Monday, December 21, 2015

Protecting Your Business from Divorce

By Claire James

It’s a scenario that seems to happen far too often. An entrepreneur spends long hours and hard-earned assets building a business, only to find his or her marriage failing. The resulting divorce can be devastating to the business owner and even the business itself.

The division of a divorcing spouse’s business begins with the characterization of the property. Only community property is subject to division by a divorce court. Even when a business entity is found to be separate property of one spouse, the income from a separate property business is generally community property. Lucy v. Lucy, 162 S.W.3d 770, 776 (Tex. App.—El Paso 2005, no pet.).

Characterization of a spouse’s business ownership can be complicated and depends on when the spouse’s interest was created, the type of business entity at stake, and the location of the business’s assets. For example, a sole proprietorship created during marriage would generally be characterized as community property. Butler v. Butler, 975 S.W.2d 765, 68 (Tex. App.—Corpus Christi 1998, no pet.). If a spouse receives interest or stock ownership in a corporation during the marriage, such property would also generally be considered community. See Horlock v. Horlock, 533 S.W.2d 52 (Tex. Civ. App.—Houston [14th Dist.] 1976, writ dism’d w.o.j.).

However, undistributed corporate or partnership earnings remain the property of the business, so they are not divisible in divorce. See, e.g., Snider v. Snider, 613 S.W.2d 8, 12 (Tex. App.—Dallas 1981, no writ). Nevertheless, non-owner spouses can attempt to subject undistributed corporate earnings to division under an alter ego theory. See Young v. Young, 168 S.W.3d 276, 281-83 (Tex. App.—Dallas 2005, no pet.).

Generally, cash dividends and income generated by an owner spouse’s shares are community property, even if the business entity is the owner spouse’s separate property. Bakken v. Bakken, 503 S.W.2d 315 (Tex. Civ. App.—Dallas 1973, no writ). On the other hand, stock dividends, stock splits, and new stock from a merger based on separate stock holdings are generally separate property. Horlock, 533 S.W.2d at 52.

Regardless of the outcome of the divorce, the cost to the parties is high. One way to minimize the impact of divorce on a spouse’s business is to take preventative measures before divorce becomes an issue.

A Premarital Agreement (“Prenup”) can prevent a spouse’s business and/or the earnings from such a business from becoming community property, thus potentially simplifying divorce litigation. A Premarital Agreement must be in writing, signed by both parties, and may be enforceable if certain other circumstances are proven. TEX. FAM. CODE § 4.104-105.

Similarly, Texas spouses can agree to partition property during marriage such that certain property becomes the separate property of one or the other spouse. A Partition Agreement, if validated, can protect a spouse’s business from being divisible in divorce.  For a Partition Agreement to be valid, certain formalities must be met, and there are ways to challenge enforceability. TEX. FAM. CODE § 4.203(a)(1), 4.205.

Whether or not the spouses have a Prenup or Partition Agreement, divorce often raises complex legal, accounting, and tax issues that require a team of experienced professionals.
 

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