When someone gets married and then starts a business, their spouse truly believed in both them and the business. A spouse may even believe in them and the business after the divorce. A divorced spouse may even choose to be a silent partner in the business after the divorce. If the business continues to expand, this might be a great idea for the business-owning spouse and the silent-partner spouse.
The alternative to continued co-ownership is that the business will be liquidated or valued and divided at the business’s current value at the time of the divorce.
Businesses are rarely liquidated by court order. Usually, the business operator is awarded the entire business.
“[W]hen the property at issue is a small business and the parties have shown that they cannot work together, it is better to award the business solely to one party or the other.” In re Marriage of Thomas, 608 NE 2d 585 – Ill: Appellate Court, 3rd Dist. 1993
“Distribution of a business interest can present difficulties, and the court should be mindful that divorcing parties might be unable to work together in a continued business association.” In re Marriage of Schlichting, 19 NE 3d 1055 – Ill: Appellate Court, 2nd Dist. 2014
Without agreement, the business will be awarded to one spouse and a portion of the business’s value will be equitably distributed to the other spouse.
“The business interest of a spouse acquired subsequent to marriage constitutes `marital property’ subject to equitable distribution upon dissolution.” In re Marriage of Schneider, 343 Ill.App.3d 628, 634, 278 Ill.Dec. 485, 798 N.E.2d 1242 (2003)
Without agreement, the valuation of a business is based on what the business is worth NOW.
“In determining the value of assets or property under this Section, the court shall employ a fair market value standard.” 750 ILCS 5/503(k)
Fair market value is “what the property would bring at a voluntary sale where the owner is ready, willing and able to sell but not compelled to do so and the buyer is likewise ready, willing and able to buy, but not forced to do so. This is theoretically an objective standard of valuation; the value of particular property is set by the forces of the marketplace at a given place and time.” Chrysler Corp. v. ILL. PROPERTY TAX APPEAL BD., 387 NE 2d 351 – Ill: Appellate Court, 2nd Dist. 1979 (citations omitted)
Paying out half of the fair market value of a business is a problem for a lot of startups and small businesses with great potential. Start-ups and growing businesses have great potential but little current value. The spouse who doesn’t operate the business may still want a piece of the upside. The spouse who operates (and keeps) the business may not be able to afford paying out half of what the business is worth today.
The business-owning spouse usually wants to retain control of the business and will gladly enjoy a few more years controlling all of the couple’s share of the business.
Preserving control for the operating spouse and future gains for the non-operating spouse is accomplished by writing trust language in the Marital Settlement Agreement.
“A trust ‘is a fiduciary relationship with respect to property, subjecting the person by whom the title to the property is held to equitable duties to deal with the property for the benefit of another person, which arises as a result of a manifestation of an intention to create it.’” Eyechaner v. Gross, 202 Ill. 2d 228, 253 (2002). (quoting Restatement (Second) of Trusts § 2 (1959))
For example:
“FRED shall hold WILMA’s beneficial interest in the Business Entity [Quarry, LLC] as a trustee for and on behalf of DIANE until such time as the Business Entity, or portion thereof, is sold, transferred or terminated, or in any manner effected such that FRED no longer has an ownership interest in the Business Entity and WILMA has received any and all distributions, return of capital or other liquidation funds in compliance with this Agreement.
Until the complete transference or termination of FRED and WILMA’s joint interest, FRED will tender 50% of all non-retained earnings to WILMA within a week of his own receipt of those earnings.
With respect to any option given to a member under the Operating Agreement, FRED shall follow WILMA’s direction regarding her 50% interest therein (i.e. purchase of another member’s interest, sale of her interest, participation in a capital call or other options presented), to the extent allowed by the Operating Agreement.
FRED shall provide WILMA, upon his receipt, and any and all documents received in connection with Quarry, LLC or any successor business/entity, including but not limited to statements, correspondence, evidence of transactions, distributions, income, sale, transfer, liabilities and withdrawals. In the event there are requests or demands made upon ROY by the Greenhouse Group, LLC or successor business/entity for a vote, decision, capital call, contribution or payment, FRED shall immediately notify WILMA and provide her with all information and documentation provided to FRED.”
To ensure that a trust is created by a Marital Settlement Agreement the language must specify: “(1) intent of the parties to create a trust, which may be shown by a declaration of trust by the settlor or by circumstances which show that the settlor intended to create a trust; (2) a definite subject matter or trust property; (3) ascertainable beneficiaries; (4) a trustee; (5) specifications of a trust purpose and how the trust is to be performed; and (6) delivery of the trust property to the trustee.” Eyechaner v. Gross, 202 Ill. 2d 228, 253 (2002).
The trust language can say whatever the parties agree to. If the parties believe they are both following the agreement and/or they are satisfied with the results of the agreement. Entering into an agreement such as this clearly requires a lot of trust…because agreements like this are not done by court order and ONLY done by agreement.
The business-operating ex-spouse is now the trustee for the other ex-spouse’s portion of the business….and that means the business-operating spouse has special duties to their ex-spouse.
“A trustee owes a fiduciary duty to the beneficiaries of a trust and must carry out the trust according to its terms and to act with the highest degree of fidelity and good faith.” Kagan v. Waldheim Cemetery Co., 2016 IL App (1st) 131274, ¶ 31.
There is no problem until the trustee allegedly violates their fiduciary duty to their ex-spouse. This could be anything: selling stock, embezzling, tanking the company on purpose, etc.
First, a breach of the fiduciary duty must be identified by the court.
“To state a cause of action for breach of fiduciary duty, a plaintiff must allege and ultimately prove (1) a fiduciary duty on the part of the defendant, (2) a breach of that duty, (3) an injury, and (4) a proximate cause between the breach and the injury.” Alpha School Bus Co. v. Wagner, 391 Ill. App. 3d 722, 747, 910 N.E.2d 1134, 1158 (2009)
Proximate cause is “a cause that directly produces an event and without which the event whould not have occurred.” Black’s Law Dictionary (11th ed. 2019)
That could be anything when running a business for the benefit of another…even making a bad business decision.
“A violation by a trustee of a duty the trustee owes to a beneficiary is a breach of trust.
(b) To remedy a breach of trust that has occurred or may occur, the court may:
(1) compel the trustee to perform the trustee’s duties;
(2) enjoin the trustee from committing a breach of trust;
(3) compel the trustee to redress a breach of trust by paying money, restoring property, or other means;
(4) order a trustee to account;
(5) appoint a special fiduciary to take possession of the trust property and administer the trust;
(6) suspend the trustee;
(7) remove the trustee as provided in Section 706;
(8) reduce or deny compensation to the trustee; or
(9) subject to Section 1012, void an act of the trustee, impose a lien or a constructive trust on trust property, or trace trust property wrongfully disposed of and recover the property or its proceeds.” 760 ILCS 3/1001(a),(b)
Realistically, a court is going to order an accounting (number 4) first to determine the extent of the breach of duty.
An accounting is “a report of all items of property, income and expenses prepared by a…trustee…and given to beneficiaries.” Black’s Law Dictionary (11th ed. 2019)
If “plaintiffs established a fiduciary relationship and an abuse of that relationship, they [are] entitled to an accounting” Kurtz v. Solomon, 275 Ill. App. 3d 643, 653 (Ill. App. Ct. 1995)
After the accounting is done and the breach of duty and its effects are properly identified…the court can do just about anything to remedy the wrong.
“Nothing in this Section limits the equitable powers of the court to order other appropriate relief.” 760 ILCS 3/1001(c)
The business might be put up for immediate sale. The business-operating spouse may be ordered to pay all profits to the non-operating spouse. The non-operating spouse could be made the new trustee and take over the business. Anything is possible.
There is a great deal of danger in operating a business in trust for your ex-spouse….but, then again, you wouldn’t have kept your ex-spouse as a silent partner unless the upside was incredible.
Few Illinois divorce lawyers know how to allocate a business’s value at the time of divorce. Fewer still divorce lawyers know how to creatively keep the entire business without paying their ex-spouse anything (for now). Even fewer lawyers know what will happen if a silent partnership with an ex-spouse falls apart.
If exploring the possibilities of your business post-divorce is of interest to you, contact my Chicago, Illinois family law firm to speak with an experienced Illinois divorce attorney.