Are you in the midst of or just going through divorce proceedings? Does your joint property include a family company? In the review before you, we will explain how the law relates to this type of company, both routinely and within the framework of divorce proceedings. Divorce.
We will expand and detail mainly on the subject of dividing the family company, determining who controls it after the divorce, and bearing the burden of the family company’s debts by both spouses.
Definition of the family company in law
Section 64A of the Income Tax Ordinance defines a family company as an entity in which all of the shareholders are first-degree relatives. The profits and losses of this company are attributed to the family member who holds the majority of the company’s shares or to one of the family members who holds the majority of the shares, if there are other relatives who hold shares to an equal extent.
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A limited liability company that wishes to be defined as a family company must submit an application to the income tax officer, the tax assessor, within 3 months of its establishment.
Amendment 132 to the Income Tax Ordinance stipulates the absence of family companies and changes their definition to transparent companies, but because regulations dealing with transparent companies have not yet been established, companies of this type continue to benefit from the definition of family companies despite the removal of the legally valid definition.
Distribution of dividends in a family company in routine
The dividend is the share capital that is divided among the controlling shareholders of the company. In other words, it is the money that the shareholders withdraw from the company as a result of its profits.
When the family company is in a routine state, the distribution is as is customary in any other company, according to the value of each partner’s holding of company shares.
Distribution of dividends during divorce
As a general rule, it is not recommended to reach this situation without purchasing the rights of one of the spouses. When it comes to a family company, it is customary to distinguish between cases in which one spouse actually works in the company while the other is a passive partner, and a case in which both spouses manage and control the company equally or both serve as an active force in the company.
The first case is relatively simple, as in this situation there is no distribution of dividends in the company, since the controlling shareholder is only the working spouse.
Example from a ruling: In the Family Court in Be’er Sheva, a case was presented to a judge in which the husband owned 90% of the company’s shares and the wife owned the remaining 10% of the company’s shares.
The couple were in the process of divorcing and when they came to divide the company’s shares, they decided Home Family Law Because control of the company will remain in the hands of the husband, but he is obligated to pay the wife the value of the shares in her possession.
The vast majority of divorce cases that reach the courts and are included in the framework Plots Property The issue of a family company is also referred to as a case of the first type, in which there is an active partner and a passive partner.
In such cases, the courts usually rule that the active spouse must bear a debt towards the passive spouse, worth approximately 50% of the company, in order to buy out his share and create a final separation.
For example: The husband needs to pay 50% of the company’s value to his wife in order to prevent her from running the company with conflicting instructions.
Below is an example from a ruling issued by Judge M. Ben Yair in the Tel Aviv District Court regarding the family company:
“It is appropriate to distinguish… between the property aspects and the other aspects inherent in the share. Insofar as this concerns the property aspects of the share, that is, the part it represents in the company’s profits that are to be distributed among the members or the part it represents in the balance of the company’s assets that are to be distributed among the participants at the time of its dissolution, it is appropriate to entitle the spouse entitled to share in his or her share of these aspects. On the other hand, insofar as it concerns the aspects of management and control inherent in the share, the spouse entitled to share in them should not be entitled to them.“.
The ruling indicates theoretically desirable conduct, but a situation is possible in which the active partner does not have the financial ability to pay for the woman’s departure from the company or vice versa.
In such a case, a receiver is appointed to the company who must sell its shares. At the end of the sale process, if it turns out that the sale amount is less than the amount that the husband undertook to pay his passive partner and buy her share, he will pay only the difference.
In cases where the spouses are in the process of divorcing and both are active in the company, if they are able to put the needs of the business first and choose to cooperate, the court may consider and approve an equal division of the shares between the spouses, provided that the company continues to operate as usual and that their private affairs do not affect the functioning of the company.
In other cases where the spouses are in the process of divorcing and both are active in the company, the normal rules of conduct for a limited company between partners in a dispute will apply to them, which are based on granting one of them the right to refuse to purchase the other’s share.
In this case, there are several options for the controlling shareholder in the company to dilute his or her active spouse, meaning to reduce the value of their holding in the company by percentage and thus reduce the financial burden that must be paid to them by performing actions such as:
- Improve the company – spend money intended to improve the company and increase its value, purchase new furniture, recruit efficient employees, fire inefficient personnel, and purchase additional assets from which the company can continue to operate.
- Perform proactive work activities – participate in the ongoing sales, service and work system and promote the company’s projects closely with the employees.
By performing these two actions, the husband can claim (for example) to his ex-wife, who is a partner in the management of the company, that he recently took actions to increase the value of the company, while presenting the data in quarterly reports, such as recruiting salespeople, a step that yielded sales results worth X%, purchasing more advanced equipment that shortened work time and actually saved Y% of expenses, and more.
By emphasizing the facts and figures, according to which the divorced husband had to raise equity and invest the best of his time in recruiting employees, and it was not she who promoted these issues, his percentage of ownership in the company increases and his ex-wife’s percentage is diluted.
Continued management of the company by both spouses after the divorce
The divorced couple, who now function as an involuntary partner, may commit acts that are harmful to the company and the relationship in general. Each of them will want to prove to the other that he is more profitable and therefore must dilute it. In practice, whether only one of the spouses is active in the company or both are active, such management is not recommended and can even cause damage to the company in the long term.
Below are several scenarios that could lead the company to a broken trough:
- If the inactive spouse holds half of the shares and does not put them up for sale, this may create conflicts in the company that may paralyze its operations.
- From a financial perspective, it is not advisable to end a legal proceeding against the passive spouse, with the granting of 50% of the shares. In the short term, no cash may be paid by the active spouse, but in the long term, this may add an unwanted element to the company, equipped with management and executive powers.
- It is advisable not to rely on Agreement Finance which is formulated by the divorcing couple’s lawyers, because it unnecessarily prolongs the separation process and forces the couple to work together despite the divorce.
Determining the value of the company during divorce
In most cases, conflicts arise between the husband and wife regarding determining the value of the company, but this detail is irrelevant because the company’s value is assessed, like any other company, according to several parameters, such as examining the level of personnel in the company, examining the financial value of its technological products, the levels of supply and demand for the company’s products in the economy, and more.
Possible tests for assessing the company’s value
- Discounting future income – calculating the cash flow expected to come in in the future, as part of calculating the company’s value.
- Calculation of the representative company’s profit.
- Checking the value of the property in which the company is located through a real estate appraiser.
- Checking the value of the company’s shares today, compared to the future forecast.
To carry out the examination, the court appoints Accountant An expert who studies the company and decides on its value when dividing the property.
After the expert’s opinion is submitted, each party can send the expert clarifying questions, demand to receive all the material on which the opinion was based, and cross-examine the expert, with the aim of trying to undermine his opinion.
The decisive date
As a rule, when the court is forced to decide on the issue of the value of a company, it defines a specific date in a legal definition called a determining date. This is the date that symbolizes the day of separation or the day on which the separation of the spouses and the change in the control structure of the company became public knowledge.
The judge usually orders the calculation to be performed on this date, in order to determine the value of the family company after the divorce.
The law of controlling shareholders in a family company in debt
Debts The company is presented from an accounting perspective as liabilities on the company’s balance sheet and from a legal perspective as an integral part of the company’s assets.
If the inactive partner in the company wishes to retain assets, he must also bear the debts. As a rule, all the debts of a family limited company are a burden for the husband and wife, by necessity being part of the partnership bond, which legally, under the shadow of which any action that can express cooperation between married couples takes place, an action that is supposed to be done during a normal life span and through joint effort.
When a claim is filed for participation in the debt of one party in the family company against the divorcing party, for example the husband who worked in the company, files the claim against his wife who was a passive partner, the burden of proof lies with her, not him.
This means that she must prove that the debt imposed on her is not part of the joint tenancy and therefore does not apply to her.
Judge Yehoshua Geifman defined in the proceedings Building code 35042/96 On 12/12/2002, the way to rebut the presumption of joint liability was as follows: The degree of proof required to rebut the presumption of joint liability is the balance of probabilities, meaning that it must be proven that the action that necessitated incurring this debt did not result from a joint effort or a common benefit for both spouses while they were still married.
A few words in conclusion
A family business is a commercial entity. This entity is a limited liability company with unique conditions vis-à-vis the tax authorities, conditions based on transparency and proof to the tax authorities that the family works tirelessly for the benefit of the company and without conflict of interest, as reflected in the company’s financial statements, even at the critical point, when the married couple who founded the company decides to divorce and thereafter.
The options available to spouses who own a company and are about to divorce are to divide the company’s shares equally, half to the husband and half to the wife, to sell the company’s shares and divide the value of the shares between the spouses, or to allow each spouse to buy the value of the shares from the other spouse.
In divorce proceedings, when assets are to be divided between spouses, one spouse often seeks to purchase the asset. However, when a company owned by two spouses is to be divided, sometimes the spouse is obligated to purchase the other spouse’s share in the company. This step helps the company continue to operate on an ongoing basis.
Spouses facing divorce proceedings and who own a family company should consult and examine how a separation or dissolution can be carried out, while minimizing damage, avoiding disruption to the company’s ongoing operations, and cooperating.
