The Family Business in Divorce: Issues for Mediators


by Jeffrey Fink

May 2013

Jeffrey Fink

There are millions of family businesses in the US, and even a buzz-word, “copreneurs,” to describe couples who work together.  Unfortunately, with up to half of all marriages ending in divorce, a significant number of these businesses will end up as a football to be tossed around between squabbling spouses.  To complicate matters, not all “family businesses” are mom and pop affairs.  A significant number have children, siblings, aunts, uncles and cousins involved.  The dynamics can get complicated.

While each situation is different, a handful of issues come up fairly often:

No Paper.  Most lawyers helping to set up a business advise clients to put certain rules of the road in writing.  In a corporation, these rules are generally in the certificate of incorporation, bylaws and a shareholders agreement; in a general or limited partnership, in the partnership agreement; and in a limited liability company, in the operating agreement.  There may also be employment agreements.  If these documents are well prepared, they provide guidance on who owns the business (sometimes surprise relatives end up holding stock certificates), the mechanics of who runs the business, what happens to profits and losses, transferring ownership interests and related matters.  If documents do not exist or do not address particular circumstances, the law may fill in the blanks.  If worse comes to worse, most of the governing statutes provide that a receiver can take over and sell the business under certain circumstances, and of course the Probate and Family Court has the power to divide marital assets.  Before any serious negotiation can take place, everyone involved should be aware of the legal and contractual landscape.  Company lawyers can be helpful in the process, although if they appear to take sides they can contribute to an atmosphere of mistrust.

Should I Stay or Should I Go?  Both parties are often emotionally as well as financially invested in the business.  It may have also been a major part of their social lives.  The parties should consider whether it makes more sense for one to buy the other out or for them to try to continue working together.  Sometimes, once tension from their personal lives is separated from their professional lives, couples do manage to make the transition to being just co-owners.  One of the major factors is whether effective lines of communications between them are still open.

Who Does What?  Small businesses are notoriously inchoate.  At the outset, everyone pitches in to do whatever is required.  As time goes on, the roles may become more defined, but in that process there is often conflict around overlapping responsibilities or jobs that do not get done.  Divorce adds an extra layer of complexity to a problem that may already exist.  Job titles only go so far.

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  • Conflict over work responsibilities affects the separation process directly.  It is very common for one party to believe the other one is lazy and incompetent for not doing a job that the other does not even think is his or hers to do.  Alternatively, as communication breaks down, each party may not know what the other is doing and attribute negative motive or inactivity. 
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  • In a divorce involving children, one of the mediator’s jobs is to focus parents on which of them is responsible for which aspects of childcare at what time.  In a divorce involving a business, the mediator should help the parties demarcate their responsibilities and who reports to whom, which will help whether they continue to work together or whether they separate.  The process should result in better lines of communication, too, which will help on both the personal and business sides of the divorce.
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The Goose and Her Golden Egg.   If one member of the couple will be staying with the business after the divorce, he or she might be tempted to hold off on making some sales or improvements until after the split is formalized.  Otherwise, he or she will just be increasing the value of the asset and, possibly, how much he or she will have to pay to buy the other partner out.  It is a natural response that may not even be conscious.  However, holding out may injure the underlying business.  If customers start to drift away or innovation is locked down for a year while the divorce trickles through the system, the spouse whose ownership is surviving may find that he or she needs a surprising amount of time and effort to revive the business after the dust settles.  Business valuators may pick up on it and point it out in a report that the judge sees, should it go to litigation – not a good result for anyone.  An advocate needs to be aware of the possibility.   A mediator should have the parties explore it early in the process.

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  • The flip side is that the party who is leaving the business may be tempted to adopt a “scorched earth” approach:  destroy everything the remaining partner has.  Self-interest might dictate a different approach, since the business may be an asset for which the departing party may be paid, or a source of income to pay alimony or child support.  Still, everyone involved should be aware that, human nature being what it is, the temptation is there.
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Cash or Carry.  Often enough, the family business is the largest asset the divorcing couple has.  It will be part of the overall property division.  At the same time, one or both spouses may be working in the business.  It is an income stream.  If only one of the partners will be staying with the business and the other is keeping an ownership interest, how do they decide how much of the business income will be coming out as salary and how much as a distribution to be split pro rata in accordance with ownership?  How do they decide if there is enough cash available for one partner to buy out the other, or if it should be done over time, or if it should be done with cash flow from the business, or with third-party financing, or with security other than the business assets?

Toxic Flypaper.  Sometimes, in a relationship we see one partner with a deeply held view that anything he or she has touched is automatically his or hers.  The downpayment for the car came out of my Christmas bonus?  It means I should get the car no matter where the monthly payments come from.  I need it more than you do anyway.

In a business, this viewpoint shows itself as, “I touched it.  I did it.  I am responsible.  I am the real business.  You are not.”  At some level, the other partner’s contributions are diminished or dismissed.  I once encountered a gentleman who referred to his 50-50 partner as a “glorified secretary” because the partner “only” took care of all the day to day business operations.  Outside the divorce context, this mindset is very common in technology companies, with each of the inventor and the CEO seeing himself as more important than the other.

Sometimes, this sense bleeds from the personal life to the business life and visa-versa.  It is not an uncommon protective response to conflict.  In more difficult cases, the mediator may have noticed unstable and violently defended ego boundaries that affect all aspects of the separation.  However, in the business context, the mediator should be slow to assume it is purely a manifestation of individual psychology.  There may be more than a grain of truth behind the party’s belief.  Sometimes even equal partners do not pull their weight, and as mediators we do not have the data to evaluate it.  We have to pay attention to the parties’ beliefs, though, or else we are not doing our clients any favors:  if operating roles are not covered in the post-separation business the business may not survive, and if one of the parties feels violated by an agreement on the family business the rest of their separation discussions will be at best strained.

As central as this sense may be to all aspects of the dispute, the mediator should be careful when opening the wounds it may have caused.  On the one hand, it may be a stumbling block the parties must get past.  On the other, it may be so deeply held a conviction that everyone is better off focusing on specific outcomes rather than how each party got there.  In the endless debate among family mediators as to whether and when private caucus sessions are appropriate, you should consider whether this particular dynamic calls out for them.

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Opening the Books.  Small business bookkeeping is not always the most accurate.  Owners rarely keep their books in strict accordance with Generally Accepted Accounting Principles.  If outside parties start to delve into them to do a valuation or to figure out how much cash flow is available to pay child support, there may well be unwelcome surprises such as cash unaccounted for, personal expenses charged to the business (including some that reveal infidelity) or games to make the value seem lower.  Sometimes, allegations of fraud, conversion or breach of fiduciary duty come out, especially if any third party partners are tempted to take sides.  Fears and suspicions about accounting are very common weapons in the war between separating spouses.

No Guaranty.  Corporations, limited liability companies and limited partnerships are limited liability entities.  As a matter of law, the debts of the business are not the debts of the owners.  Sometimes, though, a couple intertwines their personal and business assets, adding an extra layer to the usual debt-splitting discussions.

The discussion may get even more complicated.  Banks often insist that small business owners personally guaranty loans made to the business, which becomes an issue if one member of the separating couple is not staying with the business.  The departing member might reasonably ask, “Why should I be on the hook for what that one is doing when I don’t even own a part of the company any more?”  The answer is that the bank may not care.  While the loan officer may be personally sympathetic, most institutions are not interested in reducing their security.  If a new partner buys out the departing one, then the bank may accept a guaranty by the new partner.  If not, there may be a need to refinance, possibly at a higher interest rate.  If refinancing is not possible, the departing member may ask for a quid pro quo to balance the risk of the continuing guaranty or just have to accept it.

Who is Not In the Room?  In every negotiation, the mediator has to deal with the people who are not there.  They may be parents, peers, aunts and uncles who assist in childcare or someone who provided a gift.  With a more complicated asset like a business, the cast of absent characters can include employees, other family members who are part-owners, parents or grandparents who founded the business, children who hope to inherit the business, major suppliers or customers, influential advisors or people who provided lifeline financing.  The mediator should explore who these people are and decide whether and how it makes sense to bring them into the process.

It’s Not Worth That Much vs. It’s Worth Way More Than That.  If one of the partners will be buying out the other as part of a settlement, there is an inherent conflict over the price.  One party may feel an extra sense of entitlement if a gift or inheritance were involved in purchasing or capitalizing the business.  The courts would probably expect a business valuation using one of a handful of accepted methodologies.  However, many will argue that all a business valuation professional can do is give guidance as to what a third party might pay.  Sometimes the people running the business think that number is too high or too low, depending on how they project cash flow and the time period they are looking to for return on their investment.  The economic cycle dictates valuation, too.  At the time of this writing, valuations are down from what many people would expect.

And then there is the emotional factor.  People set values in their mind and dig in their heels when a spouse or even a third party tries to convince them otherwise.  Sometimes the parties themselves have a hard time distinguishing bluffing from a truly deep belief. 

Shutting the Doors.  Family businesses do close down over divorce issues.  There may not be enough cash for a buyout, or not enough talented personnel without both parties staying involved, or not enough income for the spouse who would remain with the business to make support payments.  Orderly winding up is an option.  So is bankruptcy.  Forced judicial sale may be, too, depending on the statutory regime.  These options belong on the mediator’s flip chart.  They are distasteful and frightening precisely because they may be realistic.

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Practice Tips

Mediators tend to collect techniques, the way other people collect stamps, or sports memorabilia, or cats.  Armed with the foreknowledge of what we might expect when we walk into a family conflict over separating a business, how should we approach it?

Beyond the usual normalizing of the confusion that goes along with the situation, the mediator might consider going beyond a purely facilitative process.  That kind of process can work, but adding in other elements may make it more helpful.  Parties often look to the mediator to be a more active participant in helping them generate options, so some knowledge of common small business practices is useful.  Techniques borrowed from commercial mediation have a place to get clients past particularly sticky spots if their relationship is so damaged they slip into hardball positional negotiating, but the mediator should always be aware of the potential for poison in feelings of unfair compromise.  The mediator might even consider drawing on the narrative mediation lexicon, since many of these potential issues can also be parts of a conflict story.

The number of possible legal, business and emotional issues means that there is almost always too much to resolve in a single mediation session.  The mediator should manage the parties’ impatience and expectations:  clients should understand up front that it takes time to gather and evaluate all the facts and then make difficult choices.  Parties should also anticipate “homework” between sessions relating to business operations, valuation or third party advisors. 

Separating a family business can be a divorce within the divorce.  The issues are often tied to personal self-worth and interwoven with every other aspect of the parties’ lives, and third parties often play a big role.  As a result, the decisions can be some of the most difficult in the whole separation process.  These cases call on the effective mediator to be especially patient, persistent and creative.



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Biography




Jeffrey Fink mediates business and family disputes, taking a clear and practical approach to dispute resolution. On the business side, he uses his extensive background as a transactional lawyer and outside general counsel to understand not just the law behind the disagreement, but the details of the disagreement and the reasons it arose. On the family side, he helps people untangle the emotional and practical aspects of their disputes to help them make difficult decisions. Jeff has a particular interest in partnership disputes and disputes at the intersection of business and family matters such as family businesses in divorce.



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