If you own all or most of the shares in a corporation, you should be aware of the rights that your spouse may have in that business in the event of divorce or separation.
Division of property
The Ontario Family Law Act provides for an “equalization” scheme for the division of property when married spouses divorce or when they separate with no reasonable prospect of resuming cohabitation. Under this scheme, each spouses’ net family property (the value of property owned at the end of the relationship minus the value of property owned on the date of marriage) is calculated and the spouse whose net family property is lower is entitled to one-half of the difference between them.
Ownership interests in a corporation generally form part of a spouse’s net family property. A court can order one spouse to transfer shares in the corporation, or have the corporation issue new shares to the recipient spouse, if that is the only reasonable way to satisfy the equalization or support obligations.
There are obvious problems with transferring shares and thus creating a business relationship between spouses who are involved in a matrimonial dispute and with existing business partners. The spouse who owns the business may also want to have some control over who buys shares from the recipient spouse so as to avoid being stuck with an undesirable business partner.
The Family Law Act’s equalization scheme does not apply to “common law” spouses. However, the support and compensation provisions in the Act use a broader definition of “spouse” that includes both married and cohabiting spouses, including same-sex couples. When one spouse is financially dependent upon the other, that spouse may be entitled to receive support payments from the other spouse. A spouse is also entitled to compensation for financial and non-financial contributions that he or she made to the couple’s economic situation.
Fraudulent Use of the Corporation
If your non-business assets are insufficient to pay your spouse’s claim for support and the court is convinced that you are using a corporation as a façade to avoid equalization or support payments, the corporation’s assets may be used to calculate and secure your spouse’s claim. Courts generally would rather avoid “piercing the corporate veil” like this, preferring to respect the corporation’s status as a separate legal person. However, in exceptional cases they may ignore the corporate form when the act of hiding assets within the corporation would result in a blatant injustice or defeat the desired effect of legislation. This may be the case when:
- the controlling shareholder completely dominates the corporation and uses it as a “puppet” or “alter ego”;
- the controlling shareholder is using the corporation for the fraudulent or improper purpose of shielding assets from the legitimate claims of the spouse – even if the corporation initially was created for a legitimate purpose; and
- this fraudulent action causes the spouse to suffer a material injury or loss.
The existence of third parties, such as other shareholders or directors, may make courts more hesitant to pierce the corporate veil, because the interests of third parties could be adversely affected and because their existence complicates a finding that the controlling shareholder exercises complete control.
Here are a few steps you can take to protect your business:
- If you are married or getting married, sign a marriage contract with your spouse. In this agreement you can exclude the business and its assets from your net family property and support obligations. Ensure that you disclose all relevant information and that your spouse understands the nature and consequences of the contract. If you do not, the agreement may not be enforceable.
- If you are cohabiting, sign a cohabitation agreement excluding the business from your support obligations. This agreement will become a domestic contract in the event that you and your partner later marry, so you may wish to include a clause excluding the business from your net family property as well.
- Create a Shareholders’ Agreement for the corporation. In this agreement you can set out a method for valuating and redeeming shares as well as limits on shareholders’ ability to dispose of their shares. This is a useful tool if your spouse already owns shares in the corporation or there is a possibility that he or she will become a shareholder in the future. For example, you could establish a Right of First Refusal so that shares must be offered for sale to a certain person or group of people before they can be sold to anyone else.
- If you do intend for your spouse or common law partner to be a shareholder of the business for income splitting purposes, then consider issuing a non-voting class of shares to him or her or consider setting up a discretionary family trust under which your spouse or common law partner is a beneficiary but not a trustee. This will allow you to retain control over the operations of the business while enjoying the benefits of income splitting.
- Make sure your corporate dealings are strictly business. Overuse of a private corporation for personal reasons can make a court suspicious and thus more likely to grant your spouse access to the assets of the corporation.
If it is too late for prevention, speak with the appropriate professionals about how you can meet your obligations to your spouse without giving up control of your business. They may be able to help you find an arrangement that meets your needs while managing any tax consequences that arise.