Little Shop of Horrors: Dealing With Your Business In Divorce (Part 3)

By Jennifer M. Paine

Attorney, Cordell & Cordell, P.C., Detroit office

Note: This is Part 3 of a three-part series on dealing with your business in divorce. Click here to read Part 1 and click here to read Part 2.

If you are a small business owner, dealing with your business in your divorce could send you spinning into a scene from Little Shop of Horrors.

Except, instead of a carnivorous plant reeking havoc on your business, your attorney and your soon-to-be-ex could be crying “Feed Me!” Cash, that is, and lots of it.

How can you avoid this scene and deal with your business effectively? Here are some suggestions.

Get Creative

Finally, get creative.

For most, it is unwise and impractical to divide the business with each spouse retaining a share. If each spouse retains one-half, expect decision-making deadlock. If one spouse retains a minority interest, expect oppression.

As the Michigan Supreme Court noted, “It would be a rare divorcing couple who would benefit from a judgment that requires them to maintain an ongoing business relationship.” McDougal v McDougal, 451 Mich 80; 545 NW2d 357 (1996). (This is true even for amicable divorces. Remember, you got divorced for a reason. Disagreements, particularly when business and money are involved, can and will happen.)

Usually, one spouse buys the other’s interest.

That can be a sizable sum of cash. And daunting. And impossible to pay at once. (Enter those chants of Feed me! from Little Shop of Horrors again). Try these payment options instead:

Section 71 Payments: Pay the leaving-spouse’s share for the business as “Section 71” payments with IRC 71. IRC 71 treats payments as alimony for tax purposes, which means they are taxable as income to the recipient and deductible to the payor (which most find attractive). This is true even if the payments are not traditional alimony intended for support but actually a buy-out of one spouse’s property rights. The payments must terminate at death or the recipient’s remarriage.

Therefore, be sure to tax-effect the payments (i.e., account for the tax treatment in the amount), factor the risk into the payment amount and/or require the payor to maintain life insurance or other security until paid in full.

Fiduciary Agreement: If you will retain a minority share in the business and your spouse the majority shares, before you sign the agreement be sure it contains fiduciary language. Fiduciaries owe duties of fairness, disclosure, and protection to the minority. They have responsibilities that other members do not. If they breach the responsibilities (e.g., by keeping a stock sale secret and reaping the profits), the harmed minority can file a lawsuit to disgorge the profits.

In many states, majority business interest holders are fiduciaries by operation of law. If that is your state, be sure your agreement recites the law, at a minimum, and do not be afraid to contract for more responsibilities. If this is not your state, put the language in!

Base Payments, Plus Ceiling:  Perhaps your spouse thinks the business is worth a whole lot more than you – that profits are “just around the corner.” If her suspicion stalls your settlement, consider a payment schedule that will reward her if she is right – with additional payments.

For example, the payment schedule might require payments of $500 each month plus 10% of the net profits for the month, after payment for all reasonable business expenses. But protect yourself just in case she is right! Make sure the payment plan has a ceiling.

For example, that 10% profits language might read “plus 10% of the net profits for the month, not to exceed an additional $2,000 each month, after payment for all reasonable business expenses.”

Most of all, accept that you will have to pay to keep the business (or step away from the business and accept your spouse’s cash) early in your divorce case and move on to planning the best way to do it. You must cut your emotional ties to that front desk or cash register and start anew, refreshed post-divorce.

Otherwise, you will fight and fight and fight and spend and spend and spend, and that business, neglected, really could do a Little Shop and crumble around you.

 

Note: This is Part 3 of a three-part series on dealing with your business in divorce. Click here to read Part 1 and click here to read Part 2.

 

Jennifer M. Paine is an Associate Attorney in the Detroit, Michigan office of Cordell & Cordell P.C. She is licensed to practice in Michigan, and has been admitted pro hac vice in Illinois, Ohio, and the United States Court of Federal Claims. Ms. Paine received her BA in English and Mathematics from Albion College and graduated Summa Cum Laude. She received her Juris Doctorate from MSU College of Law and graduated Summa Cum Laude.

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