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5 Settlement Documents that Divorcing Business Owners Must Have

by bvertz on Jun 8, 2011 • Comments Closed • , , , , , , , , , , , ,

When business owners get divorced, their settlement may have profound consequences for the business and other owners. Often, one spouse “sells” or gives up a share of the business to the other spouse. Since most small business owners do not have enough cash to pay a lump sum for that share, they might have to make installment payments over months or years. It is critical to structure the divorce settlement properly with documents that will minimize tax consequences, quantify and secure the payments to be made to the spouse who is leaving the business, and preserve the company’s ability to operate and obtain financing. These are the top five documents that a business owner should have when finalizing a divorce where a spouse is “selling” his or her share of the business to the other spouse:

1. Marital Settlement Agreement. Divorce courts rarely issue orders containing sufficient detail to adequately protect business owners who are divorcing. Settlement provides the best opportunity to resolve important financial and tax issues that a divorce court might overlook. A settlement agreement should contain a clear description of the stock, partnership or LLC membership units, and other business interests being sold or waived, how much is being paid, when it is being paid, and what happens if the payments are not made in full and on time. Unincorporated associations are tricky because their assets and liabilities are often intertwined with the owners’ personal assets and liabilities, so be as clear as possible. When setting the price, the business owner must consider whether the price is consistent with the value reported to tax authorities for estate planning purposes. The spouse who is making payments might be required to maintain enough life insurance, retirement assets, or investments to pay off the obligation in full upon death or default. The other documents related to the sale of the business (installment note, security agreement, etc.) can be attached to the marital settlement agreement and signed at the same time.

2. Installment Note. The installment note states the price that a business owner must pay for a spouse’s share of the business, the timing and amount of each installment payment, and the consequences for late payments or default. If the payments will be made over a period of years, the note might include interest (particularly for late payments). An acceleration clause might make the entire balance due immediately upon sale of the business, death, bankruptcy, or other major events. In some jurisdictions, a confession of judgment clause might avoid the delay and expense of a collection lawsuit if there is a default. The majority owner might be required to provide a personal guarantee. The note can also be secured by a mortgage against real estate or lien on business assets, such as equipment and receivables.

3. Mortgage/Security Agreement. An installment note can be secured by a mortgage against real estate or lien on business assets, such as equipment and receivables. The lien against business assets can be recorded publicly by filing a UCC-1. In some cases, the business might want to subordinate the mortgage or security agreement so that trade creditors and lenders who demand higher priority will not withdraw their credit.

4. Pledge of Stock. A pledge agreement creates a lien on the stock of the business. The pledge agreement might contain representations and warranties about the financial condition of the business or give the selling spouse a right to vote the pledged stock or inspect the books until paid off. If dividends or distributions are paid, the pledge agreement might direct the proceeds to be paid toward the loan. The pledge can also restrict the sale, gifting or dilution of the stock.

5. Consent and Waiver. If the business owners have previously signed a buy-sell agreement or right of first refusal, giving the company or other owners a right to buy their shares, then they should probably obtain the consent of those other owners before transferring stock between themselves. A consent and waiver confirms that the company and other owners will not exercise their rights when divorcing spouses transfer their stock.

Lump Sum Divorce Payment: Exempt Property in Bankruptcy

by bvertz on Sep 9, 2010 • Comments Closed • , , , ,

In Re Miller, 424 B.R. 171 (M.D. Pa. 2010)

Wife/Debtor filed a chapter 13 bankruptcy petition, in which she attempted to classify an “income maintenance award” of $88,500 received in a divorce decree as property exempted from the bankruptcy estate.  The divorce decree provided that Wife was to receive $88,500 cash in order to effectuate a 67%/33% division of marital property.  Next, Wife’s former divorce lawyer filed a proof of claim for unpaid legal fees and objected to Wife’s schedule of exemptions, claiming the lump sum cash award was not exempt under 11 U.S.C. § 522(d)(10)(D).  The Chapter 13 Trustee also filed objections to Wife’s exemptions, asserting the same grounds as her former lawyer.  Wife and her former lawyer stipulated that the forty-seven page report by the divorce master was incorporated into the divorce decree at issue.

In the report, the divorce master specifically stated that the husband’s obligation to Wife was for “necessary living expenses, including the mortgage, taxes, insurance, and upkeep on the marital residence” and that it “‘should not be dischargeable in bankruptcy.’” In awarding 67% of the marital property to Wife, the master found Wife had no job skills, and at the time, was making $1,300 per year cleaning houses.  The master awarded Wife alimony for the period of two years so that she could obtain additional education and employment during that time.  At the time when the matter came before the bankruptcy court, however, Wife had not received additional education and was not employed.

The bankruptcy court began its’ analysis with a discussion of 11 U.S.C. § 522(d)(10)(D), which provides “alimony, support or separate maintenance, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor…may be exempted under subsection (b)(2) of this section.”  The court noted exemptions are broadly construed, and the burden is on the party objecting to the exemption to prove the exemption is not available. The court considered three possible approaches to determining whether the obligation in Wife’s divorce decree was in the nature of support.

The court first considered In re Gianakas, 917 F.2d 759 (3d Cir. 1990), which held that federal law, not state law, determines whether a divorce obligation is in the nature of support, maintenance or alimony. The Third Circuit in Gianakas set forth a three-part test to determine the nature of whether an obligation is alimony, maintenance or support.  Yet, the bankruptcy court in Miller noted that Gianakas had addressed the discharge of a debt under 11 U.S.C. § 253(a), not a property exemption claim  under 522(d)(10)(D).  Further, Gianakas dealt with the dischargeability of an obligation under a consentual agreement rather than a court-imposed divorce decree.

Before applying the three factors set forth in Gianakas, the Miller court discussed two alternative approaches to defining support obligations in the context of a discharge determination from other federal courts.  The court reviewed the Fifth Circuit’s decision in In re Evert, 342 F.3d 358 (5th Cir. 2003), which set forth four criteria for determining whether divorce-related debts were exempt under § 552(d)(19)(D).  The Evert court held that if:

in the agreed divorce decree there is 1) also a meaningful separate alimony provision, 2) the obligation in question is described as being part of the property division, 3) the label given to the obligation in question is matched by its actual characteristics, and 4) the evidence does not suggest the parties conspired to disguise the true nature of the obligation in order to subvert the bankruptcy or tax laws, then the label given by the state court is sufficient and there is no need to look behind it to determine whether it is really alimony or a property settlement.

Evert, 342 F.3d at 368.  The Evert court concluded that the Gianakas factors should be applied only when the settlement agreement is ambiguous.  The Miller court, however, disagreed with Evert holding that a bankruptcy court must accept the state court’s characterization of an obligation unless the marital settlement agreement is ambiguous.  For these reasons, the Miller court rejected the Evert approach.

The Miller court next considered the approach taken by the District Court for the Eastern District of Michigan in In re Harbaugh, 257 B.R. 485 (E.D. Mich. 2001).  The Michigan court relied upon the legislative history of § 552(d)(10)(D) in holding that the parties’ intent behind the marital settlement agreement or the intent of the court issuing the order should be paramount in characterizing a divorce obligation.  The Harbaugh court found “Congress intended for section 552(d)(10)(D) to exempt only those monies, and potentially other equivalent awards, that concern general spousal sustenance” and therefore, the court should exempt only those payments from “the bankruptcy estate that (1) are intended by the parties or the state court to support a spouse and (2) are, in the judgment of the bankruptcy court, reasonably necessary for such purpose.” Harbaugh, 257 B.R. at 491.

The Miller court eventually endorsed the three-part Gianakas test to determine whether a divorce obligation is an exempt property under 11 U.S.C. § 522(d)(10)(D). In doing so, the Miller court pronounced its intent to avoid inconsistency with the standards by which dischargeability is judged under § 253(a). Applying the first part of the Gianakas test, the bankruptcy court first considered “the language and substance of the agreement in the context of surrounding circumstances, using extrinsic evidence if necessary.” Miller, at 177, citing Gianakas, at 762-63. Wife’s former divorce lawyer argued that the lump sum cash obligation was not support because it was set forth in a section of the master’s report entitled “Discussion and Conclusions of Law with respect to Equitable Distribution.”  Wife conceded that the sum was awarded in this section of the report, but asserted that he substance of the master’s report indicated the award was for the purpose of support.

Applying the second and third factors in Gianakas, the Miller court considered the “parties’ entire financial situation” and “the function served by the obligation at the time of the divorce or settlement.”  Miller, at 177, citing Gianakas, at 762-63.  The court held that it was “crystal clear” that the lump sum distribution to Wife was not only “related to” her support but “founded upon that need.” The court also noted that Wife’s lawyer, by stipulating to the master’s report, had thereby stipulated that the award was necessary to support Wife.  Considering the parties’ financial situation, the court noted the disparity between the parties’ incomes and earning capacities, as Husband earned far more than Wife at the time of the master’s report and at the time of the court’s opinion.  The court also noted the fact that the award was intended to pay for the necessities of life while Wife obtained additional education and employment.  Based on these factors, the court concluded the divorce obligation “was intended by the state court to serve as support and was not a division of property.” Miller, at 178.  Based on this finding, the court allowed Wife to exempt the $88,500 award from the bankruptcy estate and overruled the objections of Wife’s former counsel and the Trustee.

Massachusetts Authorizes Post-Nuptial Agreements

by bvertz on Aug 4, 2010 • Comments Closed • , , , , , , ,

The Supreme Judicial Court of Massachusetts ruled recently that agreements between spouses who plan to continue their marriage but wish to define their legal rights and obligations in the event of divorce are enforceable in that state. Some states (notably Ohio) do not permit spouses to execute agreements waiving their marital rights unless they are actually pursuing divorce, and the law of many states is unsettled. In its recent decision, the highest court of Massachusetts joined the ranks of states (including Pennsylvania) where such “post-nuptial” agreements are permissible.

Post-nuptial agreements may combine certain elements of prenuptial agreements with features of marital settlement agreements. Post-nuptial agreements may divide marital property between spouses, protect their separate property, and establish or restrict spousal support and alimony, like settlement agreements. Post-nuptial agreements can also protect family businesses, inheritance, and other separate property to be acquired in the future, just as prenuptial agreements do.

In Ansin v. Ansin-Cravin, 457 Mass. 283, 929 N.E.2d 955 (2010), the husband and wife entered into a post-nuptial agreement two years before their eventual divorce. The post-nuptial agreement in that case gave the parties a chance to attempt marital reconciliation while removing the financial risk of taking “one last chance”. The couple had been married for nineteen years at the time of their agreement. At that point, the husband separated from his wife and advised her that he would not return unless she would sign an agreement. She hired legal counsel, investigated the nature and value of their assets, and negotiated the terms of the agreement.

Having signed the agreement, the husband and wife reconciled for nearly two years. Ultimately the reconciliation did not last, but the parties were able to avoid the stress and expense of protracted divorce litigation by having an agreement in place (at least, they would have avoid those pitfalls if the wife had not challenged the validity of the agreement). The Massachusetts court applied the same standards to post-nuptial agreements as many states employ when judging the validity of prenuptial agreements and settlement agreements: (1) availability of independent legal counsel; (2) full and fair disclosure of financial resources; (3) absence of fraud or duress; and (4) reasonableness of the provisions for each spouse.

Pennsylvania has long recognized post-nuptial agreements, and for good reason. When entering into a post-nuptial agreement, full and fair disclosure is an essential element; and it may be important to engage legal counsel. While formbooks and software programs may contain “boilerplate” prenuptial agreements, post-nuptial agreements are very different and require the skill of an experienced family law attorney.

Buy-Sell Controls Value of Medical Practice in Texas Divorce

by bvertz on May 5, 2010 • Comments Closed • , , , , , , , , , , , , , ,

Texas has once again proven itself to be a haven for the affluent divorcee. In Mandell v. Mandell, 2010 WL 1006406 (March 18, 2010), the Texas Court of Appeals held that a professional spouse’s 25% interest in a medical corporation was limited under the terms of a buy-sell agreement to a nominal fixed price payable to shareholders upon divorce. The decision was summarized at BVLaw Blog as follows:

In a case of first impression, the Texas Court of Appeals considered a buy-sell agreement that purported to bind shareholders and their spouses in the event of divorce. As a further complication, the husband had signed an employment agreement with the private medical association—but neither he nor his wife had signed the shareholders’ agreement.  This unsigned agreement limited the value of a divorcing shareholder’s interest to the equity buy-in price (in this instance, a mere $11,000 for a 25% share in a business with an estimated $3 million to $5 million book value).

I share BVLaw Blog’s incredulity, but my analysis is somewhat different.

In the opinion, the Texas appeals court emphasized that the doctor, who signed the stock purchase agreement during the marriage three years before separation, tendered a check for his buy-in but never signed the shareholders agreement (which was referenced in the stock purchase agreement); and his shares were never issued. After separation, the corporation returned the shareholder’s fixed buy-in payment. At that point, the trial court  might have held that the shares were never acquired, and only the buy-in payment itself was community property.

Yet, during the pendency of the divorce litigation, the wife filed motions compelling her husband and the corporation to complete the transaction. The doctor returned the fixed sum to the corporation, and the corporation issued the shares. When the wife attempted to introduce expert testimony to prove the fair market value of the shares, she was met with a motion in limine, which was granted. The trial court held that the wife was bound by the terms of the agreements.

In Texas, the fair market value of a business is presumed to be zero if the shareholders are contractually obligated to sell back their shares upon retirement, death or divorce. A divorcing spouse may present evidence of book value or comparable sales to rebut the presumption, but in this case, the court held that the net asset value was the property of the corporation, not the shareholders.

It might be signficant that Texas is a community property jurisdiction. Since the marital community exists throughout the marriage in those jurisdictions, it could be said that the doctor’s wife was in privity with her contracting husband when he signed the stock purchase agreement. Furthermore, property in Texas apparently cannot be owned simultaneously by one legal entity (a corporation) and another legal entity (the marital community). These principles might not apply in common law (marital property) states, such as Pennsylvania, where it might be argued that the spouses were neither in privity nor intended third party beneficiaries of such contracts, and where marital property is merely a fictitious estate rather than a legal entity.

Who Really Needs a Cohabitation Agreement?

by bvertz on May 3, 2010 • Comments Closed • , , , , ,

A former client recently asked me to prepare a cohabitation agreement. It was heartening to hear about her successful new relationship after a tough divorce. It had been a while since I had been asked for a cohab agreement, so I spent a couple of weeks polishing up my form. As I considered the provisions of the agreement in light of recent development in the law, I started to think: Who really needs a cohabitation agreement anyway? Four categories came to mind:

1. Committed unmarried couples. Divorce can be difficult, but when long-term unmarried couples split, the breakup can be brutal. The law provides rules, procedures, and remedies for married couples when they part ways, but those rules do not apply to unmarried couples. Lots of different laws can create legal nightmares for unmarried couples when they break up or one of the couple passes away. Tax laws do not authorize tax-free property transfers between unmarried couples; property laws do not specify who is responsible for paying a joint apartment lease when one of the couple moves out; unmarried couples cannot inherit from each other unless they have wills, and even then, death taxes may consume their inheritance. Property laws contain provisions for dividing joint property or allocating joint bank accounts, but those legal provisions do not adapt well to breakups. The procedures for partition of joint property or contribution to joint debts may be slow, inflexible and inequitable. A cohabitation agreement can spell out the consequences of a break up or the death of an unmarried partner, avoiding costly and protracted legal proceedings.

2. Couples who are married under common law. Common law marriage is a tricky subject, surrounded by myths and falsehoods. Pennsylvania no longer recognizes common law marriage for couples who formed their relationships after December 31, 2004. Perhaps the Commonwealth might recognize a common law marriage formed under the laws of another state, or a relationship formed here before 12/31/2004. But the outcome of such cases is very uncertain. A cohabitation agreement might help by memorializing the common law marriage and spelling out the consequences of divorce or death.

3. Unmarried same-sex couples. Pennsylvania does not solemnize same-sex marriages, so same-sex couples must create contractual relationships to protect their children and property. Cohabitation agreements, along with testamentary instruments, are essential to protecting their legal rights, not only upon breakup or death, but in many everyday situations such as hospital visitation, access to children’s school records, and authority to make financial transactions.

4. Married same-sex couples. This category might be surprising. Since some states permit same-sex couples to marry or enter into domestic partnerships, why should they need a cohabitation agreement? The reason is illustrated by a recent Texas appeals court case, in which there is a challenge to the Texas court’s power to divorce same-sex couples who were legally married in another state. If a same-sex couple has been married outside of Pennsylvania, there is no guarantee yet that Pennsylvania will have the legal authority to divorce them under its existing laws. A cohabitation agreement can provide a remedy.

USA Today Says Prenups are “In”

by bvertz on Apr 8, 2010 • Comments Closed • , , , , , ,

An article published recently in USA Today reports that prenuptial agreements are more acceptable today to couples who are engaged than at any time in the past.

Nearly one-third of single adults say they would ask a significant other to sign a prenup, according to a February survey of 2,323 adults by Harris Interactive.

 Only 3% of folks with a spouse or fiancée have a prenuptial agreement, but that’s up significantly from the 1% reported when Harris conducted a similar study in April 2002.

Personal-finance expert Suze Orman encourages every engaged couple to get one to protect their current and future assets as well as to shield themselves in case a mate secretly runs up massive credit card debt (which could damage both partners’ credit scores).

 More than one-third of adults — 36% — said prenups make smart financial sense, according to the Harris survey. When Harris asked that same question in 2002, 28% said so.

“People are hopeful,” Orman says. “They want their relationship to last. … It’s just natural that they don’t think they’ll need a prenup. Never in a million years do they think (divorce) will happen.”

 In 2008, the divorce rate was about 50%. Among married Americans, the median duration of their wedded life in 2008 was 18 years, according to Pew Research Center’s analysis of government data.

Given those odds, “Hope is not a financial plan,” says Orman, who urges that every couple get a prenup. “The time to plan for a divorce is not when you’re in a state of hate,” she says.

Among the divorced, 15% say they regret not having a prenup in their most recent marriage, according to the Harris poll. Men are more likely than women to have this regret, at 19% vs. 12%. Nearly 40% of divorced Americans also say they would ask their significant other to sign a prenuptial agreement if they remarried.

Prenuptial agreements make sense for lots of reasons, especially for people who have family businesses, children from a prior relationship, or substantial personal savings or retirement savings. See my previous post:

 ”Once You Pop the Question, How do You Spring the Prenup?“

Divorce Court’s Power to Regulate Business

by bvertz on Mar 4, 2010 • Comments Closed • , , , ,

An issue that befuddles some business owners during the course of their divorce litigation is how to regulate the operation and management of their businesses. In cases where both spouses own interests in the business, they may struggle for control of important business and financial decisions.

Some issues may be resolved under the company’s partnership agreement, shareholders’ agreement, limited liability company (LLC) agreement, or corporate by-laws. Yet, these agreements are often too vague to deal effectively with disputes between divorcing spouses who own businesses together.

Early in the evolution of the Divorce Code, the Superior Court of Pennsylvania authorized the Courts to appoint receivers or trustees to prevent the dissipation of an ongoing business concern. Mayhue v. Mayhue, 485 A.2d 494 (Pa.Super.1984). The Superior Court in Mayhue held that 23 Pa.C.S. § 3505(a) and 23 Pa.C.S. § 3323(f) authorized the Courts to enter an injunction to prevent a spouse from continuing a course of conduct calculated to defeat his wife’s property rights in the business. The Superior Court in Mayhue approved the trustee’s powers to liquidate assets to pay business debts, pay delinquent taxes, and satisfy intercompany debts.

The appointment of a receiver is not practical in every case because the expense of paying a receiver may not be justified. Still, there are some cases in which third party supervision of the business might be the only practical way t0 ensure continued smooth operation of a business caught in the middle.

Tiger Woods Elin Nordegren Renegotiating Prenup? Why?

by bvertz on Dec 4, 2009 • Comments Closed • , , , , , , , ,

The Chicago Sun-Times, Huffington Post, and The Daily Beast are reporting that Elin Nordegren, the wife of golfing billionaire Tiger Woods, is demanding that Woods renegotiate the terms of their prenuptial agreement after learning of Woods’ multiple infidelities. Under their 2004 agreement, Woods allegedly agreed to pay Nordegren the sum of $20 million if they should separate after ten years of marriage. The recent news reports claim that Nordegren is now demanding $55 million to stay with Woods for another two years, seven years in total.

If the reports are true, why would Woods agree to such terms?  The obvious answer would be “to induce Nordegren to commit to marital reconciliation.” Yet, a less obvious, perhaps more cynical answer would be “to let the negative publicity abate before announcing that the couple is divorcing.” By letting the media firestorm subside, even temporarily until the couple can make a plausible announcement about having attempted to reconcile, Woods might be able to preserve his valuable sponsorships. Pure speculation on my part, sure, but if his sponsorship worth hundreds of millions of dollars per year were at stake, wouldn’t it make sense to throw a little money her way?

Parent Held Not Liable under “Verbal Agreement” to Pay College Expenses

by bvertz on Nov 19, 2009 • Comments Closed • , , , , ,

The Superior Court of Pennsylvania will be publishing my successful result in Mackay v. Mackay (2009), a case in which a parent attempted to enforce a casual conversation about college plans for their young children as a “verbal agreement” to pay college expenses. The Superior Court held that their conversation was merely an expression of plans or intentions, rather than an enforceable verbal contract.

The incident from which the dispute arose was a dinner conversation held between the parents when their children were pre-teens. The mother declared that she would like to retire after 30 years of service to her employer, and the father admonished her that both parents would have to continue working to pay for college expenses. Many years later, the parties divorced. In the divorce action, the mother testified about the dinner conversation but did not attempt to assert a contract claim in connection with the divorce. When the eldest child graduated from high school, the father pursued a reduction of his child support obligation, and the mother counter-claimed for enforcement of the alleged oral agreement.

The Superior Court examined the record exhaustively and concluded that a discussion of future plans for college did not constitute a verbal contract between the parents. The Court accepted my argument that the parents did not have an intention when they conversed to enter into a legally-binding agreement. This decision recognized and honored the difference between verbal contracts versus plans made by harmonious married couples, which are not understood or intended to have legal consequences after divorce.

192 WDA 2009

Effectively Waiving Retirement Benefits in a Settlement Agreement

by bvertz on Nov 18, 2009 • Comments Closed • , , , ,

During the statewide broadcast of PBI’s Family Law Update today, my colleague David Ladov asked me to post the features that a marital settlement agreement would have to contain in order to qualify as a QDRO (qualified domestic relations order). A QDRO is one of two possible ways that someone may waive his or her right to receive a share of his or her ex-spouse’s retirement benefits (the other being a beneficiary designation form). According to the U.S. Supreme Court’s 2009 decision in Kennedy v. Dupont, a marital settlement agreement by itself was not good enough to waive an ex-wife’s interest in an employer-sponsored pension plan, in the absence of a QDRO or beneficiary designation form.

I suggested during the broadcast that some divorce lawyers might wish to avoid this problem by crafting marital settlement agreements that would qualify as QDROs.  The requirements for QDROs under federal law are summarized on the website of the employee benefits administrator Hewitt Associates, as follows:

  1. The instrument must be a court order, judgment or decree signed by a judge or other state-approved court official.
  2. The instrument must relate to marital property rights or alimony, or the support of a child of the participant.
  3. The instrument must contain a statement that it is issued pursuant to state domestic relations law.
  4. The instrument must include the name, last known address, social security number and date of birth of the participant and alternate payee.
  5. The instrument must describe the amount or percentage of benefits to be awarded to the alternate payee.
  6. The instrument must indicate the manner of payment and when payments begin.

There are a couple of additional requirements (actually, three things the QDRO cannot do) that are described on Hewitt’s web site. In a case where a spouse is waiving his or her rights to an ex-spouse’s retirement benefits, these last few requirements might be irrelevant.

The first requirement listed above could be an obstacle in counties where settlement agreements are not routinely attached to the divorce decree or filed of record. Yet, a consent order incorporating a marital settlement agreement should be sufficient to satisfy this requirement. It is less clear that a consent order referring to an unattached settlement agreement might satisfy the requirement.