legally sound division of the business assets.
A well-drafted buyout agreement is vital in outlining the terms and conditions of the buyout. Such an agreement should cover:
- Valuation of the Business: Agree on an accurate and fair market valuation method for determining the worth of the business. This could involve hiring an independent appraiser or using a mutually agreed-upon formula.
- Payment Terms: Specify how the purchasing spouse will pay for the buyout. Options may include lump-sum payments, installment plans, or financing arrangements.
- Non-Compete Clauses: Consider including non-compete clauses to prevent the selling spouse from starting or joining a competing business within a certain period and geographic area.
- Dispute Resolution: Establish clear mechanisms for resolving any disputes that may arise during or after the buyout process, such as mediation or arbitration.
- Confidentiality: Ensure that both parties agree to maintain the confidentiality of sensitive business information throughout the buyout process.
b. Division of Shares or Ownership Interests
The division of shares or ownership interests must be handled with care to avoid legal complications. Key considerations include:
- Shareholder Agreements: Review any existing shareholder agreements to determine how they impact the transfer of shares or ownership interests.
- Legal Compliance: Ensure that the buyout complies with corporate laws and regulations governing the transfer of ownership, including any required approvals from other shareholders, directors or other stakeholders.
- Tax Implications: Consider the tax consequences for both spouses resulting from the transfer of shares or ownership interests. Consult with a tax advisor to minimize tax liabilities.
- Documentation: Prepare and execute all necessary legal documents to effectuate the transfer of shares or ownership interests, such as share transfer forms, resolutions, and amendments to corporate records.
c. Restructuring and/or Reorganizing the Assets
In some cases, it may be necessary to restructure or reorganize the business assets to facilitate the buyout. One common strategy is the Butterfly Transaction:
- Butterfly Transaction: This involves dividing the assets of the business into two or more separate corporations, allowing each spouse to retain ownership of separate entities. This can help in achieving a tax-efficient division of assets.
- Asset Allocation: Carefully allocate the business assets between the newly formed entities to ensure fairness and maintain operational efficiency.
- Tax Advice: Engage tax professionals to guide you through the restructuring process and ensure compliance with all relevant laws and regulations.
- Future Operations: Plan for the future operations of the restructured entities, including management roles, operational agreements, and business continuity strategies.
Circumstances that May Lead to a Forced Sale
The general consensus is that the Courts prefer negotiated settlements between spouses, as opposed to forcing a sale of family business. However, in certain circumstances, a forced sale is inevitable, and a spouse may seek to force the sale of a business. It is important to have an appreciation for scenarios under which a forced sale can occur and the legal principles involved:
- Absence of a Buy-Sell or Exit Agreement: If no shareholder agreement, partnership agreement, or buyout clause exists, one spouse may seek a sale to realize their share of the business’s value. Courts may order a sale if ongoing co-ownership is unworkable or settlement cannot be achieved.
- Deadlock or Irreconcilable Disputes: If both spouses own the business but cannot agree on its future operations, a corporate deadlock may justify a forced sale. The Ontario Business Corporations Act allow for court-ordered dissolution in cases of shareholder oppression or unfair treatment.
- Financial Necessity: If one spouse lacks liquidity and cannot fund a buyout, they may petition for a sale to divide proceeds rather than holding an illiquid asset. If the business was funded with joint assets, a spouse may argue that liquidation is the fairest way to distribute property.
- Court-Ordered Sale Under Family Law Principles: Under the Family Law Act, a spouse may argue that selling the business is the only viable means of equalizing family property. See: Belman v. Belman, 1995 ONSC 7220 (CanLII)[1] and LeVan v. LeVan, 2008 ONCA 388 (CanLII)[2].
Tax Implications to Consider
Dividing a business can have significant legal and tax implications. It is important to identify any potential tax liabilities, transfer taxes, or other tax issues that may arise and attend to them accordingly:
· Forced sales may trigger capital gains tax, GST/HST, and tax on deemed dividends.
· Structuring a sale as a Butterfly Transaction or Section 85 Rollover may mitigate tax consequences.
· Consulting with tax experts and financial advisors can provide valuable insights into these matters.
Conclusion
Advising a client on spousal separation and the division of a family business requires a careful and methodical approach. Indeed, it may be considered a team effort drawing on various legal areas and expertise. By thoroughly reviewing the business documents and identifying key issues, business lawyers lend their expertise to the cohort and provide the client with a solid foundation for making informed decisions. It is recommended that prior to involving financial experts and other third-parties, it is important to determine the business documents validity and applicability to the current situation. Also remember that not all matters will be settled, but instead, a spouse can attempt to force a business sale through contractual rights, corporate remedies, or court applications under family law. Notwithstanding, the best strategy for a smooth and optimal transition is proactive planning – i.e. ensuring that from the outset shareholder agreements / partnership agreement, exit clauses, and financial strategies are in place to curtail and/or prevent disputes from escalating to litigation.
Acknowledgement of Original Use in the OBA Legal Conference
This guide was originally prepared as part of the presentation materials for the OBA 2025 Ontario Legal Conference: Family, Estates, and Business Law. The guide has been adapted for publication in this newsletter to provide further insights, when navigating these issues.
ABOUT THE AUTHOR
Colleen Coleman Wright is a business lawyer and the principal lawyer of ColemanLex PC. For more information feel free to peruse www.colemanlex.ca or contact Colleen directly.
Any article or other information or content expressed or made available in this Section is that of the respective author(s) and not of the OBA.