Tuesday, February 27, 2018

Financially Enmeshed In Your Business Partner's Divorce

Daniel Kaufman is Special Council at Lander & Rogers explains how your business partner’s divorce may affect you and your practice. When going into business with colleagues, commercial risk management is a key issue to address. When deciding which business structure to adopt, medical practitioners may choose from a range of options, including partnerships, companies and trusts. Each type of business structure has distinct advantages in terms of corporate governance, taxation management and protection from certain commercial risks.

However, the protection offered by these corporate structures is limited and specific in nature. A broad gap exists, and little protection is afforded from the spectre of divorce, which has recently become an increasing focus in the area of corporate risk management.

Most people view divorce as a personal risk, associated with their own relationship, and under their own control. That may ring true, but it does not contemplate how you may be financially affected by someone else's divorce, and namely that of a business partner.

The wide and deep powers of the family law courts in respect of 'third parties', means that people in business need protection not only from their own family law issues, but also from the family law issues of their business partners.

Consider the following:

• Between one-third and one-half of marriages and de facto relationships end in a separation which gives right to entitlements under the Family Law Act. • Under the Family Law Act, corporate interests may be included in the matrimonial asset pool.
• De facto relationships give rise to effectively the same rights as marriages, but are somewhat loosely defined under the Family Law Act. A person can be in a de facto relationship and not realise it, or be in a de facto relationship at the same time as being married to another person.
• The Family Law Act gives the court power to make orders binding upon third parties, and altering the legal interest of third parties. That may include business partners, or corporate entities.
• The Family Law Act gives the court power to set aside transactions, including loans, transfers of shares, and partnership or security holder agreements, where such transactions may have the effect, irrespective of intention, of defeating a claim under the Family Law Act. That may mean that if your business partner separates:
• His or her interest in your business is a matrimonial asset.
• His or her interest may be valued at a figure below, or above, what you consider it to be worth, which may financially affect you.
• The family law courts can 'look behind the corporate veil' and may, in appropriate circumstances, disregard or change strict legal interests as defined by corporate or property documents such as share and title certificates.
• The court can set aside or vary "transactions" such as loans, share transfers, trust deeds and securityholder agreements.
• The court can transfer a party's assets, including corporate interests, to their spouse, which may impact co-investors and creditors.
• The court can cause companies or other entities to repay loans to parties to the marriage, regardless of whether that is financially suitable to the company to do so at that point in time.
• The court can order a party to sell his or her interest in a corporate entity to a third party, or to you, irrespective of whether or not that is commercially acceptable to you.
• The court can vest a discretionary trust, and cause it to distribute its capital in set proportions as if it were a fixed unit trust.
• The court can order your business partner to transfer his or her shares/ entitlements to his or her spouse, who then effectively becomes your new business partner.
• The court may have cause to thoroughly examine the assets, income and expenses of your business, for example when assessing your partner's income generating capacity or valuing the business.
• The court can, and does, refer taxation issues which may arise during the course of proceedings, to the Australian Taxation Office.


Part VIIIAA of the Family Law Act, empowers the court to make orders and injunctions binding upon third parties. The ambit of such orders or injunctions is wide. Key provisions within Part VIIIAA include the following.
• Section 90AC of the Family Law Act provides that the court's third party powers have effect despite anything to the contrary in:
• "any other law"; or
• "anything in a trust deed or other instrument".
• Section 90AE of the Family Law Act gives the court power to make orders binding upon third parties, including:
• "an order directed to a creditor….to substitute one party for both parties in relation to a debt owed to the creditor";
• "an order directed to a creditor ……to substitute the other party …to the marriage for that party in relation to the debt owed to the creditor";
• "an order directed to a creditor of the parties to the marriage that the parties be liable for a different proportion of the debt owed to the creditor than the proportion the parties are liable to before the order is made"
• "an order directed to a director of a company or to a company to register a transfer of shares from one party to the marriage to the other party";
• "an order that…directs a third party to do a thing in relation to the property of a party to the marriage"; and
• "an order that…alters the rights, liabilities or property interests of a third party in relation to the marriage". The Family Law Act provides some protection for creditors, and more generally provides that third parties must be afforded "procedural fairness", which often amounts to the right to participate in court proceedings, albeit at that party's expense. Overall, the fundamental powers afforded to the family law courts in relation to third parties are both extraordinarily wide and deep. Furthermore, the wide breadth of judicial discretion in the family law courts reduces predictability of outcomes and complicates appeals. In addition, the court process is slow, and can become inexorably delayed by the litigation behaviour of parties who are emotionally charged and are unwilling to compromise on even basic issues of fact and law. Finally, the ability to successfully claim legal costs, and recover them, is limited in the family law courts.

Amongst all the troubles of other people's relationships, the good news is that you can protect yourself, and your business, from this type of asset threat.

Corporate Australia increasingly recognises that family law issues pose a risk as great as civil law issues, but for which the traditional asset structures and insurance options offer little or no protection.

Directors who previously took little interest in their colleague's relationship troubles, may now choose to employ a suite of protection measures to provide corporate stability, and thereby add value to a business. In particular, two types of protection can be employed, ideally together, to insulate a business from a matrimonial dispute.

First and foremost, a Financial Agreement will exclude the jurisdiction of the family law courts. It is the gold seal of protection, and can be used to quarantine a company from any family law claim. Secondly, corporate ownership documents such as partnership agreements can be drafted so as to provide for a controlled manner of dealing with corporate interests in the event of a matrimonial dispute (or a broader partnership dispute).


A Financial Agreement can be entered into prior to a marriage or de facto relationship, during the relationship, or after separation.

A "forward looking" Financial Agreement will set out how the parties' assets are to be dealt with in the event of a later separation. It can also deal with issues of spousal maintenance.

Many people do not consider entering into a Financial Agreement because they believe it will be set aside, and it is only used as a tool to deprive a spouse of a fair share of the matrimonial assets.

Firstly, whilst a Financial Agreement may be set aside, just as any commercial contract may also be set aside, a Financial Agreement which has been properly drafted and executed is more likely to sustain legal challenge. The importance of doing things properly cannot be overstated.

Secondly, whilst some Financial Agreements seek to depart radically from the likely outcome in the family law courts, this does not have to be the case. Many people enter into a Financial Agreement to provide a fair settlement to both parties, and to avoid the expense and personal turmoil of matrimonial litigation in the event of a separation. This idea is mirrored to an extent in commercial contracts which provide for set outcomes in the event of preidentified business disputes.

A Financial Agreement can be used, for example, to quarantine a business interest in the event of a separation, and that may be balanced by the other party retaining greater personal assets at an equivalent or prescribed value. A Financial Agreement can also deal with all the existing and future assets, or simply exclude certain assets from the jurisdiction of the court, such as a business.

Partnership/securityholder agreements can deal with family law obligations, in a number of manners. These are ideally employed alongside a Financial Agreement, and offer a second tier of protection. At their worst, these measures offer considerably better protection than nothing at all. A securityholder agreement can, for example, include a provision for the other securityholder to have a first option on the purchase of any other securityholder's shares. A greater degree of protection could be given by providing for a mechanism by which to value those shares, or even a prescribed value. Care must be taken regarding the circumstances in which such agreements are entered into, to avoid them being subject to the accusation that they are a "sham". Ultimately, partners or securityholders must be content to live with the terms of a corporate agreement. This may boil down to a question of balance between protecting from the family law asset threat, as against other commercial imperatives.

Ultimately, this serves to underline the importance of employing a Financial Agreement in tandem with corporate documentation.

Like any other commercial or legal risk, the asset threat associated with family law issues, should be managed widely. The law provides useful tools to insulate from third party family law risk, and it makes good commercial sense to take advantage of that protection.

Lander & Rogers is a leading provider of Family Law services in Australasia and internationally, with the largest number of accredited Family Law specialists in Australia. If you are looking for relationship law advice, contact one of our family lawyers today.

Daniel Kaufman
is Special Council at Lander & Rogers

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