Blog - January 6, 2021
Separation and divorce are generally a pretty unpleasant time filled with immense challenges, unbearable stress and, from an emotional standpoint, can feel like riding the scary rollercoaster at Satan’s Amusement Park.
While there are many things that are subjective about divorce, some are not. Canadian provincial family law governs matters of separation and divorce. Generally speaking, assets acquired during a marriage are considered matrimonial or family property and are subject to division as a result of separation and divorce. Some assets are excluded from family property, though, and each province has different rules regarding these exclusions. In particular, the treatment of business assets varies significantly from province to province.
One key concept regarding the division of property is that of equalization, which means that a divorcing couple should share equally in the family property accumulated by both parties during marriage, regardless of under whose name they were accumulated.
Take for example, an Ontario couple that purchased a home jointly the month after they married, and one spouse started a business at the same time. At date of separation, the house represented $500K in equity and the shares of the business were worth $5MM. Therefore, one spouse has net assets of $250K and the other $5,250K. Under the Ontario Family Law Act the business is considered family property. That means the equalization amount on separation and divorce would require the higher net asset spouse to pay the other $2.5MM. These payments can be agreed to out of court in a separation agreement, but would be dealt with according to the Family Law Act if one party made an application to the court for an equalization determination.
The rules in British Columbia and Alberta are like Ontario in that business assets are not excluded, but they are excluded from family property in Nova Scotia. Therefore, if the above example was applied to a Nova Scotia couple, the non-business owner spouse would have a significantly lower entitlement. However, the non-business owner spouse might be eligible for significant support payments.
A significant equalization amount where business assets are involved could put a lot of financial stress on the business itself. In the above example, the business owner is facing an equalization payment of $2.5MM. In a mediated settlement, the payment of the equalization amount can be agreed to by both parties. If the court is making the equalization order, the payment could be ordered to be immediate or it could be spread over time. The courts could order the paying spouse to do a number of things that might not be palatable, such as (a) transfer dividend paying shares to the recipient spouse (b) take funds from the company which could have significant tax consequences or (c) sell the business.
Should a couple find themselves in such a situation, most legal experts strongly recommend a mediated resolution rather than resorting to the courts. A protracted legal battle would be very expensive, could result in a court making an order with regard to the business that is very undesirable, could distract the owner from the day-to-day running of the business, and would put details of the dispute into the public domain.
There are several things that can be done to preclude the worst-case scenario happening. A domestic contract put in place early in the marriage can outline what would happen in the event of a marriage breakdown. For example, the agreement could state that in the event of marriage dissolution the recipient spouse would be issued dividend-paying shares with the value equal to the required equalization amount and that the shares would be redeemed over a period of years. If this is done while still married, i.e. before the divorce is finalized, the shares can be issued on a rollover or tax-free basis.
Another issue that arises regarding business assets is what the business is worth at the date of separation. Private businesses can be challenging to value at the best of times; during a divorce if the payor spouse gets a valuation done what are the odds that the recipient spouse will accept the valuation? A domestic contract could outline that both spouses must select an independent business valuator. Or, in a mediated divorce, the mediator could obtain an independent valuation that both parties must accept.
Separation and divorce can have a significant financial impact on both spouses. Going from one household to two households is impactful, and each spouse will need to develop a new financial plan for their future. The business owner spouse now has a less financially strong business and, given the shares in the business are their most significant asset, the risks of having a worry-free retirement have increased. The business owner can engage a qualified financial planner to do some retirement cash flow projections after making some assumptions about what the business can be sold for and at what point in the future
The recipient spouse may suddenly have a large sum of money to invest and have little to no investment experience. Or a future stream of payments may be coming, some of which are taxable and some non-taxable.
For each party, other sources of retirement income may become more important to the recipient spouse as will maximizing returns and minimizing taxes. Anyone dealing with a separation should obtain good legal and financial advice. A collaborative approach is generally the best way to go – especially where business assets are involved. Our best advice is to find knowledgeable and experienced people you can trust to help you through this process. You want to be able to get off that infernal rollercoaster and move forward knowing that your best interests have been represented throughout. Sure, your knees might still be a little wobbly at first, but at least you’ll know that you’re on the right path.
(Please note that this post should, in no way, replace the advice of a lawyer in your province.)
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