A business owned by a spouse during a divorce may be the largest asset of the marital property estate. The business owner has interest in protecting the business and keeping his or her interest intact. But, divorce can present difficult issues for the business owner. It is important for the business owner to understand the legal issues in dividing marital property that will affect the business in divorce as well as some of the pitfalls.
What are the basic rules about property division in a Texas divorce?
The first step in any marital property division in a Texas divorce is to identify all of the property owned by the entire marital estate. In other words, if there’s property that either spouse possesses that isn’t owned by them, that property is eliminated from consideration. Once the marital estate is identified, the next step is to characterize the property as either community property – the assets acquired during the marriage – or separate property – the assets acquired by a spouse before the marriage or through gift or inheritance. The community property assets are divisible in a divorce. Separate property is not. The law starts with a presumption that all assets owned by either spouse at the time of divorce are community property, so the burden is on the spouse claiming separate property to prove it. The next step is to value the assets and then to divide the community assets in a just and right manner considering the equities of the parties.
Does Texas require a 50/50 division?
No, Texas does not require a 50/50 division, but that is the starting point. But the division can vary from 50/50 based on equitable factors such as fault in the breakup of the marriage, a significant separate property estate owned by one spouse, a big difference in earning capacity, or other relevant factors.
How are debts dealt with?
The legal liability on debts cannot change. In other words, whoever contracted for the debt will remain liable on the debt after the divorce. However, debts incurred during the marriage will be considered in the overall division of the assets to achieve a just and right division of the community property.
How is a business dealt with in a divorce?
How a business is dealt with in a divorce depends on the type of entity of the business – corporation, partnership, or sole proprietorship. Generally speaking, Texas follows the “entity theory” which means that a business entity of a corporation or partnership is separate from the individual, and the individual owns an interest in the entity, not each asset of the entity. A sole proprietorship is not an independent legal entity from the owner. Instead, the individual owns the assets and owes the liabilities in his or her personal capacity.
Usually a business is awarded to the spouse/owner of the business. In extreme circumstances, if the business cannot easily be awarded to one spouse, or if other extenuating circumstances exist, a receiver may be appointed by the court to take over the operation of the business and force a sale.
How is it determined whether the business is community property subject to division in a divorce or separate property?
The date a corporation or partnership is formed is the date that determines whether an entity is community or separate property. If a business is formed before the marriage, the entity will likely be the spouse’s separate property because the ownership incepted prior to the marriage. Or, if the spouse acquired the business entity during a marriage, then the entity will likely be community property. The exception to community property would be if the entity was acquired by gift or inheritance or by using funds traceable to separate property of the spouse.
How is a business valued in a divorce for purposes of a division of assets?
To know whether the division of property in a divorce is just and right, a fair market value must be determined for the assets and debts of the community estate. To determine a fair market value of a corporation or partnership, the entity as a whole, including both tangible and intangible assets as well as liabilities must be assessed a value. Usually this is done by a forensic business valuation expert. The expert will value the tangible assets of the business entity. Then the expert will examine the intangible assets such as the goodwill of the business. Goodwill looks to where the customers of a business come from.
If customers employ the business because of the reputation or abilities solely of the individual owner of the business who does the work, that intangible value is the “personal goodwill” of that individual and is not an asset that can be considered in the value of the business for division purposes. On the other hand, if the business gains customers due to the reputation of the entity itself, that intangible value is an asset of the business to be included in valuation.
Other discounts that apply to a business’ value in the divorce valuation context include a discount for a minority or noncontrolling ownership interest; also, a discount may apply for lack of marketability where the business could not easily be sold. These discounts can significantly reduce the value of a company.
Does a buy-sell agreement have an effect on the value of a business in a divorce?
A buy-sell agreement can affect or even determine the value of an interest in a business. A buy-sell agreement affixes a buy-back price if the shareholder dies, quits, gets fired, or is divorce. The non-owner spouse should have signed this agreement for it to be binding. The value may go beyond the buy-sell agreement if there is intrinsic value of the property interest to the owner. Examples may include, the value to the owner of driving a company car, having health insurance paid for, or belonging to a country club.
How does a business operate while we go through a divorce?
A very important issue to address regarding a small business during a divorce involves issues related to continued operation of the business while the divorce works through the process. This can be particularly problematic if both spouses were involved in the day-to-day activities of the business prior to the divorce being filed, but who cannot get along after the divorce is filed to co-operate the business. Under this type of circumstance, the divorce court may have to intervene and award one party or the other the right to operate the business within certain parameters. In extreme circumstances, the court may appoint an independent receiver to operate the business until the divorce can be concluded and the business awarded to one party or the other.
Is it possible to continue to operate a business together even if we are going through a divorce or after we get divorced?
This is usually only possible when the spouses get along really well in spite of the divorce or if the spouses have very defined and separated responsibilities in the business. The couples that are really able to co-operate a business either during or after a divorce is rare.
What happens if the business retains earnings that are not distributed during a divorce?
Undistributed earnings remain corporate property and only become subject to division in a divorce when they are actually distributed to a spouse. Such undistributed earnings would be an asset of the company to be considered in the overall value of the company.
What is Alter Ego in the divorce context?
When an entity has become so intertwined with a spouse that the corporate structure ceases to exist, the company may be found to be the alter ego of the spouse and the corporate structure set aside to bring the assets and liabilities of the company into the marital estate as if no corporate entity ever existed.
Does a premarital or post-marital agreement affect the rules regarding a business in a divorce?
It depends on the actual wording of the agreement, but usually the premarital agreement will identify the ownership of the business as being prior to the marriage and therefore separate property. A premarital agreement may also address the right of a spouse to use property or funds identified as owned before the marriage to buy a separate property company. Post-marital agreements are used to partition or exchange certain property between spouses, making certain assets that were otherwise community property instead separate property. One of the most important aspects of a premarital or post-marital agreement is the designation of the income from separate property, which under Texas law would be community property, and change it into separate property of the owner spouse. Texas law has strict requirements on premarital and post-marital agreements to make them enforceable under the law.
What happens if I sell my separate property business during the marriage and buy a new one?
When a separate asset is sold, the funds obtained from the sale remain separate property as long as the funds are segregated from community property funds. Then, if the funds are used to buy a new asset – whether a business or tangible asset like a car – it will be considered a mutation of the separate property and the new asset will maintain the separate property character of the original asset. The exception to this is if the separate property was comingled with community property to such extent that the separate property could not be identified.
My spouse has spent so much time growing the separate property business that there is no community property – what can I do?
This is called a Jensen claim under Texas law. This is a claim for reimbursement on behalf of the community estate for the actual time, toil, and effort the spouse expended in furtherance of the business to the detriment of the community estate. One measure of the value of this claim would be the amount of foregone compensation by the spouse that would have been community property which was used instead to reinvest into the separate property business.
About Michelle May O’Neil
Michelle May O’Neil has 24 years of experience representing small business owners, professionals, and individuals in litigation related to family law matters such as divorce, child custody, and complex property division. Described by one lawyer as “a lethal combination of sweet-and-salty,” O’Neil exudes genuine compassion for her clients’ difficulties, yet she can be relentless when in pursuit of a client’s goals. One judge said of O’Neil, “She cannot be out-gunned, out-briefed, or out-lawyered!”
Family Law Specialist
O’Neil became a board-certified family law specialist by the Texas Board of Legal Specialization in 1997 and has maintained her certification since that time. While representing clients in litigation before the trial court is an important part of her practice, O’Neil also handles appellate matters in the trial court, courts of appeals, and Texas Supreme Court. Lawyers frequently consult with O’Neil on their litigation cases about specialized legal issues requiring particularized attention both at the trial court and appellate levels. This gives her a unique perspective and depth of perception that benefits both her litigation and appellate clients.
Top Lawyers in Texas and America
O’Neil has been named one of D Magazine’s Best Lawyers in Dallas. She has also been named to the list of Texas Super Lawyers for six straight years, 2011-2016, a peer-voted honor given to only about five percent of the lawyers in the state of Texas. In 2014 to 2016, O’Neil received the special honor of being named by Texas Super Lawyers as one of the Top 50 Women Texas Super Lawyers, Top 100 Texas Super Lawyers, and Top 100 DFW Texas Super Lawyers. She was named one of the Best Lawyers in America for 2016 and 2017 in appellate law and her firm was named one of the Best Law Firms in America for 2017.
Author and Speaker
A noted author, O’Neil has written her second book “Basics of Texas Divorce Law,” which is on its third edition in 2016 and available through LuLu.com. Her first book, “All About Texas Law and Kids,” was published in September 2009 by Texas Lawyer Press (now out of print). The State Bar of Texas and other providers of continuing education for attorneys frequently enlist O’Neil to provide instruction to attorneys on topics of her expertise in the family law arena.