by Kevin Segler
Business owners typically enlist a business lawyer for advice on legal decisions regarding their business. The same business owner likely has a family lawyer provide counsel for pre-marital agreements, post-marital agreements and divorce. Business lawyers and family lawyers should work together to ensure that a client’s assets remain properly protected and classified when making decisions related to business ownership.
A Business is “Property”
A person’s interest in a closely held business is considered marital property. In Texas, property can be characterized as community property, separate property or a mix of both. Community property may be divided between spouses in a divorce, but a court cannot divide separate property. In a divorce, the presumption is that everything is community property unless you can prove to a judge—by clear and convincing evidence—that the asset is separate property. Pre-marital and post-marital agreements are helpful tools to change how property would otherwise be characterized under the law.
Proving a separate property claim generally involves determining when the property was acquired (i.e. the inception of title) and/or tracing the funds used to purchase that property back to a separate property source.
The inception of title to a closely held business is generally considered the date of incorporation or formation. However, if a business is formed during the marriage but capitalized entirely with separate property funds, it may be considered separate property.
The various types of business entities—sole proprietorships, partnerships, limited liability companies and corporations—may be treated differently under the law in both the business and family law contexts. While tax treatment, liability protection and ownership structure are the main business considerations, the manner in which the property may be divided in a divorce should also be part of the legal analysis for forming a business. For instance, a sole proprietorship may make the most sense for a fledgling startup from a business perspective, but, unlike more formal entities, the business property of a sole proprietorship can be considered community property and divided in a divorce.
Differing Perspectives – Unified Goal
A business lawyer often looks at what type of entity will provide the client with the best tax treatment, liability protection and management efficiencies. The business lawyer’s assessment may also change over time depending on the nature, growth and scope of the business. Usually, the business lawyer’s goal is to find the best way to reduce liability and maximize efficiency and profit.
A family lawyer aims to protect the client’s business in the event of a divorce. Sometimes, changing an entity type or structure makes the most sense from a strictly business perspective, but making that change during the marriage could invite unwanted consequences in the family law arena.
In these situations, the business lawyer and the family lawyer should collaborate on the best course of action for the client.
First, consider the importance of making a change to the business entity or structure, and whether or not the change is significant enough to implement. If the potential benefits of the change are small and the risk of losing half of the business in a divorce is high, the change might not be the best strategy.
Second, develop a joint strategy to make the amendment—usually by a formal merger or inclusion of special capitalization provisions in the new entity documents—with careful consideration of any pre- or post-marital agreement that may exist. Some marital property agreements may be very specific about how a change must take place.
Third, execute the change with precision so that the intent is well-documented. In a divorce, the ability to prove a change’s compliance with Texas law and the terms of any marital property agreements is imperative to maintaining the validity of any marital property agreements and protect a client’s assets.
Business lawyers advising clients about their closely-held businesses should make certain to evaluate the family law aspects and consider consulting a family lawyer before making any modifications in business ownership structure. Family lawyers should be cognizant of the fact that business needs often change and try to anticipate any potential future issues when drafting a pre- or post-marital agreement. Both family and business lawyers should work together to provide a coherent strategy that addresses the client’s needs and allows for informed decisions throughout the life of the business.
Kevin Segler is an attorney with KoonsFuller, PC. He can be reached at firstname.lastname@example.org.